AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 27, 2005April 30, 2007
 
 
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, 20042006
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  803,250,000806,108,760 
     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes þ         No o
     If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes o         No þ
     Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ         No o
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer”, in Rule 12b-2 of the Exchange Act. (Check one):
þLarge accelerated fileroAccelerated fileroNon-accelerated filer
     Indicate by check mark which financial statement item the Registrant has elected to follow:
Item 17þItem 18o
     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
Yes o                           No þ                     Item 18 o
 
 


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  9 
   Risk Factors  9 
  Information on the Company  1213 
   Pearson  1213 
   Overview of Operating Divisions  1214 
   Our Strategy  1314 
   Operating Divisions  1315 
     Pearson Education  1315 
     The FT Group  1516 
     The Penguin Group  1617
Operating Cycles18 
   Competition  1718 
   Intellectual Property  1719 
   Raw Materials  1719 
   Government Regulation  1819 
   Licenses, Patents and Contracts  1819 
   Recent Developments  1819 
   Organizational Structure  1920 
   Property, Plant and Equipment  1920
Unresolved Staff Comments21 
  Operating and Financial Review and Prospects  2021 
   General Overview  2021 
   Results of Operations  2627 
   Liquidity and Capital Resources  40 
   Accounting Principles  4243 
  Directors, Senior Management and Employees  4643 
   Directors and Senior Management  4643 
   Compensation of Senior Management  4745 
   Share Options of Senior Management  5351 
   Share Ownership of Senior Management  5552 
   Employee Share Ownership Plans  5653 
   Board Practices  5653 
   Employees  5754 
  Major Shareholders and Related Party Transactions  5755 
  Financial Information  5855 
   Legal Proceedings  5855 
  The Offer and Listing  5856 
  Additional Information  5957
Memorandum and Articles of Association57
Material Contracts61
Exchange Controls62
Tax Considerations62
Documents on Display64 
  Quantitative and Qualitative Disclosures About Market Risk  6864 
   Introduction  68
Interest Rates68
Currency Exchange Rates68
Forward Foreign Exchange Contracts69
Description of Securities Other Than Equity Securities7064 

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    Page
     
 Interest Rates65
Currency Exchange Rates65
Forward Foreign Exchange Contracts66
Derivatives66
Description of Securities Other Than Equity Securities67
 PART II
  Defaults, Dividend Arrearages and Delinquencies  7067 
  Material Modifications to the Rights of Security Holders and Use of Proceeds  7067 
  Controls and Procedures  7067
Disclosure Controls and Procedures67
Management’s Annual Report on Internal Control Over Financial Reporting67
Change in Internal Control Over Financial Reporting68 
  Audit Committee Financial Expert  7068 
  Code of Ethics  7068 
  Principal Accountant Fees and Services  7168 
  Exemptions from the Listing Standards for Audit Committees  7169 
  Purchases of Equity Securities by the Issuer and Affiliated Purchases  7169
 
 PART III
  Financial Statements  7169 
  Financial Statements  7269 
  Exhibits  7269 
 EX-2.2Exhibit 8.1
 EX-4.1Exhibit 12.1
 Ex-4.2Exhibit 12.2
 EX-8.1Exhibit 13.1
 EX-10Exhibit 13.2
 EX-12.1
EX-12.2
EX-13.1
EX-13.2Exhibit 15

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INTRODUCTION
      In this Annual Report on Form 20-F (the “Annual Report”) references to “Pearson”, the “Company” 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 3436 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 sterling figures into US dollars at the rate of £1.00 = $1.92,$1.96, the noon buying rate in The City of New York for cable transfers and foreign currencies as certified by the Federal Reserve Bank of New York for customs purposes on December 31, 2004.29, 2006, the last business day of 2006. We do not make any representation that the amounts of sterling have been, could have been or could be converted into dollars at the rates indicated. On March 30, 2007 the noon buying rate for sterling was £1.00 = $1.97.
FORWARD-LOOKING STATEMENTS
      You should not rely unduly on forward-looking statements in this Annual Report. This Annual Report, including the sections entitled “Item 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,

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 • currency risk,
 
 • US federal and state spending patterns,
 
 • debt levels, and
 
 • general market and economic conditions.
      These forward-looking statements are only predictions. They involve known and unknown risks, uncertainties and other factors that may cause our or our industry’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 Dataconsolidated financial data
      The tabletables below showsshow selected consolidated financial data under IFRS and US GAAP. Under US GAAP, the consolidated financial data has been presented for each of the years in the five-year period ended December 31, 2004.2006. The Company adopted IFRS on January 1, 2003. As a result, in accordance with the instructions of Form 20-F, selected consolidated financial data under IFRS is only presented for each of the years in the four-year period ended December 31, 2006. The selected consolidated profit and loss account data for the years ended December 31, 2004, 20032006, 2005 and 20022004 and the selected consolidated balance sheet data as at December 31, 20042006 and 20032005 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, which differs from US GAAP in certain significant respects. See “Item 5. Operating and Financial Review and Prospects — Accounting Principles” and note 3436 to ourthe consolidated financial statements. The consolidated financial statements contain a reconciliation to US GAAP of profit/lossprofit 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 20042006 amounts into US dollars at the rate of £1.00 = $1.92,$1.96, the noon buying rate in The City of New York on December 31, 2004.
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 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.29, 2006.

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  Year Ended December 31
   
  2004 2004 2003 2002 2001 2000
             
      Restated Restated Restated Restated
  $ £ £ £ £ £
  (In millions, except for per share amounts)
UK GAAP Information:
                        
Consolidated Profit and Loss Account Data
                        
Statutory Measures
                        
Total sales  7,524   3,919   4,048   4,320   4,225   3,874 
Total operating profit/(loss)  444   231   226   143   (47)  209 
Profit/(loss) after taxation  209   109   77   (89)  (403)  173 
Profit/(loss) for the financial year  169   88   55   (111)  (423)  174 
Basic earnings/(loss) per equity share(4) $0.21   11.1p  6.9p  (13.9)p  (53.2)p  23.9p
Diluted earnings/(loss) per equity share(5) $0.21   11.0p  6.9p  (13.9)p  (53.2)p  23.4p
Dividends per ordinary share $0.49   25.4p  24.2p  23.4p  22.3p  21.4p
Consolidated Balance Sheet Data
                        
Total assets (Fixed assets plus Current assets)  11,493   5,986   6,336   6,790   8,209   8,924 
Shareholders funds  4,998   2,603   2,893   3,276   3,712   4,100 
Long-term obligations(6)  (3,291)  (1,714)  (1,349)  (1,737)  (2,616)  (2,715)
Capital stock(1)  386   201   201   200   200   199 
Number of equity shares outstanding (millions of ordinary shares)  803   803   802   802   801   798 
                     
  Year ended December 31
   
  2006 2006 2005 2004 2003
           
    IFRS IFRS IFRS IFRS
  IFRS £ £ £ £
  $
  (In millions, except for per share amounts)
IFRS information:
                    
Consolidated Income Statement data
                    
Total sales  8,109   4,137   3,808   3,479   3,651 
Total operating profit  1,058   540   516   382   401 
Profit after taxation from continuing operations  892   455   330   248   249 
Profit for the financial year  919   469   644   284   275 
Basic earnings per equity share(4)  $1.10   55.9p  78.2p  32.9p  31.7p
Diluted earnings per equity share(5)  $1.09   55.8p  78.1p  32.9p  31.7p
Dividends per ordinary share  $0.57   29.3p  27.0p  25.4p  24.2p
Consolidated Balance Sheet data at period end
                    
Total assets (Fixed assets plus Current assets)  14,137   7,213   7,600   6,578   6,736 
Shareholders funds  6,813   3,476   3,564   2,800   2,969 
Long-term obligations(6)  (3,632)  (1,853)  (2,500)  (2,403)  (1,982)
Capital stock(1)  396   202   201   201   201 
Number of equity shares outstanding
(millions of ordinary shares)
  806   806   804   803   802 
                         
  Year Ended December 31
   
  2004 2004 2003 2002 2001 2000
             
      Restated Restated    
  $ £ £ £ £ £
  (In millions, 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 
Total operating profit/(loss)(2)  564   294   397   453   (389)  25 
Profit/(loss) after taxation  390   203   198   219   (1,483)  1,370 
Profit/(loss) for the financial year(8)  349   182   173   189   (1,500)  1,362 
Profit/(loss) from continuing operations for the financial year(3)  319   166   160   216   (476)  (61)
(Loss)/profit from discontinued operations(3)  31   16   16   (5)  (39)  1,434 
Loss on disposal of discontinued operations(3)        (3)  (1)  (985)   
Basic earnings/(loss) per equity share(4) $0.44   22.9p  21.8p  23.7p  (188.6)p  187.2p
Diluted earnings/(loss) per equity share(5) $0.44   22.8p  21.8p  23.7p  (188.6)p  185.0p
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
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
Basic (loss)/earnings per share from discontinued operations(3)(4) $0.04   2.0p  1.7p  (3.4)p  (128.7)p  195.6p
                          
  Year ended December 31
   
  2006 2006 2005 2004 2003 2002
             
    £ £ £ £ £
  $  
  (I n millions, except for per share amounts)
US GAAP information(7):
                        
Consolidated Income Statement data
                        
Total sales(8)  8,292   4,231   3,892   3,562   3,774   3,896 
Total operating profit(2)  902   460   364   269   361   408 
Profit after taxation from continuing operations  823   420   182   170   197   185 
Net income for the year  668   341   411   182   173   189 
Profit from continuing operations for the year(3)  780   398   164   153   159   187 
(Loss)/profit from discontinued operations(3)  (112)  (57)  8   29   17   24 
Profit/(loss) on disposal of discontinued operations(3)        239      (3)  (1)
Basic earnings per equity share(4) $0.84   42.7p  51.5p  22.8p  21.8p  23.7p
Diluted earnings per equity share(5) $0.83   42.6p  51.4p  22.8p  21.8p  23.7p
Basic earnings from continuing operations per equity                        
 Share(1)(4) $0.98   49.9p  20.5p  19.2p  20.0p  23.5p
Diluted earnings from continuing operations per equity Shares(3)(5) $0.97   49.8p  20.5p  19.2p  20.0p  23.5p
Basic (loss)/earnings per share from discontinued operations(3)(4) $(0.14)  (7.2)p  31.0p  3.6p  1.8p  2.9p
Diluted (loss)/earnings per share from discontinued operations(3)(5) $(0.14)  (7.2)p  30.9p  3.6p  1.8p  2.9p
Dividends per ordinary share $0.57   29.3p  27.0p  25.4p  24.2p  22.7p

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 Year Ended December 31 Year ended December 31
    
 2004 2004 2003 2002 2001 2000 2006 2006 2005 2004 2003 2002
                        
     Restated Restated       £ £ £ £ £
 $ £ £ £ £ £ $  
 (In millions, except for per share amounts) (I n 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
                   
Consolidated Balance Sheet data at period end
                   
Total assets  12,048  6,275  6,381  6,767  8,280  10,066   14,351  7,322  7,800  7,040  7,101  6,767 
Shareholders’ funds  6,179  3,218  3,333  3,699  4,155  6,018   7,019  3,581  3,838  3,218  3,333  4,155 
Long-term obligations(6)  (3,807)  (1,983)  (1,647)  (2,026)  (2,829)  (2,715)  (3,622)  (1,848)  (2,397)  (2,392)  (1,951)  (2,026)
 
(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 loss of £2m in 2006 (2005: £nil; 2004: profit of £14 million in 2004 (a loss of £7 million in 2003 and a loss of £15 million in 2002)£14m) on the sale of fixed assets and investments. Additionally, the US GAAP operating profit includes the operating profit impact of the GAAP adjustments discussed in note 3436 in “Item 17. Financial Statements”.
 
(3) Discontinued operations under both UK GAAPIFRS and US GAAP comprise the results of RecoletosPearson Government Solutions for all years presented, Recoletos Grupo de Comunicacion SA for 2005, 2004, 2003 and 2002 and the results of RTL Group for 2002, 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.2002. Discontinued operations under US GAAP also include the results of the Forum Corporation for 2003 2002, 2001 and 2000.2002.
 
(4) Basic earnings/lossearnings 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/lossearnings per equity share is based on diluted earnings/lossearnings for the financial period and the diluted weighted average number of ordinary shares in issue during the period. Diluted earnings/lossearnings comprise earnings/lossearnings 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 3436 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 millionCommencing in 20012006, the Company has included within Sales, shipping and profit of £1,362 million in 2000 are after charging goodwill amortization of £527 millionhandling fees and £288 million respectively. Since 2002, goodwill has no longercosts, distribution income and subrights income, which were previously reflected on a net basis within operating expenses. Sales figures for all prior years presented have 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 34 in “Item 17. Financial Statements”revised for comparative purposes (2006: £94m; 2005: £84m; 2004: £83m; 2003: £94m; and 2002: £109m).
Dividend Informationinformation
      We payThe Group pays dividends to holders of ordinary shares on dates that are fixed in accordance with the guidelines of the London Stock Exchange. OurThe board of directors normally declares an interim dividend in July or August of each year to be paid in September or October. OurThe 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 ourthe annual general meeting on April 29,

8


200527, 2007 our shareholders approved a final dividend of 15.7p18.8p per ordinary share for the year ended December 31, 2004.2006.

8


      The table below sets forth the amounts of interim, final and total dividends paid in respect of each fiscal year indicated, and is translated into cents per ordinary share at the noon buying rate in the city of New York on each of the respective payment dates for interim and final dividends. The final dividend for the 20042006 fiscal year waswill be paid inon May 2005.11, 2007.
                                          
Fiscal Year Interim Final Total Interim Final Total
Fiscal year Interim Final Total Interim Final Total
                        
 (Pence per ordinary share) (Cents per ordinary share) (Pence per ordinary share) (Cents per ordinary share)
2006
  10.5  18.8  29.3  20.6  36.8  57.4 
2005  10.0  17.0  27.0  17.2  29.2  46.4 
2004
  9.7  15.7  25.4  18.6  30.2  48.8   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 
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 Informationrate 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 during an annual period. On December 31, 2004,29, 2006, the noon buying rate for sterling was £1.00 = $1.92.$1.96. On March 30, 2007 the noon buying rate for sterling was £1.00 = $1.97.
         
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
     
March 2007 $1.97  $1.92 
February 2007 $1.97  $1.94 
January 2007 $1.98  $1.93 
December 2006 $1.98  $1.95 
November 2006 $1.97  $1.89 
October 2006 $1.91  $1.85 
        
Year Ended December 31 Average Rate
Year ended December 31 Average rate
    
2006 $1.84 
2005 $1.81 
2004 $1.84  $1.83 
2003 $1.63  $1.63 
2002 $1.51  $1.51 
2001 $1.45 
2000 $1.52 
Risk Factorsfactors
     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 result from the condition of the local state or US economy, changes in legislation, both at the federal and state 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, depend on the level of US and state educational funding. The economic slowdown in 2002 and 2003, coupled with declining tax revenues, resulted in some US states deferring

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purchases as they sought to reduce budget deficits. State budgets have begun to recover but there is no guarantee that states will fund new programs, or that we will win this business.
      Legislative changes can also affect the funding available for educational expenditure. These might include changes in the procurement process for textbooks, learning material and student tests, particularly in the adoptions market and thus our ability to grow. 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.
Our newspaper business may be adversely affected by a weak global advertising environment and other economic and market factors.
      Our newspaper business results have been adversely affected by the reduction in advertising, particularly financial advertising, since 2001. Also some of our newspapers’ circulation is declining or static due to general economic conditions and changes in consumer purchasing habits, as readers look to alternative sources and/or providers of information such as the internet.
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 StatesUS and the United Kingdom, which are theUK, jurisdictions withcovering the largest proportionsproportion of

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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 authors. This lawsuit seeks to demarcate the extent to which search engines, other internet operators and libraries may rely on the fair-use doctrine to copy content without authorization from the copyright proprietors, and may give publishers and authors more control over online users of their intellectual property. If the lawsuit is unsuccessful, publishers and authors may be unable to control copying of their content for purposes of online searching, which could have an adverse impact on our business and financial performance.
The contracting risks associated with our Professional division within Pearson Education are complexOur US educational textbook and if unmanaged, couldtesting businesses may be adversely affect our financial resultsaffected by changes in state educational funding resulting from either general economic conditions, changes in government educational funding, programs and growth prospects.legislation (both at the federal and state level), and/or changes in the state procurement process.
      In recent years we have begun, throughThe results and growth of our Professional division,US educational textbook and testing business is dependent on the level of US and state educational funding, which in turn is dependent on the robustness of state finances and the level of funding allocated to offer services ranging from call center operations to complete outsourcing of administrative functions. Customers are government agencies and professional organizations, mainlyeducational programs. Federal and/or state legislative changes can also affect the funding available for educational expenditure, e.g. the No Child Left Behind Act.
      Similarly changes in the United Statesstate procurement process for textbooks, learning material and student tests, particularly in the United Kingdom, and commercial businesses. These services are provided under contracts with values that vary significantly, from a few million to several hundred million pounds overadoptions market can also affect our markets. For example, changes in curricula, delays in the termtiming of the contract, whichadoptions and changes in the student testing process can run from one to ten years in length. The resultsall affect these programs and therefore the size of our Professional division can be significantlymarket in any given year.
      There are multiple competing demands for educational funds and there is no guarantee that states will fund new textbooks or testing programs, or that we will win this business.
Our newspaper businesses may be adversely affected by reductions in advertising revenues and/or circulation either because of competing news information distribution channels, particularly online and digital formats, or due to weak general economic conditions.
      Changes in consumer purchasing habits, as readers look to alternative sources and/or providers of information, such as the internet and other digital formats, may change the way we distribute our content. We might see a decline in print circulation in our more mature markets as readership habits change and readers migrate online, although we see further opportunities for growth in our less mature markets outside Europe. If the migration of readers to new digital formats occurs more quickly than we expect, this is likely to affect print advertising spend by our customers, adversely affecting our profitability.
      Our newspaper businesses are highly geared and remain dependent on advertising revenue; relatively small changes in revenue, positive or negative, have a small number of large contracts.
      Asdisproportionate effect on profitability. We are beginning to see an increase in advertising revenues compared to prior years, however any long-term contracting business, there are inherent risks associated with the bidding process, operational performance, contract compliance (including penalty clauses), indemnification (if available)downturn in corporate and contract re-bidding, which could adversely affectfinancial advertising spend would negatively impact 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.results.

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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/or in the case of our UK testing business, the suspension or withdrawal of our accreditation to conduct tests. 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.
Changes inOur professional services and school testing businesses involve complex contractual relationships with both government agencies and commercial customers for the Penguin businessprovision of various testing services. Our financial results, growth prospects and/or reputation may restrict our ability to growbe adversely affected if these contracts and return this business to historical profit levels.relationships are not managed.
      Weak US market conditions (particularlyThese businesses are characterized by multi-million pound contracts spread over several years. As in mass market books), higher than average historical return rates, the weak US dollar and distribution problems in the United Kingdomany contracting business, there are inherent risks associated with a new automated warehouse facility allthe bidding process, start-up, operational performance and contract compliance (including penalty clauses) which could adversely affected Penguin’saffect our financial performance in 2004. Our abilityand/or reputation.
      Several of these businesses are dependent on either single or a small number of large contracts. Failure to restore Penguin to historical profit levels will be constrained ifretain these contracts at the US mass market does not recover. Penguin’s financial performance will also be negatively affected if book return rates remain above their historical average or increase further.
      The majorityend of the contract term would adversely impact our future revenue growth. At Edexcel, our UK warehousing problems were resolved by the 2004 year end. We are planningExamination board and testing business, any change in UK Government policy to move Pearson Education into this new facility in the second half of 2005. This representsexam marking and student testing could have a short term operational risk to both businesses. We will continue to incur dual running costs until this project is successfully completed.significant impact on our present business model.
We operate in a highly competitive environment that is subject to rapid change and we must continue to invest and adapt to remain competitive.
      Our education, business information and book publishing businesses operate in highly competitive markets. These markets constantly change in response to competition, technological innovations and other factors. To remain competitive we continue to invest in our authors, products, services and services.people. 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 importedre-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 forto purchase the rights to author manuscripts, and a competitive situation arises where author advances can bemanuscripts. Our competitors may bid up to a level at which we cannotcould not generate a sufficient return on our investment.investment, and so, typically, we would not purchase these rights.
• People — the investments we make in our employees, combined with our employment policies and practices, we believe are critical factors enabling us to recruit and retain the very best people in our business sectors. However, some of our markets are presently undergoing radical restructuring with several of our competitors up for sale, particularly in the Education sector. New owners, particularly private equity, may try to recruit our key talent as part of this industry restructuring.
At Penguin, changes in product distribution channels, increased book returns and/or customer bankruptcy may restrict our ability to grow and affect our profitability.
      New distribution channels, e.g. digital format, the internet, used books, combined with the concentration of retailer power pose multiple threats (and opportunities) to our traditional consumer publishing models, potentially impacting both sales volumes and pricing.

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      Penguin’s financial performance can also be negatively affected if book return rates increase above historical average levels. Similarly, the bankruptcy of a major retail customer would disrupt short-term product supply to the market as well as result in a large debt write off.
We operate in markets which are dependent on Information Technology systems and technological change.
      All our businesses, to a greater or lesser extent, are dependent on technology. We either provide software and/or internet services to our customers 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 upgradesupgrades. The failure to recruit and retain staff with relevant skills may constrain our ability to grow as we combine traditional publishing products with online and service offerings.
Operational disruption to our business caused by a major disaster and/or external threat such as Avian Flu, restricting our ability to supply products and services to our customers.
      Across all our businesses we manage complex operational and logistical arrangements including distribution centers, third-party print sites, data centers and large office facilities. Failure to recover from a major disaster, e.g. fire, flood etc, at a key facility or the disruption of supply from a key third-party vendor could restrict our ability to service our customers. Similarly external threats, such as Avian Flu, terrorist attacks, strikes etc, could all affect our business and employees, disrupting our daily business activities.
      We have developed business continuity arrangements, including IT disaster recovery plans, to minimize any business disruption in the event of a major disaster. However, despite regular updates and testing of these plans there is no guarantee that our financial performance will not be adversely affected in the event of a major disaster at a key data center.and/or external threat to our business. Insurance coverage may minimize any losses in certain circumstances.

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Investment returns outside our traditional core US and UK markets may be lower than anticipated.
      To minimize dependence on our core markets, particularly the US, we are seeking growth opportunities outside these markets, building on our existing substantial international presence. Certain markets we may target for growth are inherently more risky than our traditional markets. Political, economic, currency and corporate governance risks (including fraud) as well as unmanaged expansion are all factors which could limit our returns on investments made in these non-traditional markets.
Our reported earnings and cash flows may be adversely affected by changes in our pension costs and funding requirements due to poor investment returns and/or changes in pension regulations.requirements.
      We operate a number of pension schemesplans throughout the world, the principal ones being in the UK and US. The major schemesplans are self-administered with the schemes’plans’ assets held independently of the Group. Regular valuations, conducted by independent qualified actuaries, are used to determine pension costs and funding requirements.
      It is our policy to ensure that each pension schemeplan is adequately funded, over time, to meet its ongoing and future liabilities. Our earnings and cash flows may be adversely affected by lowerthe need to provide additional funding to eliminate pension fund deficits in our defined benefit plans. Our greatest exposure relates to our UK defined benefit pension plan. Pension fund deficits have/may arise because of inadequate investment returns, due to a general deteriorationincreased member life expectancy, changes in equity or bond markets, requiring increased company funding of these schemes to eliminate any deficits over time. Similarly,actuarial assumptions and changes in pension regulations, including accounting rules may affectand minimum funding requirements.
      The latest valuation of our UK defined benefit pension costsplan has been completed and future funding status.arrangements have been agreed between the Company and the pension fund Trustee. Additional payments

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amounting to £100m will be made by the Company in 2007. We review these arrangements every three years and are confident that the pension funding plans are sufficient to meet future liabilities without unduly affecting the development of the Company.
Social, environmental and ethical risk
      We consider social, environmental and ethical (SEE) risks no differently to the way we manage any other business risk. Our 2006 risk assessments did not identify any significant under-managed SEE risks, nor have any of our most important SEE risks, many concerned with reputational risk, changed year on year. These are:
• Journalistic/author integrity;
• Ethical business behavior;
• Compliance with UN Global Compact principles on labor standards, human rights, environment and anti-corruption;
• Environmental impact;
• People;
• Data privacy.
We generateChanges in our tax position can significantly affect our reported earnings and cash flows.
      There are several factors which may affect our reported tax rate and/or level of tax payments in the future. The most important are as follows:
• Changes in corporate tax rates and/or other relevant tax laws in the UK and/or the US could have a substantial proportionmaterial impact on our future reported tax rate and/or our future tax payments.
• A material shortfall in profits of our revenueUS businesses below the level projected in foreign currencies, particularlyour strategic plans would require us to reconsider the amount of the deferred tax asset relating to US dollar, and foreign exchange rate fluctuationsnew operating losses in our balance sheet (£126m at December 31, 2006). This could adversely affect our earnings.lead to a material increase in the reported tax rate.
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 and the strength of our balance sheet.
      As with any international business, our earnings can be materially affected by exchange rate movements. We are particularly 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 20032005 average rates had prevailed in 2004,2006, sales for 20042006 would have been £306 million£44m or 8%1% higher. This is predominantly a currency translation risk (i.e., non-cash flow item), and not a trading risk (i.e., cash flow item), as our currency trading flows are relatively limited. Pearson generates about two-thirds of its sales in the US and each five cent change in the average £:$ exchange rate for the full year (which in 2006 was £1:$1.84 and in 2005 was £1:$1.81) would have an impact of 1p on earnings per share. We estimate that a five cent change in the averageclosing exchange rate between the US dollar and sterling in any year could affect our reported earnings per shareshareholders’ funds by approximately 1 penny.£85m.
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,

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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 Divisionsoperating divisions
      Although our businesses increasingly share markets, brands, processes and facilities, they consist of three core operations:
     Pearson Educationis a global leader in educational publishing and services.the world’s leading education company. We are a leading international publisher of textbooks, supplementary materials and electronic education programs for elementaryteachers and secondary school, higher educationstudents of all ages, and business and professional markets worldwide. We alsowe play a major role in the testing and certification of school students and professionals, mainly inprofessionals. Pearson Education consists of the US but increasingly in the UK.following three operating segments:
• School — publisher, provider of testing and software services for primary and secondary schools;
• Higher Education — publisher of textbooks and related course materials for colleges and universities;
• Professional — publisher of texts, reference and interactive products for industry professionals. Provider of various testing and service arrangements for government departments and professional bodies.
     The FT Group consistsis a leading provider of our international newspaper,business and financial news, data, comment and analysis, in print and online financial information, business magazine and professional publishing interests. Our flagship product isonline. The FT Group comprises theFinancial Times,published internationally and known for its premium editorial content and international scope both in newspaper and internet formats. following operating segments:

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• FT Publishing — publisher of theFinancial Times, other business newspapers, magazines and financial information and intelligence;
• Interactive Data (“IDC”) — provider of financial and business information to financial institutions and retail investors.
     The Penguin Groupis one of the premierworld’s foremost English language publishers in the world, with brand imprints such as Penguin, Putnam, Berkley, Viking and Dorling Kindersley (“DK”).publishers. We publish the works of many authors in an extensive portfolio of fiction, non-fiction, reference and illustrated works.works under imprints including Penguin, Hamish Hamilton, Putnam, Berkley, Viking and Dorling Kindersley.
Our Strategystrategy
      Since 1997,Over the past decade we have reshapedtransformed Pearson by divestingfocusing on companies which provide ‘education’ in the broadest sense of the word; companies that educate, inform and entertain. Through a rangecombination of non-core interestsorganic investment and investing over $7 billion in education, consumer publishing and business information companies. Eachacquisitions, we have built each one of our businesses aimsinto a leader in its market, and we have integrated our operations where appropriate so that our businesses can share assets, brands, processes, facilities, technology and central services.
      Our goal is to benefit from educating, informingproduce sustainable growth on our three key financial measures — adjusted earnings per share, cash flow and entertaining peoplereturn on invested capital — which we believe are, together, good indicators that we are building the long-term value of Pearson.
      We do this by investing consistently in an increasingly knowledge-based economy. Our strategy is:four areas, which are common to all our businesses:
 • to focus on businesses which provide “education”Content: We invest steadily in unique, valuable publishing content and keep replenishing it. Over the broadest sense of the word.past five years, for example, we have invested $1.6bn in new content in our education business alone.
 
 • to provide a combination of publishing, bothTechnology and services: We invested early and consistently in print and online, and related servicestechnology, believing that, make our publishing more valuable and take us into new, faster-growing markets.
• to continue to invest in the growthdigital world, content alone would not be enough. In 2006, we generated more than $1bn in sales from technology products and services, and our testing and assessment businesses, serving school students and professionals, made more than $1bn of our businesses, including:sales, up from around $200m seven years ago.

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 • extendingInternational markets: Though we currently generate two-thirds of 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, bothsales in the US, our brands, content and technology-plus-services models work around the world;world. All parts of Pearson are investing in selected emerging markets, where the demand for information and education is growing particularly fast.
 
 • developingEfficiency: We have invested to become a leaner, more efficient company, through savings in our fast-growing contractingindividual businesses which provide testing and other servicesthrough a strong centralized operations structure. Over the past five years, we have increased our profit margins from 9.9% to corporations13.4% and government agencies;
• building the international reachreduced average working capital as a percentage of theFinancial Times — bothsales in print through its four editions worldwidePearson Education 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.Penguin from 30.7% to 26.3%, freeing up cash for further investment.
      We believe this strategy can create a virtuous circle — efficiency, investment, market share gains and scale — which in turn can produce sustainable growth on our financial goals and the value of the Company.
• to foster a collaborative culture which facilitates greater productivity and innovation by sharing processes, costs, technology, talent and assets across our business.
• to capitalize on the growth prospects in our markets and on our leaner operations to improve profits, cash flows and returns on invested capital.
Operating Divisionsdivisions
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 Educationmaterials. It serves the growing demands of teachers, students, parents and professionals throughout the world for stimulating and effective education programs. With federalprograms in print and state governments under pressure to measure academic progress against clear objective standards, the market for educational testing services in the United States has grown significantly. Pearson Assessments & Testing enables us to combine testing and assessment with our traditional educational curriculum services and products to form one of the world’s leading integrated education companies. Pearson Assessments & Testing provides the entire spectrum of educational services — from educational curriculum to testing and assessment to data management and reporting.online.
      We report Pearson Education’s performance along the lines ofby the three marketsmarket segments it serves: School, Higher Education and Professional. In 2004,2006, Pearson Education had sales of £2,356 million£2,591m or 60%63% of Pearson’s total sales (61% in 2003).(2005: 62%) and contributed 68% (2005: 63%) to Pearson’s total operating profit.
School
      In the United States, ourOur School business includescontains a unique mix of publishing, testing and software operations.technology products, which are increasingly integrated. It generates around two-thirds of its sales in the US.
      In the US, we publish high quality curriculum programs for school students covering subjects such as reading, literature, maths, science and social studies. We publish under a range of well-known imprints that include Scott Foresman in the elementary school market and Prentice Hall in secondary. Our school testing business is the leading provider of test development, processing and scoring services to US states and the federal government, processing some 40 million tests each year. We are also the leading provider of electronic learning programs for schools, and of ‘Student Information Systems’ technology which enables schools and districts to record and manage information about student attendance and performance.
      In the US, more than 90% of government funds for schools comes from state or local government, with the remainder coming from federal sources. Our School company’s major customers are state education boards and local school districts.
      Outside of the United States,US, we have a growing English Language Teaching business and we also publish school 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, we provide professional development for teachers in kindergarten through 12th grade with the use of the latest technologies and software tools to improve classroom teaching.
      Pearson’s Assessments & Testing operations make us a leading service provider 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.
      Pearson School Systems provide 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 16,000 schools nationwide andworld’s leading provider of English Language Teaching materials for children and adults, published under the newest technologies for benchmarkwell-known Longman imprint. We are also a leading provider of testing, assessment and student progress analysis.
      Over 90% of education spending for kindergarten through 12th grade inqualification services. Our key markets outside the United States is financed atUS include Canada, the state or local level, withUK, Australia, Italy, Spain, South Africa, Hong Kong and the remainder coming from Federal 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 market directly to the school districts. In the states without adoptions, or “open territories”, local school districts choose education programs from the extensive range available. We actively market to school districts in open territories as well.
      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 began electronic scanning and marking of GCSE and A-level exams in 2004. 3.5 million scripts are expected to be marked electronically in 2005.Middle East.
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 chooseTypically, professors or other instructors select or ‘adopt’ the textbooks and online resources to be purchasedthey recommend for their students, which students then purchase either in a bookstore or online. Today the majority of our textbooks are accompanied by their students. In 2004, over one million college students registered for our online offerings,services which include homework and assessment products, onlinetools, 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. We have also introduced new

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formats such as downloadable audio study guides and electronic textbooks which are sold on subscription. In addition, ourwe have a fast-growing custom publishing business Pearson Custom,which works with professors to produce textbooks and online resources specifically adapted for their particular course. In 2006, our Higher Education business generated approximately 80% of its sales in the US. Outside the US, we adapt our textbooks and technology services for individual markets, and we have a growing local publishing program. Our key markets outside the US include Canada, the UK, Benelux, Mexico, Germany, Hong Kong, Taiwan and Malaysia.
Professional
      WeOur Professional education businesses publish text, reference,educational materials and interactive productsprovide testing and qualifications services for IT industry professionals, graphics and design users of all types, and consumers interested in software applications and certification, professional business books, and strategy guides for those who use PC and console games. Publishingadults. Our publishing imprints in this area include Addison Wesley Professional, Prentice Hall PTR, and Cisco Press (our three high end imprints)(for IT professionals), Peachpit Press and New Riders Press (our graphics(graphics and design imprints)professionals), Que/ Sams (consumer and professional imprint), and Prentice Hall Financial Times (professional(for the business imprint) and BradyGames (software game guides imprint)education market). We also generate revenues through our own website — InformIt. We also provide services to

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professional markets. We manage significant commercialhave a fast-growing Professional Testing business, Pearson VUE, which manages major long-term contracts to implement and executeprovide qualification and assessment systems for individual professions, including IT professionalsservices through its network of test centers around the world. Key customers include major technology companies, the Graduate Management Admissions Council, the National Association of Securities Dealers and nurses.
      Our Government Solutions group manages and processes student loan applications on behalf of the US Department of Education and has a number of education, testing-related contracts with various government departments.UK’s Driving Standards Agency. We also provide a range of data collection and management services, including the sale of scanners, to a wide range of customers. We also provide corporate training coursesIn December 2006, the Group announced that it had agreed to professionals.
      In 2004, our Assessment & Testing business wonsell Pearson Government Solutions to Veritas Capital, a numberprivate equity firm. This operation is disclosed as discontinued in the years ended December 31, 2006, 2005 and 2004. The assets and liabilities of contracts,Pearson Government Solutions have been reclassified to non-current assets held for sale in the most significant being a seven year contract to develop and deliver the Graduate Management Admissions Test (GMAT) worldwide. We will begin receiving revenues from this contract inGroup’s Consolidated Balance Sheet as at December 31, 2006. Another successful tender was for the contract to deliver the National Association of Security Dealers exams over nine years on a non-exclusive basis.
The FT Group
      The FT Group one of the world’s leading business information companies, aims to provideprovides a broad range of business information,data, analysis and services to an audience of internationally-minded business people.people and financial institutions. In 2004,2006, the FT Group had sales of £777 million,£698m, or 20%17% of Pearson’s total sales (19% in 2003)(2005: 17%), and contributed 21% of Pearson’s operating profit (2005: 25%). The
      It has two major parts: FT Group’sPublishing, our network of international and national business is global, producing a combination of news, data, comment, analysisnewspapers and context. In addition to professionalonline services; and business consumers, individuals worldwide are demanding such strategic business information. We believe that the FT Group is well positioned to supplyInteractive Data Corporation, our 62%-owned financial information and benefit from these trends.company.
The Financial Times NewspaperFT Publishing
      TheFinancial Timesis athe world’s leading international daily business newspaper. Its average daily circulation of 427,800430,469 copies in December 2004,2006, 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 2004 from advertising and approximately 33% from circulation. The geographic distribution of theFinancial Timesaverage daily circulation in 2004 was:is split as follows:
     
United Kingdom/ Republic of Ireland  31%31%
Continental Europe Africa and Middle East  32%27%
Americas  30%31%
Asia  7%9%
Rest of the World 2%
      TheFinancial Timesis printed on contract in 24 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 deliveryIn 2006, approximately 70% of the various editions of the newspaper to the appropriate geographic markets. TheFinancial Timesis distributedFT’s revenues were generated through independent newsagents and direct delivery to homes and institutions.
advertising. The FT seeks to make itsalso sells content available both in print and advertising online through FT.com, its internet service, and sales of electronic content to third parties.FT.com. FT.com charges subscribers 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 January 2005, FT.com had 76,000 paying subscribers. According to figures independently audited by ABC, the site has 3.7 million unique monthly users and 58.3 million page views.
Financial Times Publishing
      Our other business publishing interests include France’s leading business newspaper,Les Echoswith circulation of 119,800 and lesechos.fr, its internet service.
      FT Publishing also includes: FT Business, produceswhich publishes specialist information on the retail, personal and institutional finance industries and publishes the UK’s premier personal finance magazine,through titles includingInvestors Chronicle together with,Money Management,Financial AdvisorAdviserandThe Bankerfor professional advisers; Les Echos, France’s leading business newspaper, and financial sector professionals.a number of joint ventures and associates in business publishing.

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Recoletos
      On December 14, 2004,      In August 2006, the Group announcedFinancial Times acquired Mergermarket, 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.online financial data and intelligence provider. 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 fromacquisition strengthens the FT Group’s core focus onGroup, adding proprietary content, a premium customer base, reliable growth from new revenue sources and attractive 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.characteristics to the organization.
Interactive Data Corporation
      Through our 61% interest in Interactive Data Corporation (“Interactive Data”), we are one of the world’sis a leading global providersprovider of financial market data, analytics and business informationrelated services to financial institutions, active traders and retailindividual investors. Interactive Data suppliesThe company’s businesses supply time-sensitive pricing, dividend, corporate action,evaluations and descriptive informationreference data for more than 3.5 million securities traded around the world, including hard-to-value instruments. Customers subscribeinstruments such as illiquid bonds. We own 62% of Interactive Data Corporation; the remaining 38% is publicly traded.
Recoletos
      On April 8, 2005, the Group completed the sale to Interactive Data’s services and use the company’s analytical toolsRetos Catera S.A. of our 79% stake in supportRecoletos, a publicly quoted Spanish media Group, for gross proceeds of their trading, analysis, portfolio management, and valuation activities.743m. Net cash proceeds of £371m were received resulting in a profit on disposal of £306m.
Joint Ventures and Associates
      As at 2004 year end,2006 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, is our German language newspaper with a fully integrated online business news, analysis and data service. Its circulation grew by 5.4% in 2004 to 96,900 copies.
      A 50% interest in The Economist Group, which publishes the world’s leading weekly business and current affairs magazine.
      A 50% interest in FTSE International, a joint venture with the London Stock Exchange, which, among other things, publishes the FTSE index.
      A 33% interest inVedomosti, a leading Russian business newspaper and a partnership venture with Dow Jones and IMH Media Ltd.
      A 50% interest in Business Day and Financial Mail, publishers of South Africa’s leading financial newspaper and magazine.
      A 14% interest in Business Standard, India’s second largest daily financial newspaper.
      A 22% interest in MarketWatch, a financial and business information website (sold in January 2005).
• 50% interest in The Economist Group, publisher of the world’s leading weekly business and current affairs magazine.
• 50% interest inFT Deutschland, a German language business newspaper with a fully integrated online business news, analysis and data service.
• 50% interest in FTSE International, a joint venture with the London Stock Exchange, which publishes a wide range of global indices, including the important FTSE index.
• 33% interest inVedomosti, a leading Russian business newspaper.
• 50% interest inBusiness DayandFinancial Mail, publishers of South Africa’s leading financial newspaper and magazine.
• 14% interest inBusiness Standard, one of India’s leading business newspapers.
The Penguin Group
      Penguin is one of the world’s premier English language publishers in the world.book publishers. We publish an extensive backlist and frontlist of titles, including some of the very best new fiction and non-fiction, literary prize winners, commercial bestsellers, classics and commercial 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.titles. We rank in the top three consumer publishers, based upon sales, in all major English speaking and related markets — the United States,US, the United Kingdom,UK, Australia, New Zealand, Canada, India and South Africa.
      Penguin publishes under many imprints including, in the adult market, Allen Lane, Avery, Berkley Books, Dorling Kindersley, Dutton, Hamish Hamilton, Michael Joseph, Plume, Putnam, Riverhead and Viking. Our leading children’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2004, Penguin’s US imprints placed 132 titles onThe New York Timesbestseller list. In the United Kingdom,

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49 Penguin titles featured on the Nielsen Bookscan top fifteen bestseller list. Our illustrated reference business, Dorling Kindersley, or DK, is the leading global publisher of high quality illustrated reference books. DK has built a unique graphic style that is now recognized around the world. It produces books for children and adults covering a huge variety of subjects including childcare, health, gardening, food and wine, travel, business and sports. Not only does DK’s “lexigraphic” design approach make its books easily translatable across cultures, but it has also formed the basis of a library of 2.5 million wholly-owned images which have many applications — in print and online.
      In 2004,2006, Penguin had sales of £786 million£848m, representing 20% of Pearson’s total sales (21%(2005: 21%) and contributed 11% of Pearson’s operating profit (2005: 12%). Its largest market is the US, which generated around 60% of Penguin’s sales in 2003). Revenues are balanced between frontlist and backlist titles.2006. The Penguin Group earns over 95%around 99% of its revenues from the sale of hard cover and paperback books. The balance comes from audio books and from the sale and licensing of intellectual property rights, such as the Beatrix Potter series of fictional characters, and acting as a book distributor for a number of smaller publishing houses.
      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.

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Operating cycles
      Pearson determines a normal operating cycle separately for each entity/cash generating unit within the Group with distinct economic characteristics. The “normal operating cycle” for each of the Group’s education businesses is primarily based on the expected period over which the educational programs and titles will generate cash flows, and also takes account of the time it takes to produce the educational programs.
      Particularly for the US School and Higher Education businesses, which represent more than 50% (by sales) of our education publishing businesses, there are well established cycles operating in the market:
• The School market is primarily driven by an adoption cycle in which major state education boards ‘adopt’ programs and provide funding to schools for the purchase of these programs. There is an established and published adoption cycle with new adoptions taking place on average every 5 years for a particular subject. Once adopted, a program will typically sell over the course of the subsequent 5 years. The Company renews its pre-publication assets to meet the market adoption cycles. Therefore the operating cycle naturally follows the market cycle.
• The Higher Education market has a similar pattern, with colleges and professors typically refreshing their courses and selecting revised programs on a regular basis, often in line with the release of new editions or new technology offerings. The Company renews its pre-publication assets to meet the typical demand for new editions of, or revisions to, educational programs. Analysis of historical data shows that the average life cycle of Higher Education content is 5 years. Again the operating cycle mirrors the market cycle.
      A development phase of typically 12 to 18 months for Higher Education and up to 24 months for School precedes the period during which the Company receives and delivers against orders for the products it has developed for the program.Non-US markets operate in a similar way although often with less formal ‘adoption’ processes.
      The operating cycles in respect of the Professional and Penguin Group’s gateway internet site, Penguin.com, provides accesssegments are more specialized in nature as they relate to its focused websiteseducational or heavy reference products released into smaller markets (e.g. the financial training, IT and travel sectors). Nevertheless, in these markets, there is still a regular cycle of product renewal, in line with demand which management monitor. Typically the United States, Canada, United Kingdomlife cycle is 5 years for Professional content and Australia. Websites have also been developed to target certain niche audiences. For example, Penguinclassics.com has an entire online service4 years 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.content.
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 asMcGraw-Hill, Reed Elsevier, Houghton Mifflin Riverdeep Group and Thomson.Thomson alongside smaller niche players that specialize in a particular academic discipline or focus on a learning technology. Competition is based on the ability to deliver quality products and services that address the specified curriculum needs and appeal to the school boards, educators and government officials making purchasing decisions.
      The FT Group’s newspapers, magazines and magazineswebsites compete with newspapers and other information sources, such asThe Wall Street Journal, by offering timely and expert journalism.analysis and insight. It competes for advertisers with other forms of media based on the ability to offer an effective means for advertisers to reach their target audience. The efficiencyIDC competes with Reuters, Bloomberg and Thomson Financial on a global basis for the provision of its cost basefinancial data to the back office. In Europe Telekurs is also a competitive factor.direct competitor for these services.
      The Penguin Group competes with other publishers of fiction and non-fiction books. Principal competitors include Random House, HarperCollins, and HarperCollins.Hachette Livre. Publishers compete by developing a portfolio of books by established authors and by seeking out and promoting talented new writers.

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Intellectual Propertyproperty
      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 Materialsmaterials
      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 Regulationregulation
      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, Patentspatents and Contractscontracts
      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 Developmentsdevelopments
      In January 2005, we announcedOn February 15, 2007 the sale of our 22.4% stake in MarketWatch to Dow Jones for $101 million.
      In February 2005, we acquired the remaining 25% of Edexcel Limited that we did not already own for £30 million.
      In April 2005, weGroup completed the saledisposal of our 79% stakePearson Government Solutions, its Government services business, to Veritas Capital. Sale proceeds consist of $560m in Recoletoscash, $40m in preferred stock and 10% of the equity of the business. The Group expects to Retos Catera S.A, receiving net cash proceedsreport a post tax loss on the disposal, as the capital gain for tax purposes will exceed any book gain.
      On September 30, 2006, the Group acquired 100% of £372 million.the voting rights of Mergermarket, a financial information company providing information to financial institutions, corporations and their advisers. In addition, several other businesses were acquired in 2006 including Promissor, Paravia Bruno Mondadori (PBM), National Evaluation Systems (NES), PowerSchool and Chancery in the Education business and Quote.com in IDC.
      In JuneOn July 22, 2005, we announcedPearson acquired 100% of the acquisitionvoting rights of AGS Publishing, from WRC Media for $270 million. AGS Publishing specialises in testingan educational assessments and publishing for students with special educational needscurriculum materials publisher.
      In addition, several other businesses were acquired in the United States school market.current and prior years, none of which were individually material to the Group.

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Organizational Structurestructure
      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, 2004,2006, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.
       
    Percentage
    Interest/Votinginterest/voting
Name Country of Incorporation/Residenceincorporation/residence Powerpower
     
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. LtdEngland and Wales100%
Mergermarket Ltd England and Wales  100% 
Interactive Data Corporation United States (Delaware)  61%
Recoletos Grupo de Comunicacion SASpain79%62% 
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, Plantplant and Equipmentequipment
      Our headquarters isare 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. These properties consist mainly of offices, distribution centers and computer centers.
      The vast majority of our printing is carried out by third party suppliers. We operate two small digital print operations as part of our Pearson Assessment and Testing businesses. These operations provide short-run and print-on-demand products, typically custom client applications.
      We own the following principal properties:
       
General Useuse of Propertyproperty Location Area in Square Feetsquare 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  210,100210,112 
Warehouse/office Offices Cedar Rapids, Iowa, USA  205,000 
Warehouse/ Offices Reading, Massachusetts, USA(1)USA  158,527177,822 
Offices London, UK  152,986155,000 
Printing/ Processing Owatonna, Minnesota, USA  128,000 
Printing/ Processing Columbia, Pennsylvania, USA  121,400121,370 
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 Useuse of Propertyproperty Location Area in Square Feetsquare feet
     
Warehouses/Offices Lebanon, Indiana, USA  1,091,4001,091,435 
Warehouse/ Offices Cranbury, New Jersey, USA  886,700886,747 
WarehouseWarehouse/Offices 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, UK446,077
Offices Hudson St., New York, USA  302,000431,278 
Offices London, UK  273,000282,917 
Warehouse/Offices Austin, Texas, USA  226,100226,076 
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  151,056153,240 
Offices Parsippany, New Jersey, USA  143,800143,777 
Offices Harlow, UK  137,900 
OfficesChester, Virginia, USA123,200
Warehouse/OfficesQuarry Bay, Hong Kong121,748
Warehouse San Antonio Zomeyucan, Mexico  107,642113,638 
Offices Boston, Massachusetts, USALondon, UK  102,751112,000 
Offices New York, New York, USA  101,000107,939 
Offices Bedford, Massachusetts,Lawrence Kansas, Kansas, USA  80,348
OfficesCamberwell, Victoria, Australia52,656105,000 
Capital Expenditures
      See Item 5. “Operating and Financial Review and Prospects — Liquidity and Capital Resources” for description of the Company’s capital expenditures.
ITEM 4A.     UNRESOLVED STAFF COMMENTS
      There are no unresolved staff comments.
ITEM 5.OPERATING AND FINANCIAL REVIEW AND PROSPECTS
      The following discussion and analysis is based on and should be read in conjunction with the consolidated financial statements, including the related notes, appearing elsewhere in this Annual Report. The financial statements have been prepared in accordance with UK GAAP,IFRS, which differs in certain significant respects from US GAAP. Note 3436 to our consolidated financial statements, included in “Item 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.
General Overviewoverview
Introduction
      Sales declined from £4,048 millioncontinuing operations increased from £3,808m in 20032005 to £3,919 million£4,137m in 2004, a decrease2006, an increase of 3%9%. This declineThe increase reflected growth across all the businesses together with additional contributions from acquisitions made in both 2005 and 2006. The year on year growth was attributable to the impact ofimpacted by exchange principally the weakness ofrates, in particular the US dollar. The average US dollar exchange rate weakened in 2006, which had the affecteffect of reducing reported sales

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in 20042006 by £306 million£44m when compared to the equivalent figure at constant 20032005 rates. After taking out the effect of currency there were increases in sales at Pearson Education and IDC. Reported operating profit increased by 2%5% from £226 million£516m in 20032005 to £231 million£540m in 2004, despite2006. All parts of the adverse impactGroup contributed to the operating profit increase through good sales growth and improved margins which more than offset an increased charge for intangible amortization. Included within operating profit in 2005 was the profit on the sale of MarketWatch of £40m. There were no equivalent disposals in 2006. Reported operating profit in 2006 was £7m lower than the equivalent figure reported at constant 2005 exchange rates. There was good progress at Pearson Education and a significant improvement at the Financial Times, but Penguin’s results were disappointing.
      A £171 million profitProfit before taxation in 20042006 of £466m compares to a profit before taxation of £152 million£446m in 2003.2005. The increase of £19 million or 13% mainly£20m reflects the reduced charge for goodwill amortization andimproved operating performance offset by a reductionsmall increase in net finance costs. Net finance costs which together offset the impact of exchange.increased from £70m in 2005 to £74m in 2006. The goodwill amortization charge fellGroup’s net interest payable increased by £40 million£17m in 20042006 due to the weakerstrong rise in US dollar floating interest rates and goodwillan increase in respect of Family Education Network and Marketwatch having been fully amortized in 2003. Finance costs benefited from the reduction inGroup’s average

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net debt largely reflecting the cost of acquisitions made in 2006. Partially offsetting this effect was finance income relating to post retirement plans of £4m in 2006 compared to a general risecost of £7m in interest rates. Net2005. The adoption of IAS 39‘Financial Instruments: Recognition and Measurement’in our financial statements as at January 1, 2005 has the potential to introduce increased volatility into the net finance cost although the effect in 2006 was not significantly different from that in 2005. IAS 39 related items and foreign exchange gains and losses together reduced net finance costs also benefitedby £16m in 2004 from2006 compared to a one-off creditreduction of £9 million relating to interest on a repayment of tax£14m in France.2005.
      In December 2004,2006 the Group announced the sale of its Government contracting business, Pearson announced its intention to disposeGovernment Solutions. The sale was completed in February 2007 and the results of this business have been shown in discontinued operations in the consolidated income statement for 2006, 2005 and 2004. In 2005 the Group sold 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 by the Spanish regulatory authorities in February 2005, and the sale closed in April 2005, realizing net cash proceeds of £372 million. 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 and loss account for 2004, 2003 and 2002.2004.
      Net cash inflowgenerated from operating activities increaseddecreased to £530 million£456m in 20042006 from £359 million£487m in 2003.2005. Cash flowgeneration in 2004 benefited from collection of2006 would have shown an improvement on 2005 but for the $151 million receivable in respect of the TSA contract, together with continued underlying improvements in Pearson Education and IDC. Therelative weakness of the US Dollardollar which reduced the value of our cash flows in Sterling. Capital expenditure was in excess of depreciation in 2004 due to up-front expenditure on professional testing contracts but, onsterling. On an average basis, the use of working capital continued to improve. CashCapital expenditure in 2006 was in line with 2005 levels at constant exchange rates. The net cash outflow on acquisitions netin respect of disposalbusinesses acquired increased from £246m in 2005 to £363m in 2006. There were no significant disposals in 2006 to match the proceeds was £20 millionreceived from the sale of Recoletos and afterMarketwatch in 2005 resulting in a decrease in cash proceeds from disposals of £420m. Dividends from joint ventures and associates increased by £31m largely due to special dividends received from the Economist. Dividends paid of £195 million and£235m in 2006 (including £15m paid to minority interests) compares to £222m in 2005. After a favorable currency movement of £75 million,£126m, overall net borrowings (excluding finance leases) fell 11%increased by 6% from £1,361 million£996m at the end of 20032005 to £1,206 million£1,059m at the end of 2004.2006.
Outlook
      Pearson reported record results in 2006 and our strong trading has continued in the early part of 2007. We have made a good start in the major school textbook adoptions; continued to roll out our groundbreaking online learning and assessment platforms in Higher Education; published a string of bestsellers in Penguin; and achieved steady growth in both advertising and circulation at FT Publishing.
      We are trading in line with expectations for 2007 and expect Pearson to growachieve good underlying earnings stronglygrowth, cash conversion ahead of our 80% threshold, and a further increase in 2005 and beyond, with further progress on cash and return on invested capital. As always, our sales and profits will be concentrated in the second half of the year.
Our outlook is:expectations for the full year remain:
Pearson Education
      We expect our worldwide School business to deliver significantachieve underlying sales and profit growth in 2005. With a stronger adoption calendar, healthier state budgets, federal funds for reading and testing and our investment in new programs, we expect our US School publishing and testing operations to achieve double-digit sales growth. We also expect to achieve steady margin improvement in our US school publishing business over the next three years, as we benefit from the adoption calendar in both 2006 and 2007, in which we expect a significant increase in our new adoption participation rate compared4-6% range with 2005.
      Our USmargins improving; Higher Education business continues to benefit from its scale, the strength of its publishing and its lead in technology. We expect that those qualities will enable our businesssales to grow ahead of its industry once again in 2005, at a similar rate to 2004 and with similar margins. We see good growth prospects for our US and international higher education businesses. 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 division3-5% range with stable margins; Professional revenues to deliver sustained growth, on the basis of our long-term contracts in Government Solutions and Professional Testing.be broadly level with margins improving;

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FT Group
      We expect further profit progress at the FT Group. Advertising revenues at the Financial Times were up 3%Group profit to grow strongly with our cost measures, integration actions and revenue diversification pushing margins into double digits at FT Publishing. IDC revenues to grow in 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. IDC expects to grow its reported revenues and6-9% range with net income growth in the high single-digitsingle-digits to low double-digit range.
      The results 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.double-digits (headline growth under US GAAP);
The Penguin Group
      2005 will be a year of transition for Penguin. We expect profitsPenguin margins to improve in the UK, in spite of dual-running costs at our distribution centers. In the US we are planning on the basis that the weak market conditions experienced in the second half of 2004 continue. We are taking actionfurther, as its publishing investment and efficiency programs continue to adjust our publishing program and reduce costs, and we will expense approximately £5 million as a result of those actions in 2005.

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Exchange rates
      We generate around two-thirds of total revenues in the US and a five cent change in the average exchange rate for the full year (which in 2004 was £1: $1.83) will have an impact of approximately 1p on adjusted earnings per share.bear fruit.
Sales Informationinformation by Operating Divisionoperating 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
   
  2006 2005 2004
       
  £m £m £m
Education:            
 School  1,455   1,295   1,087 
 Higher Education  795   779   729 
 Professional  341   301   290 
FT Group:            
 FT Publishing  366   332   318 
 IDC  332   297   269 
Penguin  848   804   786 
          
Total  4,137   3,808   3,479 
          
Sales Informationinformation by Geographic Marketgeographic 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
   
  2006 2005 2004
       
  £m £m £m
 European countries  1,089   951   820 
 North America  2,642   2,451   2,309 
 Asia Pacific  298   300   263 
 Other countries  108   106   87 
          
Total  4,137   3,808   3,479 
          
Exchange Rate Fluctuationsrate 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 $1.84 in 2006, $1.81 in 2005, and $1.83 in 2004, $1.63 in 2003 and $1.51 in 2002.2004. Fluctuations in exchange rates can have a significant impact on our reported sales and profits. The GroupPearson generates approximately 65% of its sales in US dollars andthe US. We estimate that a five cent change in the averageclosing exchange rate forbetween the fullUS dollar and sterling in any year has an impact of approximately 1 pence oncould affect our reported earnings per share.share by 1p and shareholders’ funds by approximately £85m. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for more information. Theyear-end US dollar rate for 2006 was £1:$1.96 compared to £1:$1.72 for 2005. The weakening in the US dollar reduced our shareholders’ funds by £417m (see note 27 of “Item 17. Financial

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Statements”) in 2006. Theyear-end rate for 2005 was £1:$1.72 compared to £1:$1.92 for 2004 resulting in an increase in shareholders’ funds of £327m in 2005.
Critical Accounting Policiesaccounting policies
      Our consolidated financial statements, included in Item“Item 17. “FinancialFinancial Statements”, are prepared based on the accounting policies described in note 1 to the consolidated financial statements. These financial statements which are prepared in conformityaccordance with UK GAAP,IFRS, which differs in certain significant respects from US GAAP.

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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 34,36, requires management to make estimates and assumptions that affect the carrying value of assets and liabilities at the date of the consolidated financial statements and the reported amount of sales and expenses during the periods reported in these financial statements. Certain of our accounting policies require the application of management judgment in selecting assumptions when making significant estimates about matters that are inherently uncertain. Management bases its estimates on historical experience and other assumptions that it believes are reasonable.
      We believe that the following are ourthe more critical accounting policies used in the preparation of our consolidated financial statements that could have a significant impact on our future consolidated results of operations, financial position and cash flows. Actual results could differ from estimates.
Revenue Recognitionrecognition
      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 astraight-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 astand-alone basis or as an optional extra and fair value exists for each separate element, such as the provision of supplementary materials with textbooks, revenue in such multiple element arrangements is recognized forwhen each element as if it were an individual contractual arrangement.product has been delivered and all other relevant revenue recognition criteria are achieved.
      Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognized as performance occurs. The assumptions, risks, and uncertainties inherent inlong-term contract accounting can affect the amounts and timing of revenue and related expenses reported. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated aslong-term contracts with revenues recognized on a percentage of completion basis. Losses on 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.
      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.

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Pre-publication Costsassets
      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 stockrecognized as current intangible assets where the title to which they relate has a useful life in excess of one year. Thesewill generate probable future economic benefits within their normal operating cycle and costs can be measured reliably.Pre-publication assets are amortized upon publication of the title over estimated economic lives of five years or less, being an estimate of the estimated expected operating life cycle of the title, usually with a higher proportion of the amortization taken in the earlier years. The investment inpre-publication has been disclosed as part of the cash generated from operating activities in the cash flow statement. The assessment of useful lifethe recoverability ofpre-publication assets and the calculationdetermination of the amortization profile involve a significant amountdegree of estimationjudgment based on historical trends and management judgment, as management must estimate the sales cycle and lifeestimation of a particular title. The overstatement of useful livestheir future potential sales. An incorrect amortization profile could result in excess amounts being carried forward in stockas intangible assets that would otherwise have been written off to the profit and loss accountincome statement in an earlier period. Reviews are performed regularly to estimate recoverability ofpre-publication costs.

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Royalty Advancesadvances
      Advances of royalties to authors are included within debtorstrade and other receivables when the advance is paid less any provision required to bring the amount down to its net realizable value. The royalty advance is expensed at the contracted royalty rate as the related revenues are earned. The realizable value of royalty advances held within debtors is regularly reviewed by reference to anticipated future sales of books or subsidiary publishing rights but still relies on a degree of management judgment in determining the profitability of individual author contracts. If the estimated 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. The recoverability of royalty advances is based upon an annual detailed management review of the age of the advance, the future sales projections for new authors and prior sales history of repeat authors. The royalty advance is expensed at the contracted or effective royalty rate as the related revenues are earned. Royalty advances which will be consumed within one year are held in current assets. Royalty advances which will be consumed after one year are held innon-current assets.
Defined Benefit Pensionsbenefit pension 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.
      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 subsequent periods (actuarial gains and losses).
      Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognized immediately in the profitstatement of recognized income and loss accounts in future years. In particular, a reduction inexpense.
      The service cost, representing benefits accruing over the realized long-termyear, is included as an operating cost and the unwinding of the discount rate ofon the scheme liabilities and the expected return on scheme assets andas a financing charge or a reductionfinancing income.
      Obligations for contributions to defined contribution pension plans are recognized as an expense in the discount rates would result in higher pension costs in future periods.income statement as incurred.
Deferred TaxIncome taxes
      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

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income tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realized or the deferred income tax liability is settled.
      Deferred tax assets are recognized to the extent that it is probable that future taxable profits will be available against which the temporary differences can be utilized.
      Deferred income tax is provided in respect of the undistributed earnings of subsidiaries, other than where it is intended that those undistributed earnings will not be remitted in the foreseeable future.
      Deferred tax is recognized in the income statement, except when the tax relates to items charged or credited directly to equity, in which case the tax is also recognized in equity.
      The Group is subject to income taxes in numerous jurisdictions. Significant judgment is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognizes liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
      Deferred tax assets and liabilities require management judgment in determining the amounts to be recognized, and inrecognized. In particular, significant judgment is used when assessing the extent to which deferred tax assets canshould be recognized. Under Financial Reporting Standard 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 assetsrecognized with consideration given to the extent that they are recoverable, based on the probability that there will be future taxable income against which these tax losses and other timing differences may be utilized. We regularly review our deferred tax assets to ensure that they are recoverable and have exercised significant judgments when considering the timing and level of future taxable income. Our business plans andincome together with any future tax planning strategies are considerations 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.
Amortization and Impairment of Goodwill
      In accordance with UK GAAP, capitalized goodwill is amortized over its estimated useful life, not exceeding 20 years. The estimated useful life is determined after taking into account such factors as the nature and age of the business and the stability of the industry in which the acquired business operates as well as typical life spans of the acquired products to which the goodwill attaches. The estimated useful lives ascribed to goodwill range from 3 to 20 years. Goodwill relating to acquisitions in the more established book publishing businesses is typically written off over 20 years while 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.strategies.
UK GAAPGoodwill
      Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisitions of associates is included in investments in associates. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. The recoverable amounts of cash generating units have been determined based on value in use calculations. These calculations require the use of estimates. Goodwill is allocated to cash generating units for the purpose of impairment testing. The allocation is made to those cash generating units that are expected to benefit from the business combination in which the goodwill arose. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.
IFRS 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.
              
  Year ended December 31
   
  2006 2005 2004
       
  £m £m £m
Profit for the year
            
 IFRS  446   624   262 
 US GAAP  341   411   182 
Equity shareholders’ funds
            
 IFRS  3,476   3,564     
 US GAAP  3,581   3,838     
      The main differences between UK GAAPIFRS and US GAAP relate to goodwill and intangible assets, acquisition and disposal adjustments, derivatives, pensions, and stock based compensation.compensation and taxation. These differences are

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discussed in further detail under “—“ — Accounting Principles” and in note 3436 to the consolidated financial statements.
Results of Operationsoperations
Year ended December 31, 20042006 compared to year ended December 31, 20032005
Consolidated Resultsresults of Operationsoperations
Sales
      Our total sales decreasedfrom continuing operations increased by £129 million£329m, or 9%, to £3,919 million£4,137m in 2004,2006, from £4,048 million£3,808m in 2003. This decrease of 3%2005. The increase reflected growth across all the businesses together with additional contributions from acquisitions made in both 2005 and 2006. The year on year growth was attributable to the effect of foreign currency exchange. The strength of sterling compared toimpacted by movements in exchange rates, particularly in the US dollar had a significant negative effect on sales, and wedollar. We estimate that had the 20032005 average rates prevailed in 2004,2006, sales would have been higher by £306 million. In constant exchange rate termsapproximately £4,181m.
      Pearson Education had aanother strong year with an increase in sales of 4%9%. The Higher Education and Professional businesses wereSchool business was the main contributorsbiggest contributor to this growth with an increase of 12%. Some of the School increase was due to the contribution from acquisitions made in 2006 and 2005 but we estimate that after excluding these acquisitions and restating at constant exchange rates that the growth would have been 6%. US School publishing sales were up 3% compared to an industry decline of 6% (source: Association of American Publishers) and the business took a leading share of the new US adoption market. School testing sales continued to improve even after growth in US school testing revenues of more than 20% in 2005. Higher Education growth was more modest at 2% in total but was up 4% in the US. Pearson’s US Higher Education business growinghas grown faster than its marketthe industry for eight straight years. In the sixth straight year and Professional benefiting frombusiness, sales increased 13%, with testing sales ahead by more than 30% in 2006 following the successful start up of 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 otherwisenewly acquired Promissor business. Professional publishing sales were flat as new adoption spendingdeclined again in 2006 due to the US fell by approximately $200 million.continuedindustry-wide weakness intechnology-related publishing.
      The FT Group sales were 11% ahead of last year after another good yearyear. FT Publishing sales were up by 10% driven by higher advertising revenues at theFinancial Times particularly in the online, luxury goods and corporate finance categories. IDC sales were up by 12% with consistent organic growth and aided by contributions from the acquisition of IS.Teledata(re-branded Interactive Data Managed Solutions) and Quote.com.
      Penguin’s sales grew by 5% with 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 weaknessrecord number of best sellers in the US consumer publishing market.and UK, an increase in market share in the UK and continued success with the premium paperback format in the US.
      Pearson Education, our largest business sector, accounted for 60%63% of our continuing business sales in 2004,2006, compared to 61%62% in 2003.2005. North America continued to be the most significant source of our sales although sales in the region decreased,and as a proportion of total continuing sales tocontributed 64% in 2004, compared to 67% in 2003. This decrease, however, reflects the comparative strength of sterlingboth 2006 and the euro compared to the US dollar.2005.

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Cost of Salesgoods sold and Net Operating Expensesoperating 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
   
  2006 2005
     
  £m £m
Cost of goods sold  1,917   1,787 
       
 Distribution costs  299   292 
 Administration and other expenses  1,504   1,351 
 Other operating income  (99)  (84)
       
Total  1,704   1,559 
       

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     Cost of Sales.goods sold.Cost of sales consists of costs for raw materials, primarily paper, productionprinting and binding costs, amortization ofpre-publication costs and royalty charges. Our cost of sales decreasedincreased by £44 million,£130m, or 2%7%, to £1,866 million£1,917m in 2004,2006, from £1,910 million£1,787m in 2003.2005. The decreaseincrease mainly reflected the decreaseincrease in sales over the period withalthough the overall gross margin remaining consistent.also increased slightly from 53% in 2005 to 54% in 2006.
     Distribution Costs.costs.Distribution costs consist primarily of shipping costs, postage and packing.packing and are typically a fairly constant percentage of sales.
     Administration and Other Expenses.other expenses.Our administration and other expenses decreasedincreased by £89 million,£153m, or 5%11%, to £1,635 million£1,504m in 2004,2006, from £1,724 million£1,351m in 2003. Administration and other expenses as2005. As a percentage of sales decreasedthey increased to 42%36% in 2004,2006, from 43%35% 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 2003.2005. The remainder of the decreaseincrease in administration and other costs comes principally from both the effect of exchangeadditional employee benefit expense, additional property costs 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.intangible amortization.
     Other Operating Income.operating income.Other operating income mainly consists of freight recharges,sub-rights and licensing income and distribution commissions. Other operating income decreased 10%increased 18% to £46 million£99m in 20042006 from £51 million£84m in 20032005, with the decreaseincrease mainly representingdue to profits made on the continued declinedisposal of a building. See “Item 17. Financial Statements” note 36 (ix) for the treatment under US GAAP.
Other net gains and losses
      Profits or losses on the sale of businesses, associates and investments that are included in distribution commissions received for distributionour continuing operations are reported as “other net gains and losses”. In 2005 the only item in this category was the £40m profit on the sale of third party books.our associate interest in MarketWatch. In 2006, there were no similar gains or losses.
Share of results of joint ventures and associates
      The contribution from our joint ventures and associates increased from £14m in 2005 to £24m in 2006. The increase was mainly due to an increase in circulation and revenue at The Economist Group, who also recorded a gain on sale of its investment in Commonwealth Business Media Inc. There was also further reduction in losses at FT Deutschland.
Operating Profit/ Lossprofit
      The total operating profit increased by £24m, or 5%, to £540m in 2004 of £231 million compares to a profit of £226 million2006 from £516m in 2003.2005. This 2% increase was principally due to increases across all the £40 million reductionbusinesses, after taking account of theone-off gain from the sale of MarketWatch at FT Publishing of £40m in the total2005 and a charge of £7m in 2006 at Penguin relating to an adjustment to goodwill charge partially offset by the impactfollowing recognition of exchange.pre-acquisition tax losses. We estimate that had the 20032005 average rates prevailed in 2004,2006, operating profit before goodwill charges would have been £52 million greater.£7m higher.
      Operating profit attributable to Pearson Education increased by £13 million,£42m, or 12%13%, to £119 million£365m in 2004,2006, from £106 million£323m in 2003.2005. The increase was due to a £33 million reductioncontinued improvement in goodwill amortization, offset by an estimated reductionSchool margins, the profit impact of strong sales and cost reductions in profit of £29 million from exchange. After accounting for these two factors, operating profit was aheadtechnology publishing in each of the School, Higher Education and Professional businesses.
testing. Operating profit attributable to the FT Group decreased by £16m, or 12%, to £117m in 2006, from £133m in 2005. This decrease was attributable to the absence in 2006 of the £40m profit from the sale of MarketWatch that was recorded in 2005. After excluding this item profits increased by £38 million, or 136%, to £66 million£24m, £7m at IDC and £17m at FT Publishing. The FT Publishing increase reflected thepick-up in 2004, from £28 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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advertising revenues. Operating profit attributable to the Penguin Group decreased by £37 million,£2m, or 53%3%, to £33 million£58m in 2004,2006, from £70 million£60m in 2003.2005. The biggest single factor in the profit declinedecrease 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, fellan adjustment to goodwill of £7m caused by £9m, or 41%, from £22 millionthe recognition of previously unrecognized tax losses relating to the acquisition of Dorling Kindersley 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.2000.
Net Finance Costsfinance costs
      Net finance costs consist primarily of net interest expense relatedincreased from £70m in 2005 to our borrowings. Our total net£74m in 2006. Net interest payable decreasedin 2006 was £94m, up from £77m in 2005. Although we were partly protected by £11 million, or 14%, to £69 millionour fixed rate policy, the strong rise in 2004, from £80 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 inUS dollar floating interest rates and a one-off credit of £9 million for interesthad an adverse effect. Year on a repayment of tax in France reduced the net interest cost in 2004. Year end indebtedness (excluding finance leases) decreased to £1,206 million in 2004 compared to £1,361 million in 2003 due to funds generated from operations and foreign exchange movements. The weightedyear, average three month London Interbank Offered (“LIBOR”) rate, reflecting ourLIBOR (weighted for the Group’s borrowings in US dollars, euros and sterling at the year end) rose by 40 basis points, or 0.4%1.5% to 4.9%. The company is partially protected from these increases by our treasury policy, which put £736 millionCombining the rate rise with an increase in the Group’s average net debt of £40m, the year end debt on a fixed rate basis. As a result theGroup’s average net interest rate

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payable (excluding the £9 million credit referred to above) rose by only 25 basis points or 0.25%1.1% to 5%7.0%. In 2006 the net finance income relating topost-retirement plans was an income of £4m compared to a cost of £7m in 2004.the previous year. Other net finance income relating to foreign exchange andshort-term fluctuations in the market value of financial instruments remained fairly constant year on year with a £16m gain in 2006 compared to a £14m gain in 2005. For a more detailed discussion of our borrowings and interest expenses see “—“ — Liquidity and Capital Resources — Capital Resources” and “— Borrowing”“ — Borrowings” below and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
Taxation
      The overall taxationtotal tax charge for 2004 was £62 million,in 2006 of £11m represents just over 2% ofpre-tax profits compared to a charge of £75 million£116m or 26% ofpre-tax profits in 2003. In 2004 the Group recorded a total pre-tax profit of £171 million giving a2005. The low tax rate of 36% compared to a rate of 49% on total pre-tax profits of £152m in 2003. These high rates of tax were2006 was mainly a result of only partial tax relief being availableaccounted for goodwill chargedby two factors. First, in the profitlight of the announcement of the disposal of Government Solutions, we were able to recognize a deferred tax asset in relation to capital losses in the US where previously we were not confident that the benefit of the losses would be realized prior to their expiry. Second, in light of our trading performance in 2006 and 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 settlementsour strategic plans, together with the Inland Revenue authoritiesexpected utilization of US net operating losses in the Government Solutions sale, we havere-evaluated the likely utilization of operating losses both in the US and changesthe UK; this has enabled us to increase the amount of the deferred tax balances.asset carried forward in respect of such losses. The combined effect of these two factors was to create anon-recurring credit of £127m.
Minority Interestsinterests
      Minority interests principally consistFollowing the disposal of our 79% holding in Recoletos and the purchase of the public’sremaining 25% minority stake in Edexcel in 2005, our minority interests now comprise mainly the minority share in IDC. In January 2006 we increased our stake in IDC reducing the minority interest from 39% interestto 38%.
Discontinued operations
      In December 2006 the Group announced the sale of its Government contracting business, Pearson Government Solutions. The sale was completed in Interactive DataFebruary 2007 and 21% interestthe results of this business have been shown in Recoletos.discontinued operations in the consolidated income statement in both 2006 and 2005. Operating profit for Government solutions in 2006 was £22m compared to £20m in 2005. Following the disposal of Recoletos in 2005 its results were consolidated for the period up to February 28, 2005 and included in discontinued operations in 2005. The results for 2005 include an operating loss for the two months to February 28, 2005 of £3m. Thepre-tax profit on disposal of Recoletos reported in 2005 was £306m.
Profit for the Financial Yearyear
      The total profit for the financial year after taxation and equity minority interests in 20042006 was £88 million£469m compared to a profit in 20032005 of £55 million.£644m. The overall decrease of £175m was to the absence of the profits on disposal of Recoletos and MarketWatch reported in 2005. After taking account of these disposals there was an increase of £33 million, or 60%, was mainlyin profit in 2006 due to improvement in operating profits and the sharp reduction in tax due to the reduced charges for goodwill amortization, interest and tax. Increasesrecognition of losses in operating profit before goodwill have been eroded by the adverse movement in exchange.2006.

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Earnings per Ordinary Shareordinary 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 11.1 pence55.9p in 20042006 compared to 6.9 pence78.2p in 20032005 based on a weighted average number of shares in issue of 795.6 million798.4m in 20042006 and 794.4 million797.9m in 2003. This increase2005. The decrease in earnings per share was due to the additional profit for 2005 described above and was not significantly affected by the movement in the weighted average number of shares.
      The diluted earnings per ordinary share of 55.8p in 2006 and 78.1p in 2005 was not significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant.

29


Exchange rate fluctuations
      The weakening of the US dollar against sterling on an average basis had a negative impact on reported sales and profits in 2006 compared to 2005. We estimate that if 2005 average rates had prevailed in 2006, sales would have been higher by £44m and operating profit would have been higher by £7m. 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 tables summarize our sales and operating profit for each of Pearson’s divisions. Adjusted operating profit is anon-GAAP measure and is included as it is a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under FAS 131. See also note 2 of “Item 17. Financial Statements”.
      In our adjusted operating profit we have excluded amortization and adjustment of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization and adjustment of acquired intangibles is the amortization or subsequent impairment of intangible assets acquired through business combinations. The charge is not considered to 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.
      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 for continuing operations is included in the tables below:
                             
  Year Ended December 31, 2006
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,455   795   341   366   332   848   4,137 
   36%   19%   8%   9%   8%   20%   100% 
Total operating profit  167   161   37   35   82   58   540 
   31%   30%   7%   6%   15%   11%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  17      1   2   7   8   35 
Other net gains and losses including associates           (4)        (4)
Other net finance costs of associates           (1)        (1)
                      
Adjusted operating profit:
continuing operations
  184   161   38   32   89   66   570 
Adjusted operating profit:
discontinued operations
        22            22 
                      
Total adjusted operating profit  184   161   60   32   89   66   592 
                      
   31%   27%   10%   6%   15%   11%   100% 

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  Year Ended December 31, 2005
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,295   779   301   332   297   804   3,808 
   34%   20%   8%   9%   8%   21%   100% 
Total operating profit  142   156   25   58   75   60   516 
   28%   30%   5%   11%   14%   12%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  5         1   5      11 
Other net gains and losses including associates           (40)        (40)
Other net finance costs of associates           2         2 
                      
Adjusted operating profit:
continuing operations
  147   156   25   21   80   60   489 
Adjusted operating profit:
discontinued operations
        20   (3)        17 
                      
Total adjusted operating profit  147   156   45   18   80   60   506 
                      
   29%   31%   9%   3%   16%   12%   100% 
School
      School business sales increased by £160m, or 12%, to £1,455m in 2006, from £1,295m in 2005 and adjusted operating profit increased by £37m, or 25%, to £184m in 2006 from £147m in 2005. In addition to strong underlying growth in sales and profits, the School results in 2006 benefit from the inclusion of National Evaluation Systems (NES), Paravia Bruno Mondadori (PBM), Chancery and PowerSchool together with a number of smaller acquisitions all made in the first half of 2006 and from a full year contribution from AGS Publishing, acquired in July 2005. Offsetting these factors was the effect of the weakening of the US dollar, which we estimate reduced sales by £17m when compared to the equivalent figures at constant 2005 exchange rates.
      In the US school market, Pearson’s school publishing business grew 3% against the Association of American Publishers’ estimate of a decline in the industry of 6%. New adoption market share was 33% in the adoptions where Pearson competed (and 30% of the total new adoption market). The School business now has the number one or number two market share in reading, math, science and social studies. US School testing sales were up in the high single digits even after growth in excess of 20% in 2005. School testing benefited from further contract wins, market share gains and leadership in onscreen marking, online testing and embedded (formative) assessment. The acquisition of NES providing customized assessments for teacher certification in the US has allowed us to expand in an attractive adjacent market. The School technology business grew both through the acquisitions of Chancery and PowerSchool and through organic growth in the digital curriculum business which continued to grow while investing in a new generation of digital products to meet the demands of school districts for personalized classroom learning.
      The international School business, outside the US, continued to grow. The international testing business was again able to benefit from technology leadership. In the UK, we have marked over 9 million GCSE, AS and A-Level scripts on screen. In School publishing, the launch in the UK of ActiveTeach technology providing multimedia teaching resources has brought increased market share in math and science. The acquisition of PBM, one of Italy’s leading education publishers, has allowed us to expand our existing Italian business and integrate publishing, sales and marketing, distribution and back office operations. Our market leading school companies in Hong Kong and South Africa both outperformed their respective markets in 2006 and our worldwide English Language Training program for elementary schools,English Adventure(with Disney), was successfully launched in Asia and Latin America.
      School margins improved again in 2006 and were up by 1.2% points to 12.6% with continued efficiency gains in central costs, production, distribution and software development.

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Higher Education
      Sales in Higher Education increased by £16m, or 2%, to £795m in 2006, from £779m in 2005. Adjusted operating profit increased by £5m, or 3%, to £161m in 2006 from £156m in 2005. Both sales and adjusted operating profit were affected by the weakening of the US dollar which we estimate reduced sales by £8m when compared to the equivalent figures at constant 2005 exchange rates.
      In the US, the Higher Education sales were up by 4% (in US dollars) ahead of the Association of American Publishers’ estimate of industry growth once again. Over the past eight years, Pearson’s US Higher Education business has grown at an average annual rate of 7% compared to the industry’s average growth rate of 4%. In the US there was rapid growth in the online learning businesses with approximately 4.5 million US college students using one of our online programs. Of these approximately 2.3 million register for an online course on one of our ‘MyLab’ online homework and assessment programs, an increase of almost 30% on 2005. In psychology and economics, two of the three largest markets in US higher education, Pearson published successful first edition bestsellers: Cicarrelli’sPsychologytogether with MyPsychLab and Hubbard’sEconomicstogether with MyEconLab. Cicarrelli’sPsychologyincreased Pearson’s market share in the subject by 3% to 25% and is the bestselling launch of a first edition in the discipline in the past decade. Also in the US the custom publishing business, which builds customized textbooks and online services around the courses of individual faculties or professors, continued its strong progress with another year of double-digit growth.
      International Higher Education publishing sales grew by 3%, benefiting from good growth in local language publishing programs and an increasing focus on custom publishing and technology based assessment services with the MyLab suite of products.
      Higher Education margins remained constant year on year with only a small increase of 0.3% points to 20.3% in 2006.
Professional
      After excluding sales and adjusted operating profit from Government Solutions which were reported as discontinued in 2006, Professional sales increased by £40m, or 13%, to £341m in 2006 from £301m in 2005. Adjusted operating profit increased by £13m, or 52%, to £38m in 2006, from £25m in 2005. Sales were only slightly affected by the weakening US dollar, which we estimate reduced sales by £2m when compared to the equivalent figures at constant 2005 exchange rates.
      Professional testing sales were up more than 30% in 2006 benefiting in particular from the acquisition of Promissor and the successful start-up of the Graduate Management Admissions Test with 220,000 examinations delivered in 400 test centers in 96 countries during the first year of the new contract. Professional Testing has moved into profitability in 2006 compared to a break-even position in 2005. Technology publishing profits were up in 2006 as cost actions offset sales weakness in a market that continues to decline. There was a strong performance in other professional publishing with particular successes in the Wharton School Publishing and FT Press imprints.
      Overall margins in the Professional business were significantly higher at 11.1% in 2006 compared to 8.3% in 2005 as the testing business moved into profitability and the technology publishing business took specific cost actions.
FT Publishing
      Sales at FT Publishing increased by £34m or 10%, from £332m in 2005 to £366m in 2006. Adjusted operating profit increased by £11m, from £21m in 2005 to £32m in 2006. Much of the sales and profit increase was again at the FT newspaper and FT.com where sales were up 8% and profit increased by £9m to £11m.
      The FT newspaper advertising revenues were up 9% for the year with rapid growth in online, luxury goods and corporate finance categories, all up more than 30% on 2005. FT worldwide circulation was up 1% to 430,469 copies per day (Source: ABC, average for six months to December 2006). FT.com’s paying subscribers were up 7% to 90,000 while the December audience was up 29% to 4.2 million. The FT continued

32


to benefit from international expansion with approximately three-quarters of the FT’s advertising booked in two or more international editions and almost half booked for all four editions worldwide. The FT’s ‘new newsroom’ has created an integrated multi-media newsroom that improves commissioning, reporting, editing and production efficiency and provided further cost savings in 2006.
      In September 2006, the FT Publishing business acquired Mergermarket, an online financial data and intelligence provider that contributed additional sales and profit in the last three months of 2006. FT Business showed good growth and improved margins driven by strong performances in events, UK retail financial titles (Investment AdviserandFinancial Adviser) and internationally withThe Banker. Les Echosachieved modest circulation and advertising growth in a weak market ahead of the French presidential elections in 2007.FT Deutschlandoutperformed the German newspaper market once again increasing circulation by 2% and reducing losses.The Economist, in which Pearson owns a 50% stake, increased its contribution to FT Publishing’s adjusted operating profit with another good year that saw circulation increase by 9% to 1.2 million (for the July-December ABC period).
      Overall margins at FT Publishing continued to increase as the newspaper becomes more profitable and are now 8.7% compared to 6.3% in 2005.
Interactive Data
      Interactive Data, grew its sales by 12% from £297m in 2005 to £332m in 2006. Adjusted operating profit grew by 11% from £80m in 2005 to £89m in 2006. Both sales and adjusted operating profit were affected by the weakening US dollar, which we estimate reduced sales by £4m and adjusted operating profit by £1m when compared to the equivalent figures at constant 2005 exchange rates.
      Interactive Data Pricing and Reference Data (formerly FT Interactive Data), IDC’s largest business (approximately two-thirds of IDC revenues) generated strong growth in North America and Europe. Growth was driven by sustained demand for fixed income evaluated pricing services and related reference data. Interactive Data Pricing and Reference Data continued to expand its market coverage, adding independent valuations of credit default swaps and other derivative securities. There was improved momentum at Interactive Data Real-Time Services (formerly Comstock) with new sales to institutional clients and lower cancellation rates and also at eSignal with continued growth in its base of direct subscription terminals. The acquisition of Quote.com in March 2006 has expanded eSignal’s suite of real-time market data platforms and analytics and added two financial websites which enabled eSignal to generate strong growth through online advertising in 2006. IS.Teledata, acquired at the end of 2005 and rebranded Interactive Data Managed Solutions, contributed a full year of sales and profit for the first time in 2006.
      IDC margins remained roughly constant year on year at 26.8% in 2006 compared to 26.9% in 2005.
The Penguin Group
      Penguin Group sales were up 5% to £848m in 2006 from £804m in 2005 and adjusted operating profit up 10% to £66m in 2006 from £60m in 2005. Both sales and adjusted operating profit were affected by the weakening US dollar which we estimate reduced sales by £13m and adjusted operating profit by £7m when compared to the equivalent figures at constant 2005 exchange rates.
      2006 was a record year for Penguin in terms of literary success and bestseller performance. In the US, Penguin placed 139 books on theNew York Timesbestseller list, 10 more than in 2005, and kept them there for 809 weeks overall, up 119 weeks from 2005. Penguin UK placed 59 titles in the BookScan Top Ten bestseller list, up by 5 from 2005, and kept them there for 361 weeks, up 42 weeks from 2005.
      Penguin authors won a large number of prestigious awards during 2006: a Pulitzer Prize for Fiction (Marchby Geraldine Brooks); a National Book Critics Circle Award (THEM: A Memoir of Parentsby Francine du Plessix Gray); the Michael L. Printz award (Looking for Alaskaby John Green); the Orange Prize for Fiction (On Beautyby Zadie Smith); and the Man Booker Prize (The Inheritance of Lossby Kiran Desai).

33


      Penguin UK’s focus on fiction in 2006 was rewarded with a substantial increase in market share, led by Marina Lewycka’sA Short History of Tractors in Ukrainian.In the US, the premium paperback format accelerated revenue growth and increased profitability in the important mass-market category. In India, Penguin continued its rapid growth and extended its market leadership and there was also strong growth and increased market share for Penguin in South Africa. 2006 also saw strong growth in online revenues and unique visitors to the Penguin and DK websites.
      Penguin continued to focus on efficiency and improvement in operating margins and has benefited from the Pearson-wide renegotiation of major global paper, print and binding contracts, the integration of warehouse and back office operations in Australia and New Zealand and is investing in India as a pre-production and design center for reference titles.
Results of operations
Year ended December 31, 2005 compared to year ended December 31, 2004
Consolidated results of operations
Sales
      Our total sales increased by £329m, or 9%, to £3,808m in 2005, from £3,479m in 2004. Sales growth was due to strong performance in our markets, helped in part by a favorable exchange rate impact. We estimate that had the 2004 average rates prevailed in 2005, sales would have been approximately £3,765m.
      Pearson Education had a strong year with an increase in sales of 13%. The School businesses were the biggest contributors to this growth with an increase of 19%. Higher Education growth was 7% 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 sales increased 4%, with testing sales ahead of last year following 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% in 2005 ahead of 2004. FT Publishing sales were up by 4% driven by higher advertising revenues at theFinancial Timesand 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 62% of our sales in 2005, compared to 61% 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 64% in 2005, compared to 66% in 2004.
Cost of goods sold and net 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  1,787   1,631 
       
 Distribution costs  292   226 
 Administration and other expenses  1,351   1,340 
 Other operating income  (84)  (83)
       
Total  1,559   1,483 
       

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Cost of goods sold.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 £156m, or 10%, to £1,787m in 2005, from £1,631m in 2004. The increase mainly reflected the increase in sales over the period so the overall gross margin stayed constant at 53%.
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 £11m, or 1%, to £1,351m in 2005, from £1,340m in 2004, although as a percentage of sales they decreased to 35% in 2005, from 39% 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 have enabled overall operating margins to improve.
Other operating income.Other operating income mainly consists of freight recharges, sub-rights and licensing income and distribution commissions.
Other net gains and losses
      Profits or losses on the sale of businesses, associates and investments that are included in our continuing operations are reported as “other net gains and losses”. In 2005 the only item in this category was the £40m profit on the sale of our associate interest in MarketWatch. In 2004, other gains and losses amounted to £9m, 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 £8m in 2004 to £14m 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 £134m, or 35%, to £516m in 2005 from £382m in 2004. This £134m or 35% increase was due to increases across all the businesses, the one-off gain from the sale of MarketWatch of £40m and a beneficial impact of exchange. We estimate that had the 2004 average rates prevailed in 2005, operating profit would have been £12m lower.
      Operating profit attributable to Pearson Education increased by £58m, or 22%, to £323m in 2005, from £265m 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 £63m, or 90%, to £133m in 2005, from £70m in 2004. £40m of the increase was due to the profit from the sale of MarketWatch but there were also increases at IDC of £13m and FT Publishing of £10m. Operating profit attributable to the Penguin Group increased by £13m, or 28%, to £60m in 2005, from £47m 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 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 £79m in 2004 to £70m in 2005. Net interest payable in 2005 was £77m, up from £74m 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

35


adoption of IAS 39 reduced net finance costs by £14m. 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 £116m, representing a 26% rate on pre-tax profits of £446m. This compares with a 2004 rate of 18% (or £55m on a pre-tax profit of £303m). In 2004, the tax charge reflected credits of £48m relating to previous years, a substantial element of which was non-recurring; adjustments relating to previous years in 2005 resulted in a credit of £18m. The 2005 rate benefited from the fact that 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
      Following the announcement of the disposal of Government Solutions in December 2006, the results of the Pearson Government Solution business have been reclassified as discontinued in 2005 and 2004. The results for the year ended December 31, 2005 included an operating profit of £20m with a corresponding operating profit of £22m in 2004. The results of Recoletos have been consolidated for the period up to February 28, 2005 and included in discontinued operations in 2005 and 2004. The results for 2005 include an operating loss for the two months to February 28, 2005 of £3m compared to an operating profit in the full year to December 31, 2004 of £26m. The pre-tax profit on disposal of Recoletos reported in 2005 was £306m.
Profit for the year
      The total profit for the year in 2005 was £644m compared to a profit in 2004 of £284m. The overall increase of £360m was mainly due to the profit on disposal of Recoletos and 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 year divided by the weighted average number of shares in issue, was 78.2p in 2005 compared to 32.9p 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 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 11.0p78.1p in 20042005 and 6.9p32.9p in 20032004 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 Fluctuationsrate fluctuations
      The weakeningstrengthening of the US dollar against sterling on an average basis had a negativepositive impact on reported sales and profits in 20042005 compared to 2003.2004. We estimate that if the 20032004 average rates had prevailed in 2004,2005, sales would have been higherlower by £306 million£43m and operating profit would have been higherlower by £52 million.£12m. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for a discussion regarding our management of exchange rate risks.

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Sales and Operating Profitoperating profit by Divisiondivision
      The following table summarizestables summarize our sales and operating profit and results from operations for each of Pearson’s divisions. Results from operations areAdjusted operating profit is a non-GAAP measure and is included as they areit is a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under SFASFAS 131. Since 1998See also note 2 of “Item 17. Financial Statements”.
      In our adjusted operating profit we have reshapedexcluded amortization and adjustment of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization and adjustment of acquired intangibles is the Pearson portfolio by divestingamortization or subsequent impairment of non-core interestsintangible assets acquired through business combinations. The charge is not considered to be fully reflective of the underlying performance of the Group. Other gains and investing in educational publishinglosses represent profits and testing, consumer publishinglosses on the sale of subsidiaries, joint ventures, associates and business information companies. During this period of transformation management have used results frominvestments that are included within continuing operations to track underlying core business performance. Results from operations are determined by adding back to totalbut which distort the performance for the year.
      Adjusted operating profit costs or charges arising from significant acquisition activity, typically goodwill amortization charges and integration costs. This enables

29


management to more easily track the underlying operational performance of the group.Group. A reconciliation of results from operationsoperating profit to adjusted operating profit is included in the tabletables 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, 2005
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,295   779   301   332   297   804   3,808 
   34%   20%   8%   9%   8%   21%   100% 
Total operating profit  142   156   25   58   75   60   516 
   28%   30%   5%   11%   14%   12%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles  5         1   5      11 
Other net gains and losses including associates           (40)        (40)
Other net finance costs of associates           2         2 
                      
Adjusted operating profit:                            
continuing operations  147   156   25   21   80   60   489 
Adjusted operating profit:                            
discontinued operations        20   (3)        17 
                      
Total adjusted operating profit  147   156   45   18   80   60   506 
                      
   29%   31%   9%   3%   16%   12%   100% 

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Pearson Education
      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 million, or 5%, to £1,118 million in 2004, from £1,176 million in 2003 and results from operations decreased by £10 million, or 8%, to £117 million in 2004 from £127 million in 2003. Both sales and results 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 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 helped by a very significant investment in ELT and in school testing we won $200 million of multi-year contracts.
      The Higher Education business saw a decline in sales of £41 million, to £731 million in 2004, from £772 million in 2003. Results from operations decreased by £15 million, or 10%, to £133 million in 2004 from £148 million in 2003. Both sales and results 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.
      Sales and results 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 operations increased by £5 million, or 13%, to £43 million in 2004, from £38 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, 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

31


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 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 Group
      Sales at the FT Group (excluding discontinued businesses) decreased by £1 million, from £588 million in 2003 to £587 million in 2004 but results from operations increased by £28 million, or 48%, from £58 million in 2003 to £86 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 and a return to sales growth at the Financial 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 3.7 million unique users.
      Results from operations at the FT improved by £23 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 at the FT’s associates and joint ventures showed a profit of £6 million compared to £3 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 operations with The Economist’s circulation passing the 1 million mark with an average weekly circulation of 1,009,759.
      Interactive Data, our 61%-owned financial information business, grew its sales by 3% and results from operations by 9% after taking out the effect of exchange rates. FT Interactive Data and e-Signal (its online financial information and pricing business) performed well particularly in the US 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 year with sales down 6% to £786 million in 2004 from £840 million in 2003 and results from operations down 41% to £54 million in 2004 from £91 million in 2003. Both sales and

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results 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 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. 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 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
                             
  Year ended December 31, 2004
   
    Higher   FT  
£m School Education Professional Publishing IDC Penguin Total
               
Sales  1,087   729   290   318   269   786   3,479 
   31%   21%   8%   9%   8%   23%   100% 
Total operating profit  112   133   20   8   62   47   382 
   29%   35%   5%   2%   16%   13%   100% 
Add back:                            
Amortization and adjustment of acquired intangibles              5      5 
Other net gains and losses including associates  (4)  (4)  (2)  (4)     5   (9)
Other net finance costs of associates                     
                      
Adjusted operating profit:                            
continuing operations  108   129   18   4   67   52   378 
Adjusted operating profit:                            
discontinued operations        22   26         48 
                      
Total adjusted operating profit  108   129   40   30   67   52   426 
                      
   25%   30%   9%   7%   16%   13%   100% 
Consolidated Results of OperationsSchool
Sales
      Our total      School business sales decreasedincreased by £272 million£208m, or 19%, to £4,048 million,£1,295m in 2005, from £1,087m in 2004 and adjusted operating profit increased by £39m, or 6%36%, to £147m in 2003,2005 from £4,320 million£108m in 2002.2004. The decrease was mainly attributable to Pearson Education’s Professional business where the shortfall was due to the absence of reported salesSchool results in 2005 benefit from the £250 million TSA contractinclusion of AGS Publishing, acquired in July 2005 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 weakeningstrengthening of the US dollar, against sterling. Wewhich we estimate that had the 2002 average rates prevailed in 2003,added £12m to sales and £2m to adjusted operating profit before goodwill charges would have been £27 million greater.when compared to the equivalent figures at constant 2004 exchange rates.
      OperatingIn 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 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 bygrowth 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 Higher Education businesses of £12 millioninvestments in new products, includingEnglish Adventure(with Disney) for the primary school market,Skyfor secondary schools,Total Englishfor adult learners 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. Intelligent Business (withThe 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 ofEconomist) for 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.markets. 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 decreasestrong growth in the weighted average numberinternational school testing markets. Four million UK GCSE, AS and A-Level scripts were marked onscreen and 2005 saw the first year of shares.
      In 2003running 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-dilutiveUK National Curriculum tests 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”new contract for a discussion regarding our management of exchange rate risks.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.
Sales and Operating Profit by DivisionHigher Education
      The following table summarizes ourSales in Higher Education increased by £50m, or 7%, to £779m in 2005, from £729m in 2004. Adjusted operating profit and results from operations for each of Pearson’s divisions. Results from operations are included as they are a key financial measure usedincreased 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£27m, or charges arising from significant acquisition activity, typically goodwill amortization charges and integration costs. This enables

36


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%21%, to £2,451 million£156m in 20032005 from £2,756 million£129m 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

37


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 2002.2004. Both sales and results were adversely affected byadjusted operating profit benefited from the weakeningstrengthening US dollar andwhich 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 Pearsonadded £14m 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£3m to adjusted operating profit when compared to 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. Inequivalent figures at constant 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 worldwideexchange rates.

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technology publishing operations maintained margins despite a drop      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 revenues. After a severe three-year technology recession, in which our publishing revenues have fallen by 36%key academic disciplines including biology (Campbell & Reece), the rate of decline now appears to be slowing, particularlychemistry (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 United States.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 (excluding discontinued businesses) increased by £11m, or 4%, to £301m in 2005 from £290m in 2004. Adjusted operating profit increased by £7m, or 39%, to £25m in 2005, from £18m in 2004. Sales benefited from the strengthening US dollar, which we estimate added £5m to sales when compared to the equivalent figures at constant 2004 exchange rates.
      Professional testing sales were up more than 40% in 2005 benefiting from the successful start-up of major new contracts including the Driving Standards Agency, National Association of Securities Dealers and the Graduate Management Admissions Council.
      Overall margins in the Professional business were a little lower in 2005 compared to 2004 mainly due to new contract start-up costs. Margins in the Professional publishing businesses were maintained despite falling sales.
FT GroupPublishing
      Sales at the FT GroupPublishing (excluding discontinued businesses) increased £10 millionby £14m or 2%4%, from £578 million£318m in 20022004 to £588 million£332m in 2003 and results from operations2005. Adjusted operating profit increased by £7 million, or 14%,£17m, from £51 million£4m in 20022004 to £58 million£21m in 2003. The main contributors to2005. Much of the sales and profit increase was Interactive Data. Interactive Data posted a 10%at the FT newspaper; sales increase despiteat the negative impact of exchange as it benefited from the acquisition of ComStock, in February 2003. For ourother business newspapers 2003 waswere broadly level with 2004 with a small increase in adjusted operating profit compared to 2004.
      FT newspaper sales were up 6% while adjusted operating profit increased £14m to register a profit of £2m in 2005 compared to a loss of £12m in 2004. FT advertising revenues were up 9% for the third year of a corporatewith sustained growth in luxury goods and worldwide display advertising. FT.com 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 reducedsales were up 27% as some of 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 £23mbiggest advertisers shifted to integrated print and we invested some £10m in the newspaper’s continued expansion around the world. Advertising revenues were down 15% as industry conditions remained toughonline advertising. The FT’s worldwide circulation was 2% lower for the FT’s key advertising categories of corporate finance, technology and business to business. The advertising declines were significantly worse immediately before and duringyear at 426,453 average copies per day although the war in Iraq, but the rate of decline began to slow towards the endsecond half of the year showed improvement to 430,635 average copies per day. FT.com’s paying subscribers increased by 12% to 84,000 and the average unique monthly users was up 7% to 3.2m.
      Les Echos advertising and circulation revenues for 2005 were level with 2004 despite tough trading conditions. FT Business improved margins with growth in its international finance titles. Our share of the results of the FT’s joint ventures and associates improved asFT Deutschlandreduced its losses and increased its average circulation despite a weak advertising market in Germany andThe Economistincreased profits helped by 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 measurescirculation (10% to reduce costs. The Economist’s circulation growth continued, withan average weekly circulation 3% higher at 908,000.
      Interactive Data grew its sales in a declining marketof 1,038,519 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.January-June ABC period).

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Interactive Data
      Interactive Data, grew its sales by 10% from £269m in 2004 to £297m in 2005. Adjusted operating profit grew by 19% from £67m in 2004 to £80m in 2005. Both sales and adjusted operating profit benefited from the strengthening US dollar, which we estimate added £2m to sales and £1m to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      FT Interactive Data, IDC’s largest business (approximately two-thirds of IDC revenues) generated strong growth in North America and returned to growth in Europe. There was more modest growth at Comstock, IDC’s business providing real-time data for global financial institutions, and at CMS BondEdge, its fixed income analytics business. Renewal rates for IDC’s institutional businesses remain at around 95%. eSignal, IDC’s active trader services business, increased sales by 27% with continued growth in the subscriber base and a full year contribution from FutureSource, acquired in September 2004.
The Penguin Group
      The Penguin Group increased sales were up 2% to £840 million£804m in 20032005 from £838 million£786m in 20022004 and increased its resultsadjusted operating profit up 15% to £60m in 2005 from operations£52m in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £9m to £91 million in 2003sales and £6m to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates. 2005 adjusted operating profit also benefited from £87 million in 2002.reduced operating costs at our UK distribution center.
      In the US, our largest market, accountingsuccessful format innovation helped to address weakness in the mass-market category that saw a further decline of 4% for around two-thirdsthe 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.
      Penguin authors received a number of sales, our best ever schedule of new titles enabled Penguin to grow aheadawards 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 industry despite tough conditions for backlist publishing.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 our backlist performed well, helped by the relaunch of Penguin ClassicsUK. Major bestselling authors include Patricia Cornwell, John Berendt, Sue Grafton, Jared Diamond, Jamie Oliver, Gillian McKeith, Jeremy Clarkson and BBC’s The Big Read.Gloria Hunniford.
      Penguin’s best-selling books includedIn 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 debutfirst novel,The 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’shas been a New York Times bestseller for almost two years; her second,The 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 24/7Mermaid Chair, Tom Peters’Re-Imagine!and ane-Encyclopaediapublishedreached number one in association with Google.
      We increased spending on authors’ advances as we invested in a number of new imprints including Portfolio (business books)2005.The Kite Runner, 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 oneKhaled Hosseini’s first book, stayed on the New York Times bestseller list.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.
Liquidity and Capital Resourcescapital resources
Cash Flowsflows and Financingfinancing
      Net cash inflow from operating activities increaseddecreased by £171 million,£32m, or 48%5%, to £530 million£621m in 2004,2006, from £359 million£653m in 2003.2005. This cash inflowreduction was aided by collection ofentirely due to the $151 million receivable in respect of the TSA contract. Cash flows within Pearson Education and IDC in particular continued to be strong despite the weaknessweakening of the US dollar reducingcompared to sterling. The majority of the valueGroup’s cash flows arise in US dollars, so any weakening of ourthe US dollar reduces the Group’s cash flows in sterling terms. Even excluding the impactThe closing rate for translation of collecting the TSA receivable,dollar cash flows was $1.96 in 2006 ($1.72 in 2005). Underlying working capital efficiency continued to improve. On an average basis, the working capital to sales ratio for our book publishing businesses improved from 32.8%27.4% in 2005 to 32.3%. Compared to 2002, the26.3% in 2006. The net cash inflow from operating activities in 2003 decreased2005 increased by £170 million,£129m, or 32%25%, to £359 million£653m from £529 million. This reflected close-out payments to creditors£524m in 2004, even though 2004 included receipt of a $151m receivable in respect of the TSA contract andcontract. Part of this increase was due to the concentrationstrengthening of the PenguinUS dollar during that period. The closing rate for translation of dollar cash flows was

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$1.72 in 2005, compared to $1.92 in 2004. The improvement in cash flow from operating activities also reflected more efficient use of working capital. On an average basis, the working capital to sales ratio for our book publishing schedulebusinesses improved from 29.4% in the fourth quarter which pushed cash collection from debtors into 2004.2004 to 27.4% in 2005.
      Net interest paid was £85 million£82m in 2006 compared to £72m in 2005 and £85m in 2004. The 14% increase in 2006 over 2005 reflected the higher average debt resulting from the acquisitions made in the year and higher interest rates (particularly in the US). The 15% reduction in 2005 over 2004 was primarily due to the reduced debt following receipt of the proceeds from the sale of Recoletos and MarketWatch.
      Capital expenditure on property, plant and equipment was £68m in 2005 compared to £76m in 2005 and £101m in 2004. The reduction in 2006 compared to 2005 is due to the movement in US dollar exchange rates. The higher expenditure in 2004 compared to £76 million in 2003 and £140 million in 2002. The 12% increase in 2004 over 2003 reflected the year on year increase in interest rates, while the 2003 decrease compared to 2002 benefited from 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.
      In 2004 capital expenditure was in excess of depreciation due to 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 million£367m in 20042006 against £94 million£253m in 20032005 and £87 million£51m in 2002.2004. In 2006, the principal acquisition was of Mergermarket for £109m. The balance relates to various smaller bolt-on acquisitions (primarily in the school segment) including those of National Evaluation Systems and Paravia Bruno Mondadori. The principal acquisitions in 2005 were of AGS for £161m within the School business and IS. Teledata for £29m by Interactive Data. The principal acquisitions in 2004 were of KAT and Dominie Press for £10 million each by Pearson Education£10m within our education businesses and FutureSource by Interactive Data for £9 million. The principal acquisitions in 2003 were 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.£9m. The sale of subsidiaries and associates produced a cash inflow of £24 million£10m in 20042006 against £53 million£430m in 20032005 and £923 million£31m in 2002. All2004. The disposal in 2006 relates entirely to the proceeds from the take-up of share options issued to minority shareholders. The principal disposals in 2005 were of Recoletos for net cash proceeds of £371m and MarketWatch for net cash proceeds of £54m. 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£348m in 2006 primarily reflects the payment of the Group dividend (at a higher dividend per share than 2005) and the repayment of a $250m bond at its maturity date. The cash outflow from financing of £321m in 2005 reflects the improved Group dividend (compared to 2004) and the repayment of bank borrowings following the sale of Recoletos. The cash outflow from financing of £261m in 2004 reflects the payment of the Group dividend and the repayment of one550550m bond offset by the proceeds from the issue of new $350 million$350m and $400 million$400m bonds. The cash inflow from financing of £64 million in 2003 largely reflects 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.
Capital Resourcesresources
      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’sGroup’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, 2004,2006, our net debt (excluding finance leases) was £1,206 million£1,059m compared to net debt of £1,361 million£996m at December 31, 2003.2005. Net debt is defined as all short-term, medium-term and long-term borrowing (including finance leases), less all cash and liquid resources. Liquid resources comprise short-term deposits of less than one year90 days and investments that are readily realizable and held on a short-term basis. Short-term, medium-term and long-term borrowing amounted to £1,819 million£1,743m at December 31, 2004,2006, compared to £1,922 million£1,959m at December 31, 2003.2005. At December 31, 2004,2006, cash and liquid resources were £613 million,£592m, compared to £561 million£902m at December 31, 2003.2005. Some of the cash at December 31, 2006 was being held to fund a591m bond repayment due on February 1, 2007.

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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, 2006
   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  173  173       
Variable rate loan notes           Variable rate loan notes           
Bonds  1,650    130  671  849 Bonds  1,566  421  105  444  596 
Lease obligationsLease obligations  1,051  115  101  250  585 Lease obligations  1,369  123  113  276  857 
                       
Total
Total
  2,870  222  231  983  1,434 
Total
  3,108  717  218  720  1,453 
                       
      The groupAt December 31, 2006 the Group had capital commitments for fixed assets, including finance leases already under contract, of £6 million.£nil (2005: £1m). There are contingent liabilities in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries and associates. In addition there are contingent liabilities in respect of legal claims. None of these claims or guarantees is expected to result in a material gain or loss.
      The Group is committed to a fee of 0.0675% per annum, payable quarterly in arrears on the unused amount of the Group’s bank facility.
Off-Balance sheet arrangements
      The Group does not have any off-balance sheet arrangements, as defined by the SEC Final Rule 67(FR-67),“Disclosure “Disclosure in Management’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 billion term$1.75bn revolving credit facility, which matures in July 2009.May 2011. At December 31, 2004,2006, approximately $1.23 billion$1.75bn was available under this facility. This included allocations to refinance short-term borrowings not directly drawn under the facility. The credit facility contains two key covenants measured for each 12 month period ending June 30 and December 31:
      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 Policypolicy
      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

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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 Partiesparties
      There were no significant or unusual related party transactions in 2004, 20032006, 2005 or 2002.2004. Refer to note 30 in “Item 17. Financial Statements.”.
Accounting Principles
      The following summarizes the principal differences between UK GAAP and US GAAP in respect of our financial statements. For further details refer to note 34 in “Item 17. Financial Statements”.
      Prior to January 1, 1998, under UK GAAP, goodwill was written off to
Accounting principles
      For a summary of the profitprincipal differences between IFRS 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 is recorded over useful lives ranging between 3 and 20 years. Under US GAAP, goodwill arising from acquisitions completed subsequent to July 1, 2001 is no longer amortized, however it is tested for impairment at the reporting unit level at least annually or more frequently when a triggering event occurs. In addition, amortization for all goodwill balances ceased as of January 1, 2002 under US GAAP. Intangible assets under UK GAAP are recognized only when they may be disposed of without also disposing of the business to which they relate, and for that reason it is rare that intangible assets are separately identified and recorded apart from goodwill. Under US GAAP, there is no similar requirement with respect to acquired intangible assets, and they should be recognized separately from goodwill when they arise from separate contractual or legal rights or can be separately identified and be sold, transferred, licensed, rented or exchanged regardless of intent. Under US GAAP, intangible assets such as publishing rights, non-compete agreements, software, databases, patents and non-contractual customer relationships such as advertising relationships have been recognized and are being amortized over a range of useful lives between 2 and 25 years. The difference in goodwill and intangible assets also creates a difference in the gain or loss recognized on the disposal of a business due to amortization expense taken with respect to the goodwill prior to adoption of SFAS 142 and intangible assets, as UK GAAP requires that goodwill which had not been

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capitalized and amortized be removed from the profit and loss reserve upon disposal and factored into the gain or loss on disposal calculation.
      Under UK GAAP, the Group reviews the recoverability of goodwill where there is a triggering event to indicate a potential impairment or where there has been a previous impairment. These reviews are based on estimated discounted future cash flows from operating activities compared with the carrying value of goodwill, and any impairment is recognized on the basis of such comparison. Under US GAAP, a two stage impairment test is required at least annually under SFAS 142, which was adopted by the Group as of January 1, 2002. The Group performed the transitional impairment test under SFAS 142 by comparing the carrying value of each reporting unit with its fair value as determined by discounted future cash flows. The Group also completed the annual impairment tests required by SFAS 142 at the end of 2004, 2003 and 2002.
      Under UK GAAP, FRS 19,“Deferred Taxation”,which was adopted for the year ended December 31, 2002 requires a form of full provision to be made for deferred taxes. Deferred taxes are to be accounted for on all timing differences with deferred tax assets recognized to the extent that they are more likely than not recoverable against future taxable profits. Deferred tax assets not considered recoverable are adjusted for through a separate valuation allowance in the balance sheet. Under US GAAP, deferred taxes are accounted for in accordance with SFAS 109,“Accounting for Income Taxes”with a full provision also made for deferred taxes on all timing differences and a valuation allowance established for the amount of the deferred tax assets not considered recoverable. This is similar to the treatment required under FRS 19. The primary differences relate to the deferred tax on intangible assets, which are not recorded under UK GAAP and changes in estimates in respect of deferred tax balances relating to business combinations in prior years, which are required to be adjusted against goodwill under US GAAP. Deferred tax may also arise in relation to timing differences of other adjustments required under US GAAP.
      Under UK GAAP, there are no specific criteria, which must be fulfilled in order to record derivative contracts such as interest rate swaps, currency swapsour financial statements 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. Underrecent US GAAP we have adopted SFAS 133,“Accounting for Derivative Instruments and Hedging Activities”and its related guidance. During 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 changesIFRS pronouncements refer to note 36 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.“Item 17. Financial Statements”.
      Finance lease rentals are capitalised at the net present value of the total amount of rentals payable under the leasing agreement (excluding finance charges) and depreciated 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. Under US GAAP, the annual pension costs comprise the estimated cost of benefits accruing in the period, and actuarial assumptions are adjusted annually to reflect current market and economic conditions. Additionally, under US GAAP, 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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Under US GAAP, we have adopted the fair value method of accounting for options. Compensation expense is determined based upon the fair value at the grant date, and has been estimated using the Black Scholes model. Compensation cost is recognized over the service life of the awards, which is normally equal to the vesting period. Compensation expense is also recognized under US GAAP with respect to UK qualified non-compensatory plans, such as the Save as You Earn option plan and the Worldwide Save for Shares plan, as these plans offer employees a discount of greater than 5% of market value at the date of grant.
      For a further explanation of the differences between UK GAAP and US GAAP see note 34 to the consolidated financial statements.
ITEM 6.     Recent U.S. Accounting PronouncementsDIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
      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 SFAS No. 151, “Inventory Costs — An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 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, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005. The Group is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material impact.
      In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non monetary Assets — An Amendment of APB Opinion No. 29, Accounting for Non monetary Transactions” (“SFAS 153”). SFAS 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 monetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS 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. SFAS 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 SFAS 153 will have but does not expect it to have a material impact.
      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R 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 SFAS 123 no longer will be an alternative to financial statement recognition. The Group is currently evaluating the impact of adoption of SFAS 123(R) will have, but because it already applies the requirements SFAS 123 it does not expect adoption of the new standard to have a material impact.
Recent UK and International Accounting Pronouncements
      In December, 2003, UITF 38, “Accounting for ESOP trusts”, was issued by the Urgent Issues Task Force of the UK Accounting Standards Board. The consensus is that parent company shares held in trust should be treated as treasury shares and deducted from shareholders’ funds rather than being held as fixed asset investments. The Group adopted UITF 38 in 2004 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 April 7, 2004. It is effective for listed entities for accounting periods beginning on or after January 2005. It deals with the accounting for transactions where an entity obtains goods or services from other parties (including employees or suppliers) in 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 grant less exercise price). Use of the fair value of share options is expected to 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 recently been issued by the ASB. These accounting standards all mirror International Accounting Standards and will be adopted by the group as part of the transition to IFRS as noted below:
• 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”.
      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 Managementsenior management
      We are managed by a board of directors and a chief executive who reports to the board and manages through a management committee. We refer to the executive director members of the board of directors the most senior executives from each of our three main operating divisions and the chairman of the board of directors as our “senior management”.
      The following table sets forth information concerning senior management, as of April 2005.2007.
       
Name Age Position
     
Dennis StevensonGlen Moreno  5963  Chairman
Marjorie Scardino  5860  Chief Executive
David Arculus60Non-executive Director
David Bell  5860  Director for People and Chairman of theThe FT Group
Terry Burns  6163  Non-executive Director
Patrick Cescau  5658  Non-executive Director
Rona Fairhead  4345Chief Executive of The FT Group
Robin Freestone48  Chief Financial Officer
Susan Fuhrman  6163Non-executive Director
Ken Hydon62  Non-executive Director
John Makinson  5052  Chairman and Chief Executive Officer, Penguin Group
Reuben Mark66Non-executive Director
Vernon Sankey55Non-executive Director
Rana Talwar  5759  Non-executive Director
     Dennis StevensonGlen Morenowas appointed a non-executive director in 1986 and became chairman in 1997.on October 1, 2005. He is a member of our treasury committee 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.
     Marjorie Scardinojoined the board and became chief executive in January 1997. She is a member of ourPearson’s nomination committee. She trained and practiced as a lawyer and was chief executive of The Economist Group from 1993 until joining Pearson. She is also a non-executive director of Nokia Corporation.
     David Arculusbecame a non-executive director in February 2006 and currently serves on the audit and nomination committees and as chairman of the personnel committee. He is a non-executive director of Telefonica SA, and was previously chairman of O2 plc from 2004 until it was acquired by Telefonica in early 2006. His previous roles include chairman of Severn Trent plc, chairman of IPC Group, chief operating officer

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of United Business Media plc, group managing director of EMAP plc and non-executive director of Barclays Bank plc.
David Bellbecame a director in March 1996. He is chairman of the FT Group, having previously been chief executive of theFinancial Timesfrom 1993 to 1998. In July 1998, he was appointed ourPearson’s director for people with responsibility for the recruitment, motivation, development and reward of employees across the Pearson Group. He is also a non-executive director of VITEC Group plc and chairman of Sadlers Wells and Crisis, a charity for the International Youth Foundation.homeless.
     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. He has been chairman of Marks and The British Land Company PLC.Spencer Group plc since July 2006, having previously been deputy chairman from October 1, 2005.
     Patrick Cescaubecame a non-executive director in April 2002. He joined 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 andin June 2002. She was appointed chief executive of the FT Group on June 12, 2006 having previously been chief financial officer inof Pearson from June 2002.2002 and was appointed to the Interactive Data Corporation board on 15 February 2007. She had served as deputy finance director of Pearson from October 2001. From 1996 until 2001, she worked at ICI plc, where she served as executive vice president, group control and strategy, and as a member of the executive committee from 1998.

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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.
     Robin Freestonebecame a director of Pearson on June 12, 2006 and was appointed chief financial officer, having previously served as deputy chief financial officer since 2004. He was previously group financial controller of Amersham plc (now part of GE), having joined Amersham as chief financial officer of their health business in 2000. Prior to that he held a number of senior financial positions with ICI, Zeneca and Henkel. He is also a non-executive director of eChem Limited.
Susan Fuhrmanbecame a non-executive director in July 2004. She is a member of ourthe audit and nomination committee. Susancommittees. She is president of Teachers College at Columbia University, America’s oldest and largest graduate school of education having previously been 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 memberan officer of the Council for CorporateNational Academy of Education.
Ken Hydonbecame a non-executive director in February 2006 and School Partnershipscurrently serves on the nomination committee and as chairman of the Coca-Cola Foundation.audit committee. He is a non-executive director of Tesco plc, Reckitt Benckiser plc and Royal Berks NHS Foundation Trust. He was previously finance director of Vodafone Group plc and of subsidiaries of Racal Electronics.
     John Makinsonbecame chairman of the Penguin Group in May 2001 and its chief executive officer in June 2002. He was appointed chairman of Interactive Data Corporation in December 2002. He served as PearsonPearson’s 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 serves 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.
Vernon Sankeybecame a non-executive director in 1993 and currently serves 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.
Rana Talwarbecame a non-executive director in March 2000 and currently serves on the personnel nomination and treasurynomination committees. He is currently chairman of Sabre Capital.Capital Worldwide and Centurion Bank and a non-executive director of Schlumberger Limited and Fortis Bank. He served as group chief executive of Standard Chartered plc from 1998 until 2001, and was at Citicorp from 1969 to 1997, where he held a number of senior international management roles. He retired from the board at the 2007 AGM.

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Compensation of Senior Managementsenior 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.Committee. The committee also notestakes note of the remuneration for those executives with base pay over a certain level, representing approximately the top 50 executives of the company.
Remuneration Policypolicy
      Pearson seeks to generate a performance culture by developingoperating incentive programs that support its business goals and rewardingreward their achievement. It is the company’s policy that total remuneration (base compensation plus short-term andshort-and long-term incentives) should reward both shortshort- and long-term results, delivering competitive rewards for target performance, but outstanding rewards for exceptional company performance.
      The company’s policy is that base compensation should provide the appropriate rate of remuneration for the job, taking into account relevant recruitment markets and business sectors and geographic regions. Benefit programs should ensure that Pearson retains a competitive recruiting advantage.
      Share ownership is encouraged throughout the company. Equity-based reward programs align the interests of directors, and employees in general, with those of shareholders by linking rewards 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 reflects competitive market level, role and individual contribution. Annual incentives motivate the achievement of annual strategic goals. Bonus share matching encourages executive directors and other senior executives to acquire and hold Pearson shares and aligns executives and shareholders’ interests. Long-term incentives drive long-term earnings and share price growth and value creation and align executives’ and shareholders’ interests.
      Consistent with its policy, the committee places considerable emphasis on the performance-linked elements of remuneration that comprisei.e. annual bonus,incentive, bonus share matching and long-term incentives.
      The committee will continue to review the mix of fixed and performance-linked remuneration on an annual basis, consistent with its overall philosophy.
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 UK companies of comparable size and global reach in different sectors including the media sector insector. Some are of a similar size to Pearson, while others are larger, but the UK andmethod which the committee’s independent advisers use to make comparisons on remuneration takes this into account. All have very substantial overseas operations. We also use selected media companies in North America to make this comparison.America. We use these companies because they represent the wider executive talent pool from which we might expect to recruit externally and the pay market to which we might be vulnerable if our salaries wereremuneration was not competitive.
      Our policy is to review salaries annually.
Other EmolumentsBase salary
      Other emoluments may include benefits such as company car, healthcare,Our normal policy is to review salaries annually, taking into account the remuneration of directors and where relevant, amounts paidexecutives in respectsimilar positions in comparable companies, individual performance and levels of housing costs.pay and pay increases throughout the company.
Allowances and benefits
      It is the company’s policy that its benefit programs should be competitive in the context of the local labor 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.

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Annual Bonusincentives
      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 targetsmeasures relate to the company’s main drivers of business performance at both the corporate and operating company level. Performance is measured separately for each item. For each performance measure, the committee establishes thresholds, targets and maxima for different levels of payout. 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 as agreed with the CEO.
      For 2005,2007, 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.sales and operating cash flow. For subsequent years, the measures will be set at the time.
      For 2005,2007, there are 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 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 incentive plans are discretionary and the committee may award individual discretionary bonuses.reserves the right to make adjustments up or down taking into account exceptional factors.
      The committee will continue to review the bonusannual incentive plans on an annual basiseach year and to revise the bonus limitsperformance measures, targets and targetsindividual incentive opportunities in light of the current conditions.
      In the UK, bonusesAnnual incentive payments do not form part of pensionable earnings.
      For 2006, annual incentives for Marjorie Scardino, David Bell, Rona Fairhead and Robin Freestone were based on the financial performance of Pearson plc. In the US, bonuses upcase of John Makinson, 70% of his annual incentive was based on the performance of Penguin Group and 20% on the financial performance of Pearson plc. In the case of David Bell, Rona Fairhead, Robin Freestone and John Makinson, 10% of their annual incentives was based on performance against personal objectives.
      For Pearson plc, the performance measures were earnings per share growth, operating cash flow, sales and average working capital as a ratio to 50% of base salary are pensionable under the supplemental executive retirement plan,sales. Underlying growth in adjusted earnings per share at constant exchange rates consistent with US market practice.reported adjusted earnings per share of 40.2p was better than target but below the level of performance required for maximum payout. Average working capital as a ratio to sales and operating cash flow of £575m were at and above maximum respectively. Sales at £4,423m were below target but above threshold.
      For Penguin Group, the performance measures were sales, operating profit, operating cash flow and average working capital as a ratio to sales. For working capital as a ratio to sales and operating cash flow, performance was better than that required for maximum payout. Sales and operating profit were both above target but below maximum.
      None of the executive directors was directly covered by the plans for the other operating companies where the same performance measures applied.
Bonus Share Matchingshare matching
      The company encourages executive directors and other senior executives to hold Pearson shares in many ways.

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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 made since 2006, if these shares are held and the company’s adjusted earnings per share increase in real terms by at least 3% per annum compound over a five-year period, the company will match them on a gross basis of one share for every two held after

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one held. Half the matching shares will vest if the company’s adjusted earnings per share increase in real terms by at least 3% per annum compound over the first three years.
      Real growth is measured against the UK Government’s Index of Retail Prices (All Items). We choose to test our earnings per share growth against UK inflation over three and five years and another one for two originally held (i.e. a total of one-for-one) after five years.to measure the company’s financial progress over the period to which the entitlement to matching shares relates.
The Long-Term Incentive Planlong-term incentive plan
      At the annual general meeting in April 2006, shareholders approved the renewal of the long-term incentive plan first introduced in 2001.
      Executive directors, senior executives and other executives and managers are eligible to participate in Pearson’s long-term incentivethe plan introduced in 2001. The plan consists of two parts:which can deliver restricted stock options and/or restricted stock.stock options. The aim is to give the committee a range of tools with which to link corporate performance to management’s long-term reward in a flexible way. It is not the committee’s intention to grant stock options in 2007.
      Restricted stock granted to executive directors vests only when stretching corporate performance targets over a specified period have been met. Awards vest on a sliding scale based on performance over the period. There is no retesting. The principles underlying it are as follows:
• 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;
• awardscommittee determines the performance measures and targets governing an award of restricted stock are satisfied using existing shares.
      For stock options, within this overall 10% limit, up to 1.5% of new issue equity may be placed under option under the plan in any year, subject to the company’s earnings per share performance. No options may be granted unless the company’s adjusted earnings per share increase in real terms by at least 3% per annum over the three-year period prior to grant.
      The vestingperformance measures that applied for 2006 and that will apply for the 2007 awards and subsequently for the executive directors are focused on delivering and improving returns to shareholders. These are relative total shareholder return, return on invested capital and earnings per share growth.
      Pearson wishes to encourage executives and managers to build up a long-term holding of shares so as to demonstrate their commitment to the company. To achieve this, for awards of restricted stock is normally dependent on the satisfaction of a stretching corporatethat are subject to performance targetconditions over a three-year period, 75% of the award vests at the end of the three-year period. The remaining 25% of the award only vests if the participant retains the after-tax number of shares that vest at year three for a further two years.
      The committee establishes each year the expected value of individual awards taking into account assessments by the committee’s independent advisers of market practice for comparable companies, directors’ total remuneration relative to the market and the potential value of awards should the performance target be met in full.
      Restricted stock may be granted without performance conditions to satisfy recruitment and retention objectives. Restricted stock awards that are not subject to performance conditions will not be granted to any of the current executive directors.
      Where shares vest, participants receive additional shares representing the gross value of dividends that would have been paid on these shares during the performance period and reinvested. The expected value of awards made on this basis take this into account.
      In any rolling 10-year period, no more than 10% of Pearson equity will be issued, or be capable of being issued, under all Pearson’s share plans, and no more than 5% of Pearson equity will be issued, or be capable of being issued, under executive or discretionary plans.
Shareholding Policypolicy
      As previously noted, in line with the policy of encouraging widespread employee ownership, the company encourages executive directors as well as other senior management, to build up a substantial shareholding in the company. However,
      Given the share retention features of the annual bonus share matching and long-term incentive plans and the volatility of the stock market, we do not think it is appropriate to specify a particular relationship of shareholding to salary.

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Service Agreementsagreements
      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 the These 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 in some instances they specify the compensation payable by way of liquidated damages in circumstances where the company terminates the agreements without notice or cause. We feel that these notice periods and provisions for liquidated damages are adequate compensation for loss of office and in line with the market. The compensation payable in these circumstances is typically 100% of annual salary, 100% of other benefits and a proportion of potential bonus.
      For health reasons, Peter Jovanovich stood down as a director of the company on January 31, 2005, but remains entitled to contractual short- and long-term disability and other benefits. These arrangements are set out in an agreement dated January 28, 2005 between the company and Mr Jovanovich. The major terms of this agreement are set forth in “Item 10. Additional Information — material contracts”.

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Retirement Benefitsbenefits
      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 JovanovichRobin Freestone will also receive benefits under unapproved arrangements because of the cap on the amount of benefits that can be provided from the approved arrangements in the US and the UK.
      The pension arrangements for all the executive directors include life insurance cover while in employment, and entitlement to a pension in the event of ill-health or disability. A pension for their spouse and/or 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 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 executive directors participate in either the Final Pay or the Money Purchase 2003 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, dependentdependant children and/or nominated financial dependentdependant are payable in the event of death.
      Members of the Pearson Group Pension Plan who joined after May 1989 are subject to an upper limit of earnings that can be used for pension purposes, known as the earnings cap. This limit, £108,600 as at April 5, 2006, was abolished by the Finance Act 2004. However the Pearson Group Pension Plan has retained its own ‘cap’, which will increase annually in line with the UK Government’s Index of Retail Prices (All Items).
      In response to the UK Government’s plans for pensions simplification and so-called‘A-Day’ effective from April 2006, UK executive directors and other members of the Pearson Group Pension Plan who are, or become, affected by the lifetime allowance were offered a cash supplement as an alternative to further accrual of pension benefits on a basis that is broadly cost neutral to the company.
Marjorie Scardino
      Marjorie Scardino participates in the Pearson Inc. Pension Plan and the approved 401(k) plan.
      Additional pension benefits will be provided through an unfunded unapproved defined contribution plan and a funded defined contribution plan approved by the UK InlandHM Revenue and Customs as a corresponding schemeplan to

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replace part of the unfunded plan. The account balance of the unfunded unapproved defined contribution plan is determined by reference to the value of a notional cash account that increases annually by a specified notional interest rate. This plan provides the opportunity to convert a proportion of this notional cash account into a notional share account reflecting the value of a number of Pearson ordinary shares. The number of shares in the notional share account is determined by reference to the market value of Pearson shares at the date of conversion.
David Bell
      David Bell is a member of the Pearson Group Pension Plan. He is eligible for a pension of two-thirds of his final base salary at age 62 due to his long service but early retirement with a reduced pension before that date is possible, subject to company consent.
Rona Fairhead
      Rona Fairhead is a member of the Pearson Group Pension Plan. Her pension accrual rate is 1/30th of pensionable salary per annum, restricted to the plan earnings cap introduced bycap.
      Until April 2006, the Finance Act 1989. The company also contributescontributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on her behalf. In the event of death before retirement, the proceeds of the FURBS account will be used to provide benefits for her dependants. Since April 2006, she has received a taxable and non-pensionable cash supplement in replacement of the FURBS.

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Peter JovanovichRobin Freestone
      Peter JovanovichRobin Freestone 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 accrualMoney Purchase 2003 section of 2% of final average earnings, less benefits accrued in the Pearson Inc.Group Pension Plan and US Social Security. He ceasedPlan. Company contributions are 16% of pensionable salary per annum, restricted to build up further benefits in the SERP at December 31, 2002. Additional defined contribution benefits are provided throughplan earnings cap.
      Until April 2006, the company also contributed to a funded, unapproved 401(k) excess plan and an unfunded, unapproved arrangement.Funded Unapproved Retirement Benefits Scheme (FURBS) on his behalf. In the event of death while in receiptbefore retirement, the proceeds of disability benefits, the FURBS account balances in the defined contribution arrangements will be used to provide benefits for his dependants. The SERP arrangement providesSince April 2006, he has received a spouse’s pension on death whiletaxable and non-pensionable cash supplement in receiptreplacement of disability benefits and the option of a death in retirement pension by reducing the member’s pension.FURBS.
John Makinson
      John Makinson is a member of the Pearson Group Pension Plan under which his pensionable salary is restricted to the plan earnings cap. The company ceased contributions on December 31, 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 pensionspension payable from the Pearson Group Pension Plan and the closed FURBS to target a pension of two-thirds of a revalued base salary on retirement at age 62. The revalued base salary is defined as £450,000 effective at June 1, 2002, increased at January 1, each year by reference to the increase in the UK Government’s Index of Retail Prices.Prices (All Items). In the event of his death a pension from the Pearson Group Pension Plan, the FURBS and the UURBS will be paid to his spouse or nominated financial dependant. Early retirement is possible from age 50, with company consent. The pension is reduced to reflect the shorter service, and before age 60, further reduced for early payment.
Executive directors’ non-executive directorships
      Our policy is that executive directors may, by agreement with the board, serve as non-executives of other companies and retain any fees payable for their services.
      The following executive directors served as non-executive directors elsewhere for the period covered by this report as follows: Marjorie Scardino (Nokia Corporation and MacArthur Foundation); David Bell (VITEC Group plc); Rona Fairhead (HSBC Holdings plc); Robin Freestone (eChem) and John Makinson (George Weston Limited).

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Chairman’s Remunerationremuneration
      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
      In accordance with the terms of his appointment, the committee intends to review the chairman’s remuneration in 2007. Any change to current remuneration is eligiblesubject to participate in the company’s worldwide save for shares plan on the same terms as all other eligible employees.
      For 2004, the committee’s view was that, taking into account the remuneration of chairmen in comparable positions, the appropriate total pay level was £425,000 per year.
      Having been informedapproval 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 thefull 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.
      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 2005.2007.
Non-executive DirectorsNon-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. The level and structure of non-executive directors’ fees effective from January 2005 is as follows:

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Fees payable from
January 1, 2005
(£)
Basic non-executive director fee45,000
Chairmanship of audit and personnel committees10,000
Membership of audit and personnel committees5,000
Senior independent director’s fee10,000
Overseas meetings (per meeting)2,500
      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, £10,000One-third of the totalbasic fee, or all of the entire fee in the case of Rana Talwar, was payableis paid in the form of Pearson shares whichthat the non-executive directors have committed to retain for the period of their directorships.
      For 2005, the chairman and the executive directors of thePatrick Cescau’s fee is paid over to his employer.
      The board reviewedintends to review 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, an increase in the fee for the committee chairmen, the introduction of separate fees for committee membership and the senior independent director and the replacement of the fee for non-UK based directors with a fee for overseas meetings. One-third of the basic fee will be paid in Pearson shares. Full details2007. Any changes to existing arrangements will be set out in the report on directors’ remuneration for 2005.2007.
      Non-executive directors serve Pearson under letters of appointment and do not have service contracts. There is no entitlement to compensation on the termination of their directorships.
Remuneration of Senior Managementsenior management
      Excluding contributions to pension funds and related benefits, senior management remuneration for 20042006 was as follows:
                    
            Salaries/ Annual      
 Salaries/Fees Bonus(1) Other(2) Total Fees incentive(1) Allowances(2) Benefits Total
                  
 £’000 £’000 £’000 £’000 £000 £000 £000 £000 £000
Chairman
                             
Dennis Stevenson  325      325 
Glen Moreno  425        425 
Executive directors
                             
Marjorie Scardino  645  831  62  1,538   830  1,067  50  15  1,962 
David Bell  375  483  16  874   425  512    17  954 
Rona Fairhead  390  503  14  907   470  573    19  1,062 
Peter Jovanovich  473  571  8  1,052 
Robin Freestone (appointed June 12, 2006)  209  243    8  460 
John Makinson  460  119  212  791   490  627  183  26  1,326 
                    
Senior management as a group
  2,668  2,507  312  5,487   2,849  3,022  233  85  6,189 
                    

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(1) For Marjorie Scardino, David Bell and Rona Fairhead, bonuses were related to the performance of Pearson plc.full year, Robin Freestone’s remuneration was: salary/fees — £315,170; annual incentive — £329,438; benefits — £13,980; total — £658,588.
      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, growth in adjusted earnings per share at constant exchange rates and average working capital as a ratio to sales were above maximum, and growth in underlying 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 margin were above target but below maximum.
      For Penguin Group, growth in underlying sales, operating margin, working capital as a ratio to sales and operating cash conversion were below threshold.
      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, in the case ofAllowances for Marjorie Scardino include £37,955£40,190 in respect of housing costs.costs and a US payroll supplement of £9,646. John Makinson is entitled to a location and market premium in relation to the management of the business of the Penguin Group in the US. HeUS and received £184,517£183,125 for 2004.2006.
(3) Benefits include company car, car allowance and health care. Marjorie Scardino, Rona Fairhead, David Bell and John Makinson have the use of a chauffeur.
(4) No amounts as compensation for loss of office and no expense allowances chargeable to UK income tax were paid during the year.
Share Optionsoptions of Senior Managementsenior management
      This table sets forth for each director the number of share options held as of December 31, 20042006 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 Stevenson3,556b494.8p01/08/1101/02/12
Total
3,556
Marjorie ScardinoScardino(2)  176,556   a*  974p973.3p   09/14/09/01   09/14/09/08 
   5,660   a*  1090p1090.0p   09/14/09/01   09/14/09/08
2,839b687p01/08/0501/02/06
2,224b425p01/08/0601/02/07 
   37,583   c*  1373p1372.4p   06/08/06/02   06/08/06/09 
   37,583   c*  1648p1647.5p   06/08/06/02   06/08/06/09
37,583c1922p08/06/0208/06/09 
   36,983   c   2764p3224.3p   05/03/05/03   05/03/05/10
36,983c3225p03/05/0303/05/10 
   41,550   d*  1421p1421.0p   05/09/05/02   05/09/05/11 
   41,550   d*  1421p1421.0p   05/09/05/03   05/09/05/11 
   41,550   d*  1421p1421.0p   05/09/05/04   05/09/05/11 
   41,550   d*  1421p1421.0p   05/09/05/05   05/09/05/11 
                
Total
  540,194460,565                
                
David Bell  20,496   a*  974p973.3p   09/14/09/01   09/14/09/08
184b*913p01/08/0401/02/05
202b*957p01/08/0401/02/05
272b696p01/08/0501/02/06
444b425p01/08/0601/02/07 
   1,142   b   494.8p   08/01/08/07   02/01/08
373b507.6p08/01/0802/0801/09
297b629.6p08/01/0902/01/10 
   18,705   c*  1373p1372.4p   06/08/06/02   06/08/06/09 
   18,705   c*  1648p1647.5p   06/08/06/02   06/08/06/09
18,705c1922p08/06/0208/06/09 
   18,686   c   2764p3224.3p   05/03/05/03   05/03/05/10
18,686c3225p03/05/0303/05/10 
   16,350   d*  1421p1421.0p   05/09/05/02   05/09/05/11 
   16,350   d*  1421p1421.0p   05/09/05/03   05/09/05/11 
   16,350   d*  1421p1421.0p   05/09/05/04   05/09/05/11 
   16,350   d*  1421p1421.0p   05/09/05/05   05/09/05/11 
                
Total
  181,627143,804
Rona Fairhead1,904b494.8p08/01/0702/01/08
20,000d*822.0p11/01/0211/01/11
20,000d*822.0p11/01/0311/01/11
20,000d*822.0p11/01/0411/01/11
Total
61,904                
                

5351


                     
  Number of   Exercise Earliest  
Director 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 
   102,520   a*  677p   12/09/00   12/09/07 
   32,406   c   1373p   08/06/02   08/06/09 
   32,406   c   1648p   08/06/02   08/06/09 
   32,406   c   1922p   08/06/02   08/06/09 
   33,528   c   2764p   03/05/03   03/05/10 
   33,528   c   3225p   03/05/03   03/05/10 
   31,170   d* $21.00   09/05/02   09/05/11 
   31,170   d* $21.00   09/05/03   09/05/11 
   31,170   d* $21.00   09/05/04   09/05/11 
   31,170   d  $21.00   09/05/05   09/05/11 
   19,998   d* $11.97   01/11/02   01/11/11 
   19,998   d* $11.97   01/11/03   01/11/11 
   20,004   d  $11.97   01/11/04   01/11/11 
                
Total
  459,724                
                
John Makinson  20,160   a*  487p   20/04/98   20/04/05 
   36,736   a*  584p   08/08/99   08/08/06 
   73,920   a*  677p   12/09/00   12/09/07 
   30,576   a*  974p   14/09/01   14/09/08 
   4,178   b   425p   01/08/10   01/02/11 
   21,477   c   1373p   08/06/02   08/06/09 
   21,477   c   1648p   08/06/02   08/06/09 
   21,477   c   1922p   08/06/02   08/06/09 
   21,356   c   2764p   03/05/03   03/05/10 
   21,356   c   3225p   03/05/03   03/05/10 
   19,785   d*  1421p   09/05/02   09/05/11 
   19,785   d*  1421p   09/05/03   09/05/11 
   19,785   d*  1421p   09/05/04   09/05/11 
   19,785   d   1421p   09/05/05   09/05/11 
                
Total
  351,853                
                
Number ofExerciseEarliest
DirectorOptions(1)PriceExercise DateExpiry Date
Robin Freestone1,866b507.6p08/01/0802/01/09
Total
1,866
John Makinson73,920a*676.4p09/12/0009/12/07
30,576a*973.3p09/14/0109/14/08
4,178b424.8p08/01/1002/01/11
21,477c*1372.4p06/08/0206/08/09
21,477c*1647.5p06/08/0206/08/09
21,356c3224.3p05/03/0305/03/10
19,785d*1421.0p05/09/0205/09/11
19,785d*1421.0p05/09/0305/09/11
19,785d*1421.0p05/09/0405/09/11
19,785d*1421.0p05/09/0505/09/11
Total
252,124
 
(1) 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,The plans under which these options were granted were replaced with the introduction of the long-term incentive plan in 2001. No executive options becomehave been granted to the directors since 1998. All options that remain outstanding are exercisable on the third anniversary of the date of grant(all performance conditions having already been met prior to 2005) 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 exercisetenth anniversary 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.date of grant.
bWorldwide save for shares
 The acquisition of shares under the worldwide save for shares plan is not subject to the satisfaction of a performance target.
cPremium priced
 Subject toThe plan under which these options were granted was replaced with the performance conditions being met,introduction of the long-term incentive plan in 2001. No Premium Priced Options (PPOs) have been granted to the directors since 1999. The share price targets for the three-year and five-year tranches of PPOs granted in 1999 have already been met prior to 2006. The share price target for the seven-year tranche of PPOs granted in 1999 was not met in 2006 and the options lapsed. The share price target for the outstanding PPOs granted in 2000 has yet to be met. The secondary real growth in earnings per share target for any PPOs to become exercisable onhas already been met prior to 2006.
All PPOs that remain outstanding lapse if they remain unexercised at the thirdtenth anniversary of the date of grantgrant.
dLong-term incentive
All options that remain outstanding are exercisable and lapse if they remain unexercised at the tenth.
PPOs were granted in three tranches. For these to become exercisable, the Pearson share price has to stay above the option price for 20 consecutive days within three, five and seven years respectively. In addition, for options to be exercisable, the company’s adjusted earnings per share have to increase in real terms by at least 3% per annum over the three-year period prior to exercise.
d       Long-term incentive
Options granted in 2001 were based on pre-grant earnings per share growth of 75% against a target of 16.6% over the period 1997 to 2000 and are not subject to further performance conditions on exercise.
Long-term incentive options granted on May 9, 2001 become exercisable in tranches on the first, second, third and fourthtenth 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, Marjorie Scardino contributes US$1,000 per month (the maximum allowed) to the above listed optionsUS employee stock purchase plan. The terms of this plan allow participants to make monthly contributions for one year and to acquire shares at the end of that period at a price that is the lower of the market price at the beginning or the end of the period, both Marjorie Scardino and Peter Jovanovich participate in the Pearson US Employee Stock Purchase Plan saving the maximum amount of US$12,000 per annum.less 15%.
Share Ownershipownership of Senior Managementsenior management
      The table below sets forth the number of ordinary shares and restricted shares held by each of our directors as at March 31, 2005.2007. Additional information with respect to share options held by, and bonus

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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, 20052007 was 571,754734,913 representing less than 1% of the issued share capital on March 31, 2005.2007.
                
As at March 31, 2005 Ordinary Shares(1) Restricted Shares(2)
     Ordinary Restricted
Dennis Stevenson  168,190  30,000 
As at March 31, 2007 shares(1) shares(2)
    
Glen Moreno  110,000   
Marjorie Scardino  145,044  975,648   216,777  1,668,675 
David Arculus (appointed February 28, 2006)  1,317   
David Bell  84,106  455,969   109,578  658,625 
Terry Burns  4,432     7,349   
Patrick Cescau       2,758   
Rona Fairhead  15,660  444,803   62,593  750,046 
Robin Freestone (appointed June 12, 2006)  2,089  153,435 
Susan Fuhrman  992     4,163   
Ken Hydon (appointed February 28, 2006)  6,317   
John Makinson  124,127  511,184   172,872  724,562 
Reuben Mark  15,245   
Vernon Sankey  4,287   
Rana Talwar  9,671   
Reuben Mark (resigned April 21, 2006)  16,908   
Vernon Sankey (resigned April 21, 2006)  5,563   
Rana Talwar (resigned April 27, 2007)  18,683   
 
(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 andlong-term incentive plans. The number of shares shown represents the maximum number of shares which may vest, subject to the performance conditions being fulfilled.
Employee Share Ownership Plansshare ownership plans
Worldwide Savesave for Sharesshares & US Employee Share Purchase Plansemployee 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 part-time, fourapart-timenon-executive, five executive directors and six (this will be 5 following the resignation of Rana Talwar after April 27, 2007)non-executive directors. Our articles of association provide that at every annual general meeting,one-third of the board of directors, or the number nearest toone-third, shall retire from office. The directors to retire each year are the directors who have been longest in office since their last election or appointment. A retiring director is eligible forre-election. If at any annual general meeting, the place of a retiring director is not filled, the retiring director, if willing, is deemed to have beenre-elected, unless at or prior to such meeting it is expressly resolved not to fill the vacated office, or unless a resolution for there-election of that director has been put to the meeting and

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lost. Our articles of association also provide that every director be subject tore-appointment by shareholders at the next annual general meeting following their appointment.
      Details of our approach to corporate governance and an account of how we comply with NYSE requirements can be found on our website (www.pearson.com/investor/corpgov.htm).
      The board of directors has established the following committees, all of which have written terms of reference setting out their authority and duties:
Audit Committeecommittee
      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. Vernon SankeyKen Hydon chairs this committee and its other members are David Arculus, Patrick Cescau and Susan Fuhrman. Ken Hydon is also the designated audit committee financial expert within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission. Our internal and external auditors have direct access to the committee to raise any matter of concern and to report the results of work directed by the committee. The committee reports to the full board of directors.
Personnel Committeecommittee
      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. David Arculus chairs this committee and its other members are Terry Burns, Rana Talwar and, since 1 January 2007, Glen Moreno.

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Nomination Committeecommittee
      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 thenon-executive directors.
Treasury Committeecommittee
      ThisFollowing a review of the board committees by the new chairman during 2006, it was decided to disband the treasury committee, is chaired by Dennis Stevensondividing its responsibilities between the board (with regard to approval of treasury policies) and also comprises Rona Fairhead, Vernon Sankey and Rana Talwar. Thethe audit committee sets the policies for our treasury department and reviews its procedures on a regular basis.(to monitor compliance with these policies).
Employees
      The average numbers of persons employed by us during each of the three fiscal years ended 20042006 were as follows:
 • 33,38934,341 in fiscal 20042006
 
 • 30,86832,203 in fiscal 2003,2005, and
 
 • 30,35933,086 in fiscal 2002.2004.
      We, through our subsidiaries, have entered into collective bargaining agreements with employees in various locations. Our management has no reason to believe that we would not be able to renegotiate any such agreements on satisfactory terms. We encourage employees to contribute actively to the business in the context of their particular job roles and believe that the relations with our employees are generally good.

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      The table set forth below shows for 2006, 2005 and 2004 the average number of persons employed in each of our operating divisions in the United Kingdom, the United States, other locations and in total.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 2006 2005 2004
       
School  11,064   10,133   10,403 
Higher Education  4,368   4,196   4,087 
Professional  3,754   3,809   3,368 
Penguin  3,943   4,051   4,085 
FT Publishing  2,285   1,952   1,989 
IDC  2,200   1,956   1,826 
Other  1,669   1,573   1,365 
Continuing operations  29,283   27,670   27,123 
          
Discontinued operations  5,058   4,533   5,963 
          
Total  34,341   32,203   33,086 
          
ITEM 7.MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
      To our knowledge, as of March 31, 2005,February 28, 2007, the only beneficial owners of 3% or more of our issued and outstanding ordinary share capital were The Capital Group CompaniesFranklin Resources Inc. which owned 120,639,432103,908,285 ordinary shares representing 15.0%12.9% of our outstanding ordinary shares, Franklin Resources Inc.FMR Corp. and Fidelity International Limited which owned 96,437,79449,800,888 ordinary shares representing 12.0%6.2% of our outstanding ordinary shares and Legal and General Group plc which owned 24,046,75928,868,364 ordinary shares representing 3.0%3.6% of our outstanding ordinary shares. On March 31, 2005,February 28, 2007, record holders with registered addresses in the United States held 20,196,87736,623,444 ADRs, which represented 2.5%4.5% of our outstanding ordinary shares. Because some of these ADRs are held by nominees, these numbers may not accurately represent the number of beneficial owners in the United States.
      Loans and equity advanced to joint ventures and associates during the year and as at December 31, 20042006 are shown in notesnote 13 and 14 in “Item 17. Financial Statements.”. Amounts due from joint ventures and associates are set out in note 1719 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 2004.2006.

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ITEM 8.FINANCIAL INFORMATION
      The financial statements filed as part of this Annual Report are included on pages F-1 through F-69F-70 hereof.
      Other than those events described in note 3135 in “Item 17. Financial Statements” of this Form 20-F and seasonal fluctuations in borrowings, there has been no significant change to our financial condition or results of operations since December 31, 2003.2006. Our borrowings fluctuate by season due to the effect of the school year on the working capital requirements of the educational book business. Assuming no acquisitions or disposals, our maximum level of net debt normally occurs in July, and our minimum level of net debt normally occurs in December.
      Our policy with respect to dividend distributions is described in response to “Item 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

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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.
      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.
              
  Ordinary  
  shares  
    Average daily
Reference period High Low trading volume
       
    (Ordinary shares)
  (In pence)  
Five most recent fiscal years
            
 2006  811   671   5,004,500 
 2005  695   608   5,296,700 
 2004  682   579   6,219,200 
 2003  680   430   6,631,800 
 2002  922   505   6,164,500 
Most recent quarter and two most recent fiscal years
            
 2007 First quarter  842   762   5,864,200 
 2006 Fourth quarter  796   742   3,979,500 
 Third quarter  767   689   3,900,700 
 Second quarter  798   688   5,728,800 
 First quarter  812   671   6,395,400 
 2005 Fourth quarter  692   616   4,947,900 
 Third quarter  695   652   4,860,700 
 Second quarter  668   628   5,823,300 
 First quarter  662   608   5,626,100 
Most recent six months
            
 March 2007  872   783   8,538,000 
 February 2007  834   790   4,812,500 
 January 2007  842   762   6,380,300 
 December 2006  781   742   4,378,900 
 November 2006  789   751   3,509,000 
 October 2006  796   761   4,099,600 

5856


               
  Ordinary Shares  
    Average Daily
Reference Period High Low Trading Volume
       
    (Ordinary
  (In pence) shares)
Five Most Recent Fiscal Years
            
 2004  682   579   6,219,200 
 2003  680   430   6,631,800 
 2002  922   505   6,164,500 
 2001  1,726   645   5,245,000 
 2000  2,302   1,470   2,686,700 
Most Recent Quarter and Two Most Recent Fiscal Years
            
2005 First quarter  662   608   5,626,100 
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 
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 
ITEM 10.ADDITIONAL INFORMATION
Memorandum and Articlesarticles of Associationassociation
      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
Directors’ powers
      Our business shall be managed by the board of directors and the board may exercise all such of our powers as are not required by law or by the Articles of Association to be exercised by resolution of the shareholders in general meeting.
Interested Directors
Interested directors
      A director shall not be disqualified from contracting with us by virtue of his or her office or from having any other interest, whether direct or indirect, in any contract or arrangement entered into by or on behalf of us. An interested director must declare the nature of his or her interest in any contract or arrangement entered into by or on behalf of us in accordance with the Companies Act 1985. Provided that the director has declared his interest and acted in accordance with law, no such contract or arrangement shall be avoided and no

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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 orsub-underwriting of which a director is to participate;
 
 • any proposal relating to an arrangement for the benefit of our employees or any of our subsidiaries that does not award him or her any privilege or benefit not generally awarded to the employees to whom such arrangement relates; and
 
 • any proposal concerning insurance that we propose to maintain or purchase for the benefit of directors or for the benefit of persons, including directors.

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      Where proposals are under consideration concerning the appointment of two or more directors to offices or employment with us or any company in which we are interested, these proposals may be divided and considered separately and each of these directors, if not prohibited from voting under the proviso of the fourth clause above, will be entitled to vote and be counted in the quorum with respect to each resolution except that concerning his or her own appointment.
Borrowing Powers
Borrowing powers
      The board of directors may exercise all powers to borrow money and to mortgage or charge our undertaking, property and uncalled capital and to issue debentures and other securities, whether outright or as collateral security for any of our or any third party’s debts, liabilities or obligations. The board of directors must restrict the borrowings in order to secure that the aggregate amount of undischarged monies borrowed by us (and any of our subsidiaries), but excluding anyintra-group debts, shall not at any time exceed a sum equal to twice the aggregate of the adjusted capital and reserves, unless the shareholders in general meeting sanction an excession of this limitation.
Other Provisions Relating to Directors
Other provisions relating to directors
      Under the articles of association, directors are paid out of our funds for their services as we may from time to time determine by ordinary resolution and, in the case ofnon-executive directors, up to an aggregate of £500,000 or such other amounts as resolved by the shareholders at a general meeting. Directors currently are not required to be qualified by owning our shares. WhileChanges to the Companies Act, 1985 states that nowhich came into force on April 7, 2007, now permit the appointment of a director may be appointed after he reaches the age of 70 our articles of association provide for the reappointment, after retirement, of directors attaining the age of 70. This is permissible under the Companies Act 1985.or over.

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Annual General Meetings and Extraordinary General Meetings
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 ofone-third of the members of the board of directors at every annual general meeting, the appointment or election of directors in the place of those retiring by rotation or otherwise;
 
 • appointment or reappointment of, and determination of the remuneration of, the auditors; and
 
 • the renewal, limitation, extension, variation or grant of any authority of or to the board, pursuant to the Companies Act 1985, to allot securities.
      Business transacted at an extraordinary general meeting may also be transacted at an annual general meeting.
      We hold a general meeting as our annual general meeting within fifteen months after the date of the preceding annual general meeting, at a place and time determined by the board. The board may call an extraordinary general meeting at any time and for any reason. The board must convene an extraordinary general meeting if requested to do so by shareholders holding not less thanone-tenth of our issued share capital.
      Three shareholders present in person and entitled to vote will constitute a quorum for any general meeting. If a quorum for a meeting convened at the request of shareholders is not present within fifteen minutes of the appointed time, the meeting will be dissolved. In any other case, the general meeting will be adjourned to the same day in the next week, at the same time and place, or to a time and place that the chairman fixes. If at that rescheduled meeting a quorum is not present within fifteen minutes from the time

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appointed for holding the meeting, the shareholders present in person or by proxy will be a quorum. The chairman or, in his absence, the deputy chairman or any other director nominated by the board, will preside as chairman at every general meeting. If no director is present at the general meeting or no director consents to act as chairman, the shareholders present shall elect one of their number to be chairman of the meeting.
Ordinary Shares
Ordinary shares
      Certificates representing ordinary shares are issued in registered form and, subject to the terms of issue of those shares, are issued following allotment or receipt of the form of transfer bearing the appropriate stamp duty by our registrar, Lloyds Bank Registrars, theThe Causeway, Worthing, West Sussex BN99 6DA, United Kingdom, telephone number +44-1903-502-541.
Share Capital
Share capital
      Any share may be issued with such preferred, deferred or other special rights or other restrictions as we may determine by way of a shareholders’ 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.
Changes in Capital
Changes in capital
      We may from time to time, by ordinary resolution:
 • consolidate and divide our share capital into shares of a larger amount than its existing shares; or
 
 • sub-divide all of or any of our existing shares into shares of smaller amounts than is fixed by the Memorandum of Association, subject to the Companies Act 1985; or
 
 • cancel any shares which, at the date of passing of the resolution, have not been taken, or agreed to be taken, by any person and diminish the amount of our share capital by the amount of the shares so cancelled.
      We may, from time to time, by ordinary resolution increase our share capital and, by special resolution, decrease our share capital, capital redemption reserve fund and any share premium account in any way.
Voting Rights
Voting rights
      Every holder of ordinary shares present in person at a meeting of shareholders has one vote on a vote taken by a show of hands. On a poll, every holder of ordinary shares who is present in person or by proxy has one vote for every ordinary share of which he or she is the holder. Voting at any meeting of shareholders is by a show of hands unless a poll is properly demanded before the declaration of the results of a show of hands. A poll may be demanded by:
 • the chairman of the meeting;
 
 • at least three shareholders present in person or by proxy and entitled to vote;
 
 • any shareholder or shareholders present in person or by proxy representing not less thanone-tenth of the total voting rights of all shareholders having the right to vote at the meeting; or

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 • any shareholder or shareholders present in person or by proxy holding shares conferring a right to vote at the meeting being shares on which the aggregate sum paid up is equal to not less thanone-tenth of the total sum paid up on all shares conferring that right.
Dividends
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
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
Other provisions of the articles of association
      Whenever our capital is divided into different classes of shares, the special rights attached to any class may, unless otherwise provided by the terms of the issue of the shares of that class, be varied or abrogated, either with the written consent of the holders ofthree-fourths of the issued shares of the class or with the sanction of an extraordinary resolution passed at a separate meeting of these holders.
      In the event that a shareholder or other person appearing to the board of directors to be interested in ordinary shares fails to comply with a notice requiring him or her to provide information with respect to their interest in voting shares pursuant to section 212 of the Companies Act 1985, we may serve that shareholder with a notice of default. After service of a default notice, that shareholder shall not be entitled to attend or vote at any general meeting or at a separate meeting of holders of a class of shares or on a poll until he or she has complied in full with our information request.
      If the shares described in the default notice represent at leastone-fourth of 1% in nominal value of the issued ordinary shares, then the default notice may additionally direct that in respect of those shares:
 • we will not pay dividends (or issue shares in lieu of dividends); and
 
 • we will not 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%,

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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
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 Contractscontracts
      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
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$350m principal amount of 4.70% senior notes due 2009 and $400 million$400m 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 firstsemi-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.
Issuance of $300,000,000 4.625% Senior Notes due 2018
Issuance of $300,000,000 4.625% Senior Notes due 2018
      We issued $300 million$300m principal amount of 4.625% senior notes due 2018 under an indenture dated June 23, 2003 between us and The Bank of New York, as trustee. The firstsemi-annual interest payment was made on December 15, 2003. We may redeem the notes at any time, in whole or in part, at our option.
      The indenture describes the circumstances that would be considered events of default. If an event of default occurs, other than the insolvency or bankruptcy of us or a principal subsidiary (as defined in the indenture), the holders of at least 25% of the principal amount of the then outstanding notes may declare the notes, along with accrued, but unpaid, interest and other amounts described in the indenture, as immediately due and payable.
      The indenture limits our ability to create liens to secure certain types of debt intended to be listed or traded on an exchange.

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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
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 Controlscontrols
      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 Considerationsconsiderations
      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,
 
 • 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

65


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

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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
UK income taxation of distributions
      The United Kingdom does not impose dividend withholding tax on dividends paid to US holders.
US Income Taxation of Distributions
US income taxation of distributions
      Distributions that we make with respect to the ordinary shares or ADSs, other than distributions in liquidation and distributions in redemption of stock that are treated as exchanges, will be taxed to US holders as ordinary dividend income to the extent that the distributions do not exceed our current and accumulated earnings and profits. The amount of any distribution will equal the amount of the cash distribution. Distributions, if any, in excess of our current and accumulated earnings and profits will constitute anon-taxable return of capital to a US holder and will be applied against and reduce the US holder’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 20092011 will be taxed as net capital gain at a maximum rate of 15%, provided certain holding periods are met, to the extent such distribution is treated as a dividend under U.S. federal income tax principles.
UK Income Taxation of Capital Gains
UK income taxation of capital gains
      Under the New Income Tax Treaty, each country generally may tax capital gains in accordance with the provisions of its domestic law. Under present UK law, a US holder that is not a resident, and, in the case of an individual, not ordinarily resident, in the United Kingdom for UK tax purposes and who does not carry on a trade, profession or vocation in the United Kingdom through a branch or agency to which ordinary shares or ADSs are attributable will not be liable for UK taxation on capital gains or eligible for relief for allowable losses, realized on the sale or other disposal (including redemption) of these ordinary shares or ADSs.

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US Income Taxation of Capital Gains
US income taxation of capital gains
      Upon a sale or exchange of ordinary shares or ADSs to a person other than Pearson, a US holder will recognize gain or loss in an amount equal to the difference between the amount realized on the sale or exchange and the US holder’s adjusted tax basis in the ordinary shares or ADSs. Any gain or loss recognized will be capital gain or loss and will belong-term capital gain or loss if the US holder has held the ordinary shares or ADSs for more than one year.Long-term capital gain of a noncorporate US holder is generally taxed at a maximum rate of 15%. Thislong-term capital gain rate is scheduled to expire in 2009.2011.
      Gain or loss realized by a US holder on the sale or exchange of ordinary shares or ADSs generally will be treated asUS-source gain or loss for US foreign tax credit purposes.

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Estate and Gift Tax
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
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
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 Displaydisplay
      Copies of our Memorandum and Articles of Association, the material contracts described above and filed as exhibits to this Annual Report and certain other documents referred to in this Annual Report are available for inspection at our registered office at 80 Strand, London WC2R 0RL (c/o the Company Secretary), or, in the United States, at the registered office of Pearson Inc. at 1330 Avenue of the Americas, 7th Floor, New York, New York, during usual business hours upon reasonable prior request.

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ITEM 11.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Introduction
      Our principal market risks are changes in interest rates and currency exchange rates. Following an evaluation of these positions, we selectively enter into derivative financial instruments to manage our risk exposure. For this purpose, we primarily use interest rate swaps, interest rate caps and collars, forward rate agreements, currency swaps and forward foreign exchange contracts. Managing market risks is the responsibility of the Chief Financial Officer, who acts pursuant to policies approved by ourthe board of directors. A TreasuryThe Audit Committee of the board receives regular reports on our treasury activities, which outsideand we periodically meet with external advisers alsoto review periodically.our activities.

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      We have a policy of not undertaking any speculative transactions, and we do not hold theour derivative and other financial instruments for purposes other than trading.trading purposes.
      We have formulated our policies for hedging exposures to interest rate and foreign exchange risk, and have used derivatives to ensure compliance with these policies. Although the majority of our derivative contracts were transacted without regard to existing US GAAP requirements on hedge accounting, during 20042006 and 2005 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 note 19 in “Item 17. Financial Statements” for discussion of treasury policy in these areas.
Interest Ratesrates
      OurThe Group’s financial exposuresexposure to interest rates arisearises primarily from our borrowings, particularly those in US dollars. We manage ourits borrowings. The Group manages its exposure by borrowing at fixed and variable rates of interest, and by entering into derivative instruments.transactions. Objectives approved by ourthe board concerning the proportion of debt outstanding at fixed rates govern ourthe use of these financial instruments.
      OurThe Group’s objectives are applied to core net debt, which is measured at the year-end and comprises borrowings net of year-end cash and other liquid funds. Those objectives are that for between 40% and 65%Our objective is to maintain a proportion of currentforecast core net debt the rate of interest should bein fixed or capped form for the next four years. Within this target range the proportionyears, subject to a maximum of 65% and a minimum that is hedged is triggeredstarts at 40% and falls by a formula based on historical interest rate frequencies.10% each year.
      The principal method to hedgeof hedging interest rate risk is to enter into an agreement with a bank counterparty to pay a fixed-rate and receive a variable rate, known as a swap. Under interest rate swaps, we agreethe Group agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and variable-rate amounts calculated by reference to an agreed notional principal amount. The majority of thesethe company’s swap contracts are US dollar denominated, and some of them have deferred start dates, in order to maintain the desired risk profile as other contracts mature. The variable rates received are normally based on three-month andor six-month LIBOR, and the dates on which these rates are set do not necessarily exactly match those of the hedged borrowings. We believeManagement believes that our portfolio of these types of swaps is an efficient hedge of our portfolio of variable rate borrowings.
      In addition, from time to time, we issuethe Group issues bonds or other capital market instruments to refinance existing debt. To avoid the fixed rate on a single transaction unduly influencing our overall net interest expense, itour practice is our normal practice to enter into a related derivative contract effectively converting the interest rate profile of the bond transaction to that of the debt which it is refinancing. Most often this is a variable interest rate denominated in US dollars.rate. In severalsome cases, the bond issue was denominated in a different currency thanto the debt being refinancedGroup’s desired borrowing risk profile and we havethe Group entered into a related cross currency interest rate and currency swap in order to maintain an unchanged borrowingthis risk profile.profile, which is predominantly borrowings denominated in US dollars.
      The Group’s accounting objective in its use of interest rate derivatives is to minimize the impact on the income statement of changes in the mark-to-market value of its derivative portfolio as a whole. It uses duration calculations to estimate the sensitivity of the derivatives to movements in market rates. The Group also identifies which derivatives are eligible for fair value hedge accounting (which reduces significantly the income statement impact of changes in the market value of a derivative). The Group then divides the total portfolio betweenhedge-accounted and pooled segments, so that the expected movement on the pooled segment is minimized.
Currency Exchange Ratesexchange 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.

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      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 externalprofit (from February 2007, the policy is amended slightly to align core net borrowings with forecast operating profit before depreciation and currency swaps to manage this exposure.amortization). This policy aims to dampen the impact of

65


changes in foreign exchange rates on consolidated interest cover and earnings. While long-term core borrowingThis policy applies only to currencies that account for more than 15% of group operating profit, which currently is now limited toonly the US dollars, euro and sterling, wedollar. However, the Group still borrowborrows small amounts in other currencies, typically for seasonal working capital needs.
In addition, the Group currently expects to hold its legacy borrowings in euros and sterling to their maturity dates: the Group’s policy does not require existing currency debt to be terminated to match declines in that currency’s share of group operating profit. At December 31, 20042006 the splitGroup’s net borrowings/(cash) in our main currencies (taking into account the effect of aggregate net borrowings in core currencies wascross currency rate swaps) were: US dollar 88%,£979m, euro 7%£158m and sterling 5%. We are also exposed£30m.
      The Group uses both currency denominated debt and derivative instruments to implement the above policy. Its intention is that gains/losses on the derivatives and debt offset the losses/gains on the foreign currency assets and income. Each quarter the value of hedging instruments is monitored against the assets in the relevant currency and, where practical, a decision is made whether to treat the debt or derivative as a net investment hedge (permitting foreign exchange rates in our cash transactionsmovements on it to be taken to reserves) for the purposes of reporting under IFRS and our investments in overseas transactions. Cash transactions — typically for purchases, sales, interest or dividends — require cash conversions between currencies. Fluctuations in currency exchange rates affect the cash amounts that we pay or receive.US GAAP.
      Investments in overseas operations are consolidated for accounting purposes by translating values in one currency to another currency, in particular from US dollars to sterling. Fluctuations in currency exchange rates affect the currency values recorded in our accounts, particularly those in sterling, although they do not give rise to any realized gain or loss, nor to any currency cash flows.
      The Group is also exposed to currency exchange rates in its cash transactions and its investments in overseas operations. Cash transactions — typically for purchases, sales, interest or dividends — require cash conversions between currencies. Fluctuations in currency exchange rates affect the cash amounts that the Group pays or receives.
Forward Foreign Exchange Contractsforeign 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 exchange rate. OurThe Group’s policy is to effect routine transactional conversions between currencies, for example to collect receivables or settle payables, at the relevant spot exchange rate.
      We 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 use usingshort-dated foreign exchange swaps between currencies.
      Although we prepare ourthe Group prepares its consolidated accountsfinancial statements in sterling, wesignificant sums have been invested significant sums in overseas assets, particularly in the United States. Therefore, fluctuations in currency exchange rates, particularly between the US dollar and sterling, and alsoto a lesser extent between the euro and sterling, are likely to affect shareholders’ 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, unlike 20032006 and 2002,2005 the Group qualified for hedge accounting under US GAAP in respect of a number of its key derivative contracts. The remainder of our derivatives did not meetmet the prescribed designation requirements and hedge effectiveness tests under US GAAP which are notfor some 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 hedged item.

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      In line with the Group’s treasury policy, none of these instruments were considered trading instruments and each instrument was transacted solely to match an underlying financial exposure.

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Quantitative information about market risk
      The sensitivity of the Group’s derivative portfolio to changes in interest rates is found in note 16 to the financial statements.
ITEM 12.DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
      Not applicable.
PART II
ITEM 13.     DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
ITEM 13.DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
      None.
ITEM 14.MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
      Not applicable.None.
ITEM 15.     CONTROLS AND PROCEDURES
ITEM 15.CONTROLS AND PROCEDURES
Disclosure controls and procedures
      An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 20042006 was carried out by us under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer. Based on that evaluation the Chief Executive Officer and Chief Financial Officer concluded that Pearson’s disclosure controls and procedures have been designed to provide, and are effective in providing, reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms.forms and that such information is accumulated and communicated to management, including the principal executive and financial officers, as appropriate to allow such timely decision regarding required disclosures. A controls system, no matter how well designed and operated cannot provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. We recently identified a US GAAP adjustment,detected, and that such information is accumulated and communicated to reflectmanagement, including the correct accounting treatment of incentivesprincipal executive and fixed rental escalations under one of our leases, which we considerprincipal financial officers, as appropriate, to be material.allow such timely decisions regarding required disclosure.
Management’s annual report on internal control over financial reporting
      The US GAAP profitCompany’s management is responsible for establishing and loss account and shareholders’ fundsmaintaining adequate internal control over financial reporting for the Company. Internal control over financial yearsreporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS, including the reconciliations required under US GAAP.
      Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
      Management has assessed the effectiveness of internal control over financial reporting, as at December 31, 2006, and has concluded that such internal control over financial reporting was effective.

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      PricewaterhouseCoopers LLP, which has audited the consolidated financial statements of the Company for the year ended December 31, 20032006, has also audited management’s assessment of the effectiveness of internal control over financial reporting 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 respecteffectiveness of the Company’s primary UK GAAPinternal control over financial statements and no issuesreporting under Auditing Standard No. 2 of governance arise as a consequence of making these adjustments. The Chief Executive Officer and Chiefthe Public Company Accounting Oversight Board (United States). Their audit report is included under “Item 17. Financial Officer believe that the need for this restatement constitutes a significantStatements” page F-2.
Change in internal control deficiency but not a material control weakness (as such terms are used in the US federal securities laws) forover financial reporting
      During 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

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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
     
  £m £m
Statutory audit and audit-related regulatory reporting services  4   3 
Non-audit services  2   2 
Non-audit services were as follows:        
Tax compliance services  1   1 
Tax advisory services  1   1 
         
Auditors’ Remuneration 2006 2005
     
  £m £m
Audit fees  5   4 
Audit-related fees  4    
Tax fees  1   1 
All other fees  1   2 
NoteIncluded in statutory audit fees are amounts relating to the parent company of £20,000 (2003: £20,000). Audit-related regulatory reporting fees are £225,000 (2003: £200,000). Non-audit fees in the UK in 2004 are £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
      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
         
AprilMarch 1, 20042006 - April 30, 2004March 31, 2006  170,850900,000   £6.65 7.40   N/A   N/A 
May 1, 20042006 - May 31, 20042006  85,510900,000   £6.75 7.67N/AN/A
August 1, 2006 - August 31, 2006900,000£ 7.43N/AN/A
December 1, 2006 - December 31, 20062,000,000£ 7.73   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.
4.2Irrevocable 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.Jovanovich.#
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.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
   
  Page
Report of Independent Registered Public Accounting Firm F-2
Consolidated Profit and Loss AccountIncome Statement for the Year Endedyear ended December 31, 2006, 2005 and 2004 F-3F-4
Statement of Recognized Income and Expense for the year ended December 31, 2006, 2005 and 2004F-5
Consolidated Balance Sheet as at December 31, 20042006 and 2005 F-4F-5
Consolidated Cash Flow Statement for the Year Endedyear ended December 31, 2006, 2005 and 2004 F-5
Statement of Total Recognized Gains and Losses for the Year Ended December 31, 2004F-7 F-6
Reconciliation of Movements in Equity Shareholders’ Funds for the Year Ended December 31, 2004F-6
Notes to the AccountsConsolidated Financial Staetments F-8

F-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Pearson plc:plc
      We have completed an integrated audit of Pearson plc’s December 31, 2006 consolidated financial statements and of its internal control over financial reporting as of December 31, 2006 and an audit of its December 31, 2005 and December 31, 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
      In our opinion, the accompanying consolidated balance sheetsincome statements and the related consolidated profit and loss accounts,balance sheets, consolidated statements of total recognized gains and losses, reconciliations of movements in equity shareholders’ funds,cash flows and, consolidated cash flow statements of recognised income and expense present fairly, in all material respects, the financial position of Pearson plc and its subsidiaries (the “Group”) at December 31, December 20042006 and 2003,2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, December 2004,2006, in conformity with accounting principles generally accepted inInternational Financial Reporting Standards (IFRSs) as adopted by the United Kingdom.European Union. These financial statements are the responsibility of the Company’s management; ourGroup’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with 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 of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statementstatements 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 trustsGroup adopted International Accounting Standard (IAS) 32 “Financial Instruments: Disclosure and employee share schemesPresentation”, and IAS 39 “Financial Instruments: Recognition and Measurement”, prospectively from 1 January 2005. As discussed in accordance withNote 31 to the accounting principles generally accepted inconsolidated financial statements, during the United Kingdom. The change has been accounted for by restating comparative information atyear ended December 31, 2003 and 2002 and for2006, the years then ended.Group reclassified investment in pre-publication assets from cash used in investing activities to cash generated from operations.
      Accounting principles generally accepted inIFRSs as adopted by the United KingdomEuropean Union vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in note 34, as restated,Note 36 to the consolidated financial statements.
Internal control over financial reporting
      Also, in our opinion, management’s assessment, included in Managements’ annual report on internal control over financial reporting as set out in “Item 15. Controls and Procedures”, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Group’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Group’s internal control over financial reporting based on our audit.
      We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment,

F-2


testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting standards and principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting standards and principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
London
United Kingdom
June 27, 2005April 30, 2007

F-2F-3


CONSOLIDATED PROFIT AND LOSS ACCOUNTINCOME STATEMENT
YEAR ENDED 31 DECEMBER 20042006
(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 2006 2005 2004
         
Continuing operations
                
Sales  2   4,137   3,808   3,479 
Cost of goods sold  5   (1,917)  (1,787)  (1,631)
             
Gross profit
      2,220   2,021   1,848 
Operating expenses  5   (1,704)  (1,559)  (1,483)
Other net gains and losses  4      40   9 
Share of results of joint ventures and associates  13   24   14   8 
             
Operating profit
  2   540   516   382 
Finance costs  7   (133)  (132)  (96)
Finance income  7   59   62   17 
             
Profit before tax
      466   446   303 
Income tax  8   (11)  (116)  (55)
             
Profit for the year from continuing operations
      455   330   248 
Profit for the year from discontinued operations  3   14   314   36 
             
Profit for the year
      469   644   284 
             
Attributable to:
                
Equity holders of the Company      446   624   262 
Minority interest      23   20   22 
             
Earnings per share for profit from continuing and discontinued operations attributable to the equity holders of the Company during the year
(expressed in pence per share)
                
— basic  9   55.9p   78.2p   32.9p 
— diluted  9   55.8p   78.1p   32.9p 
             
Earnings per share for profit from continuing operations attributable to the equity holders of the Company during the year(expressed in pence per share)
                
— basic  9   54.1p   38.9p   29.0p 
— diluted  9   54.0p   38.8p   29.0p 
             
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-3F-4


CONSOLIDATED STATEMENT OF RECOGNISED INCOME AND EXPENSE
YEAR ENDED 31 DECEMBER 2006
(All figures in £ millions)
                 
  Notes 2006 2005 2004
         
Net exchange differences on translation of foreign operations  27   (417)  327   (203)
Actuarial gains/(losses) on defined benefit pension and post-retirement medical plans  24   107   26   (61)
Taxation on items charged to equity  8   12   12   9 
             
Net (expense)/income recognised directly in equity
      (298)  365   (255)
Profit for the year      469   644   284 
             
Total recognised income and expense for the year
      171   1,009   29 
             
Attributable to:
                
Equity holders of the Company      148   989   7 
Minority interest      23   20   22 
             
Effect of transition adjustment on adoption of IAS 39
                
Attributable to:                
Equity holders of the Company         (12)   
             
CONSOLIDATED BALANCE SHEET
AS AT 31 DECEMBER 20042006
(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 2006 2005
       
Assets
            
Non-current assets            
Property, plant and equipment  11   348   384 
Intangible assets  12   3,581   3,854 
Investments in joint ventures and associates  13   20   36 
Deferred income tax assets  14   417   385 
Financial assets — Derivative financial instruments  16   36   79 
Other financial assets  15   17   18 
Other receivables  19   124   108 
          
       4,543   4,864 
Current assets
            
Intangible assets — Pre-publication  17   402   426 
Inventories  18   354   373 
Trade and other receivables  19   953   1,031 
Financial assets — Derivative financial instruments  16   50   4 
Financial assets — Marketable securities      25    
Cash and cash equivalents (excluding overdrafts)  20   592   902 
          
       2,376   2,736 
Non-current assets classified as held for sale  29   294    
          
       2,670   2,736 
          
Total assets
      7,213   7,600 
          

F-5


CONSOLIDATED BALANCE SHEET (CONTINUED)
AS AT 31 DECEMBER 2006
(All figures in £ millions)
             
  Notes 2006 2005
       
Liabilities
            
Non-current liabilities            
Financial liabilities—Borrowings  21   (1,148)  (1,703)
Financial liabilities—Derivative financial instruments  16   (19)  (22)
Deferred income tax liabilities  14   (245)  (204)
Retirement benefit obligations  24   (250)  (389)
Provisions for other liabilities and charges  22   (29)  (31)
Other liabilities  23   (162)  (151)
          
       (1,853)  (2,500)
Current liabilities
            
Trade and other liabilities  23   (998)  (974)
Financial liabilities—Borrowings  21   (595)  (256)
Current income tax liabilities      (74)  (104)
Provisions for other liabilities and charges  22   (23)  (33)
          
       (1,690)  (1,367)
Liabilities directly associated with non-current assets classified as held for sale  29   (26)   
          
Total liabilities
      (3,569)  (3,867)
          
Net assets
      3,644   3,733 
          
Equity
            
Share capital  25   202   201 
Share premium  25   2,487   2,477 
Treasury shares  26   (189)  (153)
Other reserves  27   (592)  (175)
Retained earnings  27   1,568   1,214 
          
Total equity attributable to equity holders of the Company
      3,476   3,564 
Minority interest      168   169 
Total equity
      3,644   3,733 
          
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 27 February 20059 March 2007 and signed on its behalf by
Dennis Stevenson, Chairman
Robin Freestone, Chief financial officer
Rona Fairhead, Chief financial officer

F-4F-6


CONSOLIDATED CASH FLOW STATEMENT
YEAR ENDED 31 DECEMBER 20042006
(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 2006 2005 2004
         
Cash flows from operating activities
                
Cash generated from operations  31   621   653   524 
Interest paid      (106)  (101)  (98)
Tax paid      (59)  (65)  (45)
             
Net cash generated from operating activities
      456   487   381 
             
Cash flows from investing activities
                
Acquisition of subsidiaries, net of cash acquired  28   (363)  (246)  (41)
Acquisition of joint ventures and associates      (4)  (7)  (10)
Purchase of property, plant and equipment (PPE)      (68)  (76)  (101)
Proceeds from sale of PPE      8   3   4 
Purchase of intangible assets      (29)  (24)  (24)
Purchase of other financial assets         (2)  (1)
Disposal of subsidiaries, net of cash disposed  30   10   376   7 
Disposal of joint ventures and associates         54   24 
Disposal of other financial assets            17 
Interest received      24   29   13 
Dividends received from joint ventures and associates      45   14   12 
             
Net cash (used in)/generated from investing activities
      (377)  121   (100)
             
Cash flows from financing activities
                
Proceeds from issue of ordinary shares  25   11   4   4 
Purchase of treasury shares  26   (36)  (21)  (10)
Proceeds from borrowings      84      473 
Short-term investments required            (5)
Liquid resources acquired      (24)      
Repayments of borrowings      (145)  (79)  (524)
Finance lease principal payments      (3)  (3)  (2)
Dividends paid to Company’s shareholders  10   (220)  (205)  (195)
Dividends paid to minority interests      (15)  (17)  (2)
             
Net cash used in financing activities
      (348)  (321)  (261)
Effects of exchange rate changes on cash and cash equivalents      (44)  13   (4)
             
Net (decrease)/increase in cash and cash equivalents
      (313)  300   16 
             
Cash and cash equivalents at beginning of year      844   544   528 
             
Cash and cash equivalents at end of year
  20   531   844   544 
             

F-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 9 March 2007.
1ACCOUNTING POLICIESAccounting policies
      AccountingThe principal accounting policies have been consistently applied except that UITF 38 ’Accounting for ESOP trusts’ andin the revision of UITF 17 ‘Employee share schemes’ have been adopted in these statements. The adoptionpreparation of these standards represents a change in accounting policy and the comparative figures have been restated accordingly. The effect of these changes in accounting policy is disclosed in note 24.consolidated financial statements are set out below.
a.     Basis of accountingpreparation —
      These consolidated financial statements have been prepared in accordance with EU-adopted International Financial Reporting Standards (IFRS) and International Financial Reporting Interpretations Committee (IFRIC) interpretations and with those parts of the Companies Act 1985 applicable to companies reporting under IFRS. The accounts areGroup transitioned from UK GAAP to IFRS on 1 January 2003.
      These consolidated financial statements have been prepared under the historical cost convention as modified by the revaluation of financial assets and liabilities (including derivative instruments) at fair value.
(1) Interpretations and amendments to published standards effective in accordance2006 — The following amendments and interpretations to standards are mandatory for the Group’s accounting periods beginning on or after 1 January 2006:
• IAS 21 ‘The Effects of Changes in Foreign Currency’;
• IAS 39 (Amendment) ‘Cash Flow Hedge Accounting of Forecast Intragroup Transactions’;
• IAS 39 (Amendment) ‘The Fair Value Option’;
• IAS 39 and IFRS 4 (Amendment) ‘Financial Guarantee Contracts’;
• IFRS 6 ‘Exploration for and Evaluation of Mineral Resources’;
• IFRIC 4 ‘Determining whether an Arrangement contains a Lease’;
• IFRIC 5 ‘Rights to Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds’;
• IFRIC 6 ‘Liabilities arising from Participating in a Specific Market — Waste Electrical and Electronic Equipment’.
      Management assessed the relevance of these amendments and interpretations with respect to the Companies ActGroup’s operations and applicableconcluded that they are not relevant or material to the Group.
(2) Standards, interpretations and amendments to published standards that are not yet effective —Certain new standards, amendments and interpretations to existing standards have been published that are

F-8


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
mandatory for the Group’s accounting standards. A summaryperiods beginning on or after 1 January 2007 or later periods. The Group has not early adopted any of the new pronouncements which are as follows:
• IFRS 7 ‘Financial Instruments: Disclosures’ (effective from 1 January 2007). IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specific minimum disclosures about credit risk, liquidity risk and market risk.
• A complementary amendment to IAS 1 ‘Presentation of Financial Statements — Capital Disclosures’(effective from 1 January 2007). The amendment to IAS 1 introduces disclosures about the level and the management of the capital of an entity.
• IFRS 8 ‘Operating Segments’ (effective 1 January 2009). IFRS 8 requires an entity to adopt the ‘management approach’ to reporting on the financial performance of its operating segments, revise explanations of the basis on which the segment information is prepared and provide reconciliations to the amounts recognised in the income statement and balance sheet.
• Management is currently assessing the impact of IFRS 7, IFRS 8 and the complementary amendment to IAS 1 on the Group’s financial statements.
      In addition, management has assessed the relevance of the following amendments and interpretations with respect to the Group’s operations:
• IFRIC 8 ‘Scope of IFRS 2’ (effective for annual periods beginning on or after 1 May 2006). IFRIC 8 requires consideration of transactions involving the issuance of equity instruments — where the identifiable consideration received is less than the fair value of the equity instruments issued — to establish whether or not they fall within the scope of IFRS 2. The Group will apply IFRIC 8 from 1 January 2007, but it is not expected to have any impact on the Group’s accounts;
• IFRIC 10 ‘Interim Financial Reporting and Impairment’ (effective for annual periods beginning on or after 1 November 2006). IFRIC 10 prohibits impairment losses recognised in an interim period on goodwill, investments in equity instruments and investments in financial assets carried at cost to be reversed at a subsequent balance sheet date. The Group will apply IFRIC 10 from 1 January 2007;
• IFRIC 7 ‘Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies’(effective for annual reporting periods beginning on or after 1 March 2006). IFRIC 7 provides guidance on how to apply the requirements of IAS 29 in a reporting period in which an entity identifies the existence of hyperinflation in the economy of its functional currency, when the economy was not hyperinflationary in the prior period. As none of the Group entities have a currency of a hyperinflationary economy as their functional currency, IFRIC 7 is not relevant to the Group’s operations; and
• IFRIC 9 ‘Reassessment of Embedded Derivatives’ (effective for annual periods beginning on or after 1 June 2006). IFRIC 9 requires an entity to assess whether an embedded derivative is required to be separated from the host contract and accounted for as a derivative when the entity first becomes a party to the contract. Subsequent reassessment is prohibited unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract, in which case reassessment is required. The Group does not expect IFRIC 9 to have a material impact.
(3) Critical accounting assumptions and judgements —The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting assumptions. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas requiring a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the

F-9


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
consolidated financial statements, are discussed in the relevant accounting policies is set out below.under the following headings:
• Intangible assets:Goodwill
• Intangible assets:Pre-publication assets
• Royalty advances
• Taxation
• Employee benefits:Retirement benefit obligations
• Revenue recognition.
b.Consolidation
     b. Basis(1) Business combinations —The purchase method of consolidation — The consolidated accounts include the accounts of all subsidiaries made upaccounting is used to 31 December. Where companies have become or ceased to be subsidiaries or associates during the year, the Group results include resultsaccount for the period during which they wereacquisition of subsidiaries or associates.
by the Group. The resultscost of an acquisition is measured as the fair value of the Group includesassets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. Identifiable assets and contingent assets acquired and identifiable liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. For material acquisitions, the fair value of the acquired intangible assets is determined by an external, independent valuer. The excess of the cost of acquisition over the fair value of the Group’s share of the 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) Subsidiaries —Subsidiaries are entities over which the Group has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. Subsidiaries are fully consolidated from the date on which control is transferred to the Group and are de-consolidated from the date that control ceases.
(3) Joint ventures and associates Joint ventures are entities in which the Group holds an interest on a long-term basis and which are jointly controlled, with one or more other venturers, under a contractual arrangement. Associates are entities over which the consolidated balance sheet includesGroup has significant influence but not the Group’s interestpower to control the financial and operating policies, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in joint ventures and associates are accounted for by the equity method and are initially recognised at cost. The Group’s investment in associates includes related goodwill.
      The Group’s share of its joint ventures’ and associates’ post-acquisition profits or losses is recognised in the income statement, and its share of post-acquisition movements in reserves is recognised in reserves. The Group’s share of its joint ventures’ and associates’ results is recognised as a component of operating profit as these operations form part of the core publishing business of the Group and an integral part of existing wholly owned businesses. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in a joint venture or associate equals or exceeds its interest in the joint venture or associate, the Group does not recognise further losses, unless the Group has incurred obligations or made payments on behalf of the joint venture or associate.
c.Foreign currency translation
(1) Functional and presentation currency — Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.
(2) Transactions and balances — Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the bookdates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of

F-10


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
monetary assets and liabilities denominated in foreign currencies, are recognised in the income statement, except when deferred in equity as qualifying net investment hedges.
      Translation differences on other non-monetary items such as equities held at fair value are reported as part of the fair value gain or loss through the income statement. Fair value adjustments on non-monetary items such as equities classified as available for sale financial assets, are included in the fair value reserve in equity.
(3) Group companies — The results and financial position of all Group companies that have a functional currency different from the presentation currency are translated into the presentation currency as follows:
      i) assets and liabilities are translated at the closing rate at the date of the balance sheet;
      ii) income and expenses are translated at average exchange rates;
      iii) all resulting exchange differences are recognised as a separate component of equity.
      On consolidation, exchange differences arising from the translation of the net investment in foreign entities, and of borrowings and other currency instruments designated as hedges of such investments, are taken to shareholders’ equity. The Group treats specific inter-company loan balances, which are not intended to be repaid in the foreseeable future, as part of its net investment. When a 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 $1.84 (2005: $1.81) and the year end rate was $1.96 (2005: $1.72).
d.     Property, plant and equipment
      Property, plant and equipment is stated at historical cost less depreciation. Land is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives as follows:
      Buildings (freehold): 20-50 years
      Buildings (leasehold): 50 years (or over the period of the lease if shorter)
      Plant and equipment: 3-20 years
      The asset’s residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
      The carrying value of attributable netan asset is written down to its recoverable amount if the carrying value of the asset is greater than its estimated recoverable amount.
e.     Intangible assets and attributable goodwill.
     c.(1) Goodwill — From 1 January 1998 goodwill, being eitherGoodwill represents the net excess of the cost of shares in subsidiaries, joint ventures and associatesan acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisitions of associates is included in investments in associates. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. The recoverable amounts of cash generating units have been determined based on value in use calculations. These calculations require the use of estimates (see note 12). Goodwill is allocated to cash generating units for the purpose of impairment testing. The allocation is made to those cash

F-11


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
generating units that are expected to benefit from the business combination in which the goodwill arose. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. IFRS 3 ‘Business Combinations’ has not been applied retrospectively to business combinations before the date of transition to IFRS. Subject to the transition adjustments to IFRS required by IFRS 1, the accounting for business combinations before the date of transition has been grandfathered.
(2) Acquired software — Software separately acquired for internal use is capitalised at cost. Software acquired in material business combinations is capitalised at its fair value as determined by an independent valuer. Acquired software is amortised on a straight line basis over its estimated useful life of between three and five years.
(3) Internally developed software — Internal and external costs incurred during the preliminary stage of developing computer software for internal use are expensed as incurred. Internal and external costs incurred to develop computer software for internal use during the application development stage are capitalised if the Group expects economic benefits from the development. Capitalisation in the application development stage begins once the Group can reliably measure the expenditure attributable to their net assets on acquisition or the cost of other goodwill by purchase,software development and has demonstrated its intention to complete and use the software. Internally developed software is capitalised and amortised through the profit and loss account on a straight-line basis over its estimated useful life not exceedingof between three and five years.
(4) Acquired intangible assets — Acquired intangible assets comprise publishing rights, customer lists and relationships, technology, trade names and trademarks. These assets are capitalised on acquisition at cost and included in intangible assets. Intangible assets acquired in material business combinations are capitalised at their fair value as determined by an independent valuer. Intangible assets are amortised over their estimated useful lives of between two and 20 years, using a depreciation method that reflects the pattern of their consumption.
(5) Pre-publication assets — Pre-publication costs represent direct costs incurred in the development of educational programmes and titles prior to their publication. These costs are recognised as current intangible assets where the title will generate probable future economic benefits within their normal operating cycle and costs can be measured reliably. Pre-publication assets are amortised upon publication of the title over estimated economic lives of five years or less, being the estimated expected operating life cycle of the title, with a higher proportion of the amortisation taken in the earlier years. Estimated useful lifeThe investment in pre-publication assets has been disclosed as part of the cash generated from operations in the cash flow statement(see note 31).
      The assessment of the recoverability of pre-publication asset and the determination of the amortisation profile involve a significant degree of judgement based on historical trends and management estimation of future potential sales. An incorrect amortisation profile could result in excess amounts being carried forward as intangible assets that would otherwise have been written off to the income statement in an earlier period. Reviews are performed regularly to estimate recoverability of pre-publication assets. The carrying amount of pre-publication assets is set out in note 17.
f.     Other financial assets
      Other financial assets, designated as available for sale investments, are non-derivative financial assets measured at estimated fair value. Changes in the fair value are recorded in equity in the fair value reserve. On the subsequent disposal of the asset, the net fair value gains or losses are taken through the income statement.
g.     Inventories
      Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first in first out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads. Net realisable value is the estimated selling price

F-12


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
in the ordinary course of business, less estimated costs necessary to make the sale. Provisions are made for slow moving and obsolete stock.
h.     Royalty advances
      Advances of royalties to authors are included within trade and other receivables when the advance is paid less any provision required to adjust the advance to its net realisable value. The realisable value of royalty advances relies on a degree of management judgement in determining the profitability of individual author contracts. If the estimated realisable value of author contracts is overstated then this will have an adverse effect on operating profits as these excess amounts will be written off. The recoverability of royalty advances is based upon an annual detailed management review of the age of the advance, the future sales projections for new authors and prior sales history of repeat authors. The royalty advance is expensed at the contracted or effective royalty rate as the related revenues are earned. Royalty advances which will be consumed within one year are held in current assets. Royalty advances which will be consumed after one year are held in non-current assets.
i.     Newspaper development costs
      Investment in the development of newspaper titles consists of measures to increase the volume and geographical spread of circulation. The measures include additional and enhanced editorial content, extended distribution and remote printing. These cost are expensed as incurred as they do not meet the criteria under IAS 38 to be capitalised as intangible assets.
j.     Cash and cash equivalents
      Cash and cash equivalents in the cash flow statement include cash in hand, deposits held at call with banks, other short-term highly liquid investments with original maturities of three months or less, and bank overdrafts. Bank overdrafts are included in borrowings in current liabilities in the balance sheet.
k.     Share capital
      Ordinary shares are classified as equity.
      Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds.
      Where any Group company purchases the Company’s equity share capital (Treasury shares) the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the Company’s equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to the Company’s equity holders.
l.     Borrowings
      Borrowings are recognised initially at fair value, which is proceeds received net of transaction costs incurred. Borrowings are subsequently stated at amortised cost with any difference between the proceeds (net of transaction costs) and the redemption value being recognised in the income statement over the period of the borrowings using the effective interest method. Accrued interest is included as part of borrowings. Where a debt instrument is in a fair value hedging relationship, an adjustment is made to its carrying value to reflect the hedged risk. Interest on borrowings is expensed as incurred.

F-13


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
m.     Derivative financial instruments
      Derivatives are initially recognised at fair value at the date of transition to IAS 39(1 January 2005)or, if later, on the date a derivative is entered into. Derivatives are subsequently remeasured at their fair value. The fair value of derivatives has been determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models. The Group designates certain of the derivative instruments within its portfolio to be hedges of the fair value of its bonds(fair value hedges) or hedges of net investments in foreign operations (net investment hedges).
      Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair 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 fair value is recognised in finance income or finance costs in the income statement immediately.
n.     Taxation
      Current tax is recognised on the amounts expected to be paid or recovered under the tax rates and laws that have been enacted or substantively enacted at the balance sheet date.
      Deferred income tax is provided, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts. Deferred income tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred income tax liability is settled.
      Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised.
      Deferred income tax is provided in respect of the undistributed earnings of subsidiaries other than where it is intended that those undistributed earnings will not be remitted in the foreseeable future.
      Current and deferred tax are recognised in the income statement, except when the tax relates to items charged or credited directly to equity, in which case the tax is also recognised in equity.
      The Group is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
      Deferred tax assets and liabilities require management judgement in determining the amounts to be recognised. In particular, significant judgement is used when assessing the extent to which deferred tax assets should be recognised with consideration given to the timing and level of future taxable income together with any future tax planning strategies.

F-14


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
o.     Employee benefits
(1) Retirement benefit obligations — The liability in respect of defined benefit pension plans is the present value of the defined benefit obligations at the balance sheet date less the fair value of plan assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting estimated future cash flows using yields on high quality corporate bonds which have terms to maturity approximating the terms of the related liability.
      The determination of the pension cost and defined benefit obligation of the Group’s defined benefit pension schemes depends on the selection of certain assumptions, which include the discount rate, inflation rate, salary growth, longevity and expected return on scheme assets. Differences arising from actual experience or future changes in assumptions will be reflected in subsequent periods (actuarial gains and losses).
      Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognised immediately in the statement of recognised income and expense.
      The service cost, representing benefits accruing over the year, is included in the income statement as an operating cost. The unwinding of the discount rate on the scheme liabilities and the expected return on scheme asset are presented as finance costs or finance income.
      Obligations for contributions to defined contribution pension plans are recognised as an operating expense in the income statement as incurred.
(2) Other post-retirement obligations — The Group provides certain healthcare and life assurance benefits. The principal plans are unfunded. The expected costs of these benefits are accrued over the period of employment, using an accounting methodology which is the same as that for defined benefit pension plans. The liabilities and costs relating to other post-retirement obligations are assessed annually by independent qualified actuaries.
(3) Share-based payments — The Group has a number of employee option and share plans. The fair value of options or shares granted is recognised as an employee expense after taking into account such factors as the nature and ageGroup’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 option or share. The fair value of the options granted is measured using whichever of the Black-Scholes, Binomial and Monte Carlo model is most appropriate to the award. The fair value of shares awarded is measured using the share price at the date of grant unless another method is more appropriate. Any proceeds received are credited to share capital and share premium when the options are exercised. The Group has applied IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the date of transition to IFRS.
p.     Provisions
      Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is more likely than not that an outflow of resources will be required to settle the obligation and the 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 fore 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

F-15


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
provision is based on the present value of future payments for surplus leased properties under non-cancellable operating leases, net of estimated sub-leasing revenue.
q.     Revenue recognition
      Revenue comprises the fair value of the 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 recognised as follows:
      Revenue from the sale of books is recognised when title passes. AnticipatedA provision for anticipated returns areis made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period.
      Circulation and advertising revenue is recognised when the newspaper or other publication is published.
Subscription revenue is recognised on a straight-line basis over the life of the subscription.
      Where a contractual arrangement consists of two or more separate elements that can be provided to customers either on a stand-alone basis or as an optional extra and fair value exists for each separate element, such as the provision of supplementary materials with textbooks, revenue in such multiple element arrangements is recognised forwhen each element as if it were an individual contractual arrangement.product has been delivered and all other relevant revenue recognition criteria are achieved.
      Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognised as performance occurs. The assumptions, risks, and uncertainties inherent in long-term contract accounting can affect the amounts and timing of revenue and related expenses reported. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated as long-term contracts with revenue recognised on a percentage of completion basis. Losses on contracts are recognised in the period in which the loss first becomes foreseeable. Contract losses are determined to be the amount by which estimated 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.
      Income from recharges of freight and other activities which are incidental to the normal revenue generating activities is included in other income.
e. Pension costsr.     Leases — The regular pension cost
      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 Group’s defined benefit pension schemeslease 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 to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of finance charges, are included in financial liabilities — borrowings. The interest element of the finance cost is charged to the profit and loss account in accordance with SSAP 24 ‘Accounting for pension costs’ in order to apportion the cost of pensionsincome statement over the service liveslease period to produce a constant periodic rate of employees ininterest on the schemes.
      Variations are apportioned over the expected service lives of current employees in the schemes. The pension costremaining balance of the Group’s defined contribution schemes is the amount of contributions payableliability for the year.
f. Post-retirement benefits other than pensions — Post-retirement benefits other than pensions are accounted for on an accruals basis to recognise the obligation over the expected service lives of the employees concerned.
g. Tangible fixed assets —each period. The cost of tangible fixed assets other than freehold landproperty, plant and equipment acquired under finance leases is depreciated over estimated economic lives in equal annual amounts. Generally, freeholds are depreciated at 1% to 5% per annum, leaseholds at 2% per annum, or over the periodshorter of the lease if shorter, and plant and equipment at various rates between 5% and 33% per annum.
h. Leases — Finance lease rentals are capitalised at the net present valueuseful life of the total amount of rentals payable underasset or the leasing agreement (excluding finance charges) and depreciated in accordance with policy g above. Finance charges are written off over the periodlease term.
      Leases where a significant portion of the lease in reducing amounts in relation torisks and rewards of ownership are retained by the written down carrying cost. Operating lease rentalslessor 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 profit and loss accountincome statement on a straight-line basis over the duration of each lease term.
i. Fixed asset investments — Fixed asset investments are stated at cost less provisions for diminution in value.
j. Share schemes — Shares held by employee share ownership trusts are shown at cost 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 pay more tax in the future. Deferred tax assets are recognised to the extent that it is regarded as more likely

F-9


NOTES TO THE ACCOUNTS (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.
      The Group uses derivative financial instruments to manage its exposure to interest rate and foreign exchange risks. These include interest rate swaps, currency swaps and forward currency contracts.
      Amounts payable or receivable in respect of interest rate derivatives are accrued with net interest payable over the period of the contract. Where the derivative instrument is terminated early, the gain or loss is spread over the remaining maturity of the original instrument. Where the underlying exposure ceases to exist, any termination gain or loss is taken to the profit and loss account. Foreign currency borrowings and their related derivatives are carried in the balance sheet at the relevant exchange rates at the balance sheet date. Gains or losses in respect of the hedging of overseas subsidiaries are taken to reserves. Gains or losses arising from foreign exchange contracts are taken to the profit and loss account in line with the transactions which they are hedging. Premiums paid on contracts designed to manage currency exposure on specific acquisitions or disposals are charged to the profit and loss account.
      The company participates in offset arrangements with certain banks whereby cash and overdraft amounts are offset against each other.
q. Foreign currencies — Profit and loss accounts in overseas currencies are translated into sterling at average rates. Balance sheets are translated into sterling at the rates ruling at 31 December. Exchange differences arising on consolidation are taken directly to reserves. Other exchange differences are taken to the profit and loss account where they relate to trading transactions and directly to reserves where they relate to investments.
      The principal overseas currency for the Group is the US dollar. The average rate for the year against sterling was $1.83 (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 on a short-term basis.
s. Retained profits of overseas subsidiaries and associates — No provision is made for any additional taxation, less double taxation relief, which would arise on the remittance of profits retained where there is no intention to remit such profits.

F-10


NOTES TO THE ACCOUNTS (Continued)
2aANALYSIS OF SALES
             
  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 
          
                                     
  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-11


NOTES TO THE ACCOUNTS (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 
                

F-12


NOTES TO THE ACCOUNTS (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 
                
Note Discontinued operations relate to the disposal of the Group’s interest in Recoletos, see note 31. Included within operating profit for 2004 is an amount of £1m attributable to acquisitions made during the year.
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-13


NOTES TO THE ACCOUNTS (Continued)
             
  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)
          
2d     SHARE OF OPERATING PROFIT/(LOSS) OF ASSOCIATES
             
  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-14


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 ACCOUNTS (Continued)
3ANALYSIS OF CONSOLIDATED PROFIT AND LOSS ACCOUNT
             
  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)
          
Note Other items are all included in administration and other expenses. Included above are the following amounts in respect of discontinued operations: cost of sales £61m (2003: £53m), distribution costs £40m (2003: £33m) and administration 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 
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:lease.

F-16


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
£341,000)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.
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 tax advisory, tax compliancenon-current assets classified as held for sale. Amounts relating to non-current assets held for sale are classified as discontinued operations in the income statement.
u.     Trade receivables
      Trade receivables are stated at fair value less provision for bad and doubtful debts and anticipated future sales returns (see also note 1q).
2     Segment information
      Due to the differing risks and rewards associated with each business segment and the different customer focus of each segment, the Group’s primary segment reporting format is by business. The Group is organised into the following five business segments:
School — publisher, provider of testing and software services for primary and secondary schools;
Higher Education — publisher of textbooks and related course materials for colleges and universities;
Penguin — publisher with brand imprints such as Penguin, Putnam, Berkley, Viking, Dorling Kindersley;
FT Publishing — publisher of theFinancial Times, other business newspapers, magazines and specialist information;
Interactive Data Corporation (IDC) — provider of financial and business information to financial institutions and retail investors.
      The remaining business group, Professional, brings together a number of education publishing, testing and services businesses that publish texts, reference and interactive products for industry professionals and does not meet the criteria for classification as a ‘segment’ under IFRS. For more detail on the services and other advisory services. The remainder ofproducts included in each business segment refer to the non-audit fees relate to overseas subsidiaries.Business Review.
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-17


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
Primary reporting format — business segments
6NET INTEREST PAYABLE — GROUP
             
  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)
          
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)
          
                                     
      Higher     FT     2006
  Notes School Education Professional Penguin Publishing IDC Corporate Group
                   
  (All figures in £ millions)
Continuing operations
                                    
Sales (external)      1,455   795   341   848   366   332      4,137 
Sales (inter-segment)      1         18            19 
                            
Operating profit before joint ventures and associates      161   161   36   58   18   82      516 
Share of results of joint ventures and associates      6      1      17         24 
                            
Operating profit
      167   161   37   58   35   82      540 
                            
Finance costs  7                               (133)
Finance income  7                               59 
                            
Profit before tax
                                  466 
                            
Income tax  8                               (11)
                            
Profit for the year from continuing operations
                                  455 
                            
Reconciliation to adjusted operating profit
                                    
Operating profit      167   161   37   58   35   82      540 
Adjustment to goodwill on recognition of pre-acquisition deferred tax               7            7 
Amortisation of acquired intangibles      17      1   1   2   7      28 
Other net gains and losses of associates                  (4)        (4)
Other net finance costs of associates                  (1)        (1)
                            
Adjusted operating profit — continuing operations      184   161   38   66   32   89      570 
                            
Segment assets      2,684   1,347   580   954   317   314   703   6,899 
Joint ventures  13   5         3   4         12 
Associates  13   4            4         8 
                            
Assets — continuing operations      2,693   1,347   580   957   325   314   703   6,919 
Assets — discontinued operations            294               294 
                            
Total assets
      2,693   1,347   874   957   325   314   703   7,213 
                            
Total liabilities
      (662)  (268)  (177)  (269)  (300)  (131)  (1,762)  (3,569)
                            
Other segment items
                                    
Capital expenditure  11, 12, 17   124   88   30   38   19   20      319 
Depreciation  11   21   8   19   7   9   13      77 
Amortisation  12, 17   117   78   21   34   4   7      261 
                            

F-18


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (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 
          
                                     
      Higher     FT     2005
  Notes School Education Professional Penguin Publishing IDC Corporate Group
                   
  (All figures in £ millions)
Continuing operations
                                    
Sales (external)      1,295   779   301   804   332   297      3,808 
Sales (inter-segment)               16            16 
                            
Operating profit before joint ventures and associates      138   156   24   60   49   75      502 
Share of results of joint ventures and associates      4      1      9         14 
                            
Operating profit
      142   156   25   60   58   75      516 
                            
Finance costs  7                               (132)
Finance income  7                               62 
                            
Profit before tax
                                  446 
                            
Income tax  8                               (116)
                            
Profit for the year from continuing operations
                                  330 
                            
Reconciliation to adjusted operating profit
                                    
Operating profit      142   156   25   60   58   75      516 
Amortisation of acquired intangibles      5            1   5      11 
Other net gains and losses                  (40)        (40)
Other net finance costs of associates                  2         2 
                            
Adjusted operating profit — continuing operations      147   156   25   60   21   80      489 
                            
Segment assets      2,347   1,648   1,179   960   154   291   985   7,564 
Joint ventures  13   6         2   4         12 
Associates  13   6            18         24 
                            
Total assets
      2,359   1,648   1,179   962   176   291   985   7,600 
                            
Total liabilities
      (557)  (341)  (263)  (280)  (336)  (109)  (1,981)  (3,867)
                            
Other segment items
                                    
Capital expenditure  11, 12, 17   114   96   43   34   14   19      320 
Depreciation  11   26   8   17   7   11   11      80 
Amortisation  12, 17   91   78   20   24   3   5      221 
                            
             
  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 ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
                                     
      Higher     FT     2004
  Notes School Education Professional Penguin Publishing IDC Corporate Group
                   
  (All figures in £ millions)
Continuing operations
                                    
Sales (external)      1,087   729   290   786   318   269      3,479 
Sales (inter-segment)               15            15 
                            
Operating profit before joint ventures and associates      109   133   20   46   4   62      374 
Share of results of joint ventures and associates      3         1   4         8 
                            
Operating profit
      112   133   20   47   8   62      382 
                            
Finance costs  7                               (96)
Finance income  7                               17 
                            
Profit before tax
                                  303 
                            
Income tax  8                               (55)
                            
Profit for the year from continuing operations
                                  248 
                            
Reconciliation to adjusted operating profit
                                    
Operating profit      112   133   20   47   8   62      382 
Amortisation of acquired intangibles                      5      5 
Other net gains and losses      (4)  (4)  (2)  5   (4)        (9)
                            
Other net finance costs of associates                              
Adjusted operating profit — continuing operations      108   129   18   52   4   67      378 
                            
Segment assets      1,860   1,224   1,345   892   502   247   461   6,531 
Joint ventures  13   7         5   2         14 
Associates  13   5            28         33 
                            
Total assets
      1,872   1,224   1,345   897   532   247   461   6,578 
                            
Total liabilities
      (439)  (286)  (212)  (259)  (435)  (110)  (1,823)  (3,564)
                            
Other segment items
                                    
Capital expenditure  11, 12, 17   104   79   62   36   15   12      308 
Depreciation  11   25   9   16   9   16   9      84 
Amortisation  12, 17   74   65   18   29   2   5      193 
                            
      In 2006, sales from the provision of goods were £3,117m (2005: £2,956m; 2004: 2,787m) and sales from the provision of services were £1,020m (2005: £852m; 2004: 692m). Sales from the Group’s educational publishing, consumer publishing and newspaper business are classified as being from the provision of goods and sales from its assessment and testing, marketpricing, corporate training and management service businesses are classified as being from the provision of services.
      Corporate costs are allocated to business segments on an appropriate basis depending on the nature of the cost and therefore the segment result is equal to the Group operating profit. Inter-segment pricing is determined on an arm’s length basis. Segment assets consist primarily of property, plant and equipment, intangible assets, inventories, receivables and deferred taxation and exclude cash and cash equivalents and derivative assets. Segment liabilities comprise operating liabilities and exclude borrowings and derivative liabilities. Corporate assets and liabilities comprise cash and cash equivalents, marketable securities, borrowings and derivative financial instruments. Capital expenditure comprises additions to property, plant and equipment and intangible assets, including pre-publication but excluding goodwill (see notes 11, 12 and 17).

F-20


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Property, plant and equipment and intangible assets acquired through business combinations were £173m (2005: £111m; 2004: £16m) (see notes 11, 12 and 17). Capital expenditure, depreciation and amortisation include amounts relating to discontinued operations. In April 2005, Pearson sold its 79% interest in Recoletos Grupo de Communicación S.A.. This operation is disclosed as a discontinued operation in 2005 (see note 3). In December 2006 Pearson announced its intention to sell Pearson Government Solutions. This operation is disclosed as a discontinued operation (see note 3) and the assets and liabilities are classified as held for sale (see note 29).
Secondary reporting format — geographic segments
      The Group’s business segments are managed on a worldwide basis and operate in the following main geographic areas:
                                     
  Sales Total assets Capital expenditure
       
  2006 2005 2004 2006 2005 2004 2006 2005 2004
                   
  (All figures in £ millions)
Continuing operations
                                    
European countries  1,089   951   820   1,608   1,711   1,112   70   63   79 
North America  2,642   2,451   2,309   4,908   5,476   4,716   231   242   208 
Asia Pacific  298   300   263   327   325   302   12   13   10 
Other countries  108   106   87   56   52   43   2   2   3 
                            
Total
  4,137   3,808   3,479   6,899   7,564   6,173   315   320   300 
                            
Discontinued operations
                                    
European countries  17   39   205   9      358   1      8 
North America  257   266   195   281         2       
Other countries  12   10   7   4         1       
                            
Total
  286   315   407   294      358   4      8 
Joint ventures and associates           20   36   47          
                            
Total
  4,423   4,123   3,886   7,213   7,600   6,578   319   320   308 
                            
      Sales are allocated based on the country in which the customer is located. This does not differ materially from the location where the order is received.

F-21


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
93EARNINGS/(LOSS) PER SHAREDiscontinued operations
      On 11 December 2006, Pearson announced that it had agreed to sell Pearson Government Solutions to Veritas Capital, a private equity firm. This operation is disclosed as discontinued and the assets and liabilities of Pearson Government Solutions have been reclassified to non-current assets held for sale (see notes 29 and 35).
      Discontinued operations in 2005 also relate to the sale of Pearson’s 79% interest in Recoletos Grupo de Communicación S.A..
      An analysis of the results and cash flows of discontinued operations are as follows:
                             
  2006 2005     2004    
  Pearson Pearson     Pearson    
  Government Government 2005 2005 Government 2004 2004
  Solutions Solutions Recoletos Total Solutions Recoletos Total
               
  (All figures in £ millions)
Sales  286   288   27   315   217   190   407 
 ��                    
Operating profit/(loss)  22   20   (3)  17   22   26   48 
Net finance income                 3   3 
                      
Profit/(loss) before tax
  22   20   (3)  17   22   29   51 
                      
Attributable tax (expense)/benefit  (8)  (8)  1   (7)  (8)  (7)  (15)
                      
Profit/(loss) after tax
  14   12   (2)  10   14   22   36 
Profit on disposal of discontinued operations before tax        306   306          
Attributable tax expense        (2)  (2)         
                      
Profit for the year from discontinued operations
  14   12   302   314   14   22   36 
                      
Operating cash flows  20   22   (6)  16   112   12   124 
Investing cash flows  (8)  (13)     (13)  (5)  17   12 
Financing cash flows  (1)  (1)     (1)         
                      
Total cash flows
  11   8   (6)  2   107   29   136 
                      
4Other net gains and losses
                             
    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     
                      
             
  2006 2005 2004
       
  (All figures in £ millions)
Profit on sale of interest in MarketWatch     40    
Other items        9 
          
Total other net gains and losses     40   9 
          
      Other net gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and other financial assets that are included within continuing operations.

F-22


10a     EMPLOYEE INFORMATIONNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5Operating expenses
             
  2006 2005 2004
       
  (All figures in £ millions)
By function:
            
Cost of goods sold  1,917   1,787   1,631 
          
Operating expenses
            
Distribution costs  299   292   226 
Administrative and other expenses  1,504   1,351   1,340 
Other income  (99)  (84)  (83)
          
Total operating expenses
  1,704   1,559   1,483 
          
Total
  3,621   3,346   3,114 
          
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
By nature:
                
Utilisation of inventory  18   820   767   699 
Depreciation of property, plant and equipment  11   71   76   74 
Amortisation of intangible assets — pre-publication  17   210   192   168 
Amortisation of intangible assets — other  12   48   26   24 
Employee benefit expense  6   1,280   1,177   1,074 
Operating lease rentals      125   111   126 
Other property costs      121   84   69 
Royalties expensed      360   363   331 
Advertising, promotion and marketing      212   198   171 
Information technology costs      90   81   73 
Other costs      383   355   351 
Other income      (99)  (84)  (46)
             
Total
      3,621   3,346   3,114 
             
      During the year the Group obtained the following services from the Group’s auditor:
             
  2006 2005 2004
       
  (All figures in £ millions)
Audit services
            
Fees payable to the Company’s auditor for the audit of parent company and consolidated accounts  1   1   1 
Non-audit services
            
Fees payable to the Company’s auditor and its associates for other services:            
 — The audit of the Company’s subsidiaries pursuant to legislation  4   3   3 
 — Other services pursuant to legislation  4       
 — Tax services  1   1   2 
 — Services relating to corporate finance transactions  1   1    
 — All other services     1    
          
   11   7   6 
          

F-23


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      ‘Other services pursuant to legislation’ represents fees payable for services in relation to other statutory filings or engagements that are required to be carried out by the appointed auditor. In particular, this includes fees for reports under section 404 (S-404) of the US Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes-Oxley) which are required for the first time in 2006.
      ‘Services relating to corporate finance transactions’ relate to a carve-out audit of Pearson Government Solutions in 2006. In 2005 this largely related to due diligence work at IDC.
      ‘All other services’ in 2005 relate to IFRS transition work and Sarbanes-Oxley section 404 compliance services.
      Audit fees in relation to the IDC SEC filings have been entirely included in ‘The audit of the Company’s subsidiaries pursuant to legislation’. The audit fee relates to an integrated S-404 review and audit in which the audit work takes leverage from the results of S-404 testing. The fees for the S-404 review and the audit are not separate, therefore no IDC fees have been included in ‘Other services pursuant to legislation’.
6Employee information
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Employee benefit expense
                
Wages and salaries (including termination benefits and restructuring costs)      1,080   993   903 
Social security costs      111   100   89 
Share-based payment costs  24   25   23   25 
Pension costs — defined contribution plans  24   36   35   32 
Pension costs — defined benefit plans  24   29   25   24 
Other post-retirement benefits  24   (1)  1   1 
             
       1,280   1,177   1,074 
             
      The details of the emoluments of the directors of Pearson plc are shown on pages 46 to 57.in Item 6 of this Form 20-F.
             
  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 
             
             
  2006 2005 2004
       
  (Average number employed)
School  11,064   10,133   10,403 
Higher Education  4,368   4,196   4,087 
Professional  3,754   3,809   3,368 
Penguin  3,943   4,051   4,085 
FT Publishing  2,285   1,952   1,989 
IDC  2,200   1,956   1,826 
Other  1,669   1,573   1,365 
          
Continuing operations
  29,283   27,670   27,123 
          
Discontinued operations
  5,058   4,533   5,963 
          
   34,341   32,203   33,086 
          

F-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 
             
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Interest payable      (117)  (98)  (91)
Finance costs re employee benefits  24      (7)  (5)
Net foreign exchange losses      (2)  (9)   
Other losses on financial instruments in a hedging relationship:                
— fair value hedges         (1)   
— net investment hedges      (2)      
Other losses on financial instruments not in a hedging relationship:                
— derivatives      (12)  (17)   
             
Finance costs
      (133)  (132)  (96)
             
Interest receivable      23   21   17 
Finance income re employee benefits  24   4       
Net foreign exchange gains      21   21    
Other gains on financial instruments in a hedging relationship:                
— fair value hedges         1    
— net investment hedges         3    
Other gains on financial instruments not in a hedging relationship:                
— amortisation of transitional adjustment on bonds      8   7    
— derivatives      3   9    
             
Finance income
      59   62   17 
             
Net finance costs
      (74)  (70)  (79)
             
Analysed as:
                
Net interest payable      (94)  (77)  (74)
Finance income/(costs) re employee benefits  24   4   (7)  (5)
             
Net finance costs reflected in adjusted earnings      (90)  (84)  (79)
Other net finance income      16   14    
             
Total net finance costs
      (74)  (70)  (79)
             

F-25


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8Income tax
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Current tax
                
Charge in respect of current year      (88)  (68)  (57)
Recognition of previously unrecognised trading losses      23       
Other adjustments in respect of prior years      35   (1)  25 
             
Total current tax charge
      (30)  (69)  (32)
             
Deferred tax
                
In respect of timing differences      (73)  (66)  (46)
Recognition of previously unrecognised capital losses      76       
Recognition of previously unrecognised trading losses      37       
Other adjustments in respect of prior years      (21)  19   23 
             
Total deferred tax benefit/(charge)
  14   19   (47)  (23)
             
Total tax charge
      (11)  (116)  (55)
             
      In 2006, the Group has recognised a deferred tax asset in relation to capital losses in the US which will be utilised on the sale of Pearson Government Solutions. Previously it had not been possible to foresee the utilisation of these losses prior to their expiry. In addition, due to improved trading performance and revised strategic plans together with the expected utilisation of US net operating losses in the Pearson Government Solutions sale, the Group has re-evaluated the likely utilisation of operating losses both in the US and UK and as a consequence has increased the amount of the deferred tax asset carried forward in respect of such losses. The combined effect of these two factors was to create a non-recurring tax benefit of £127m.
      The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the UK tax rate as follows:
             
  2006 2005 2004
       
  (All figures in £ millions)
Profit before tax  466   446   303 
Tax calculated at UK rate  (140)  (134)  (91)
Effect of overseas tax rates  (19)  (20)  (6)
Joint venture and associate income reported net of tax  7   5   2 
Income not subject to tax  5   16   6 
Expenses not deductible for tax purposes  (18)  (9)  (5)
Utilisation of previously unrecognised tax losses  7   11   5 
Recognition of previously unrecognised tax losses  136       
Unutilised tax losses  (3)  (3)  (14)
Prior year adjustments  14   18   48 
          
Total tax charge
  (11)  (116)  (55)
          
UK  (15)  (26)  5 
Overseas  4   (90)  (60)
          
Total tax charge
  (11)  (116)  (55)
          

F-26


10b     PENSIONSNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The tax benefit/(charge) on items charged to equity is as follows:
             
  2006 2005 2004
       
  (All figures in £ millions)
Deferred tax on share based payments  2   3   4 
Deferred tax on net investment hedges  3       
Deferred tax on actuarial gains and losses  9       
Current tax on foreign exchange gains and losses  (2)  9   5 
          
   12   12   9 
          
9Earnings per share
Basic
      Basic earnings per share is calculated by dividing the profit attributable to equity shareholders of the Company by the weighted average number of ordinary shares in issue during the year, excluding ordinary shares purchased by the Company and held as treasury shares.
Diluted
      Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares to take account of all dilutive potential ordinary shares and adjusting the profit attributable, if applicable, to account for any tax consequences that might arise from conversion of those shares.
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Earnings      446   624   262 
Adjustments to exclude profit for the year from discontinued operations:                
Profit for the year from discontinued operations  3   (14)  (314)  (36)
Majority interest share of above            5 
             
Earnings — continuing operations
      432   310   231 
             
Earnings      446   624   262 
             
Weighted average number of shares (millions)      798.4   797.9   795.6 
Effect of dilutive share options (millions)      1.5   1.1   1.1 
Weighted average number of shares (millions) for diluted earnings      799.9   799.0   796.7 
             
             
  2006 2005 2004
       
Earnings per share from continuing and discontinued operations
            
Basic  55.9p  78.2p  32.9p
Diluted  55.8p  78.1p  32.9p
          
Earnings per share from continuing operations
            
Basic  54.1p  38.9p  29.0p
Diluted  54.0p  38.8p  29.0p
          
Earnings per share from discontinued operations
            
Basic  1.8p  39.3p  3.9p
Diluted  1.8p  39.3p  3.9p
          

F-27


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10Dividends
             
  2006 2005 2004
       
  (All figures in £ millions)
Final paid in respect of prior year 17p (2005: 15.7p; 2004: 14.8p)  136   125   119 
Interim paid in respect of current year 10.5p (2005: 10p; 2004: 9.7p)  84   80   76 
          
   220   205   195 
          
      A final dividend in respect of the financial year ending 31 December 2006 of 18.8p per share has been approved and will absorb an estimated £151m of shareholders’ funds. It will be paid on 11 May 2007 to shareholders who are on the register of members on 10 April 2007. These financial statements do not reflect this dividend.
11Property, plant and equipment
                 
      Assets in  
  Land and Plant and course of  
  buildings equipment construction Total
         
  (All figures in £ millions)
Cost
                
At 1 January 2005
  280   604   13   897 
Exchange differences  18   40      58 
Transfers     13      13 
Additions  32   41   1   74 
Disposals  (5)  (28)     (33)
Acquisition through business combination  3   6      9 
Reclassifications     7   (7)   
             
At 31 December 2005
  328   683   7   1,018 
             
Exchange differences  (20)  (54)     (74)
Transfers     (11)  (1)  (12)
Additions  12   52   13   77 
Disposals  (9)  (32)     (41)
Acquisition through business combination  9   12      21 
Reclassifications     8   (8)   
Transfer to non-current assets held for sale  (7)  (27)     (34)
             
At 31 December 2006
  313   631   11   955 
             

F-28


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
                 
      Assets in  
  Land and Plant and course of  
  buildings equipment construction Total
         
  (All figures in £ millions)
Depreciation
                
At 1 January 2005  (106)  (436)     (542)
Exchange differences  (7)  (33)     (40)
Charge for the year  (17)  (63)     (80)
Disposals     30      30 
Acquisition through business combination     (2)     (2)
             
At 31 December 2005
  (130)  (504)     (634)
             
Exchange differences  10   41      51 
Transfers     5      5 
Charge for the year  (17)  (60)     (77)
Disposals  4   27      31 
Acquisition through business combination     (8)     (8)
Transfer to non-current assets held for sale  5   20      25 
             
At 31 December 2006
  (128)  (479)     (607)
             
Carrying amounts
                
At 1 January 2005  174   168   13   355 
At 31 December 2005  198   179   7   384 
At 31 December 2006
  185   152   11   348 
             
      Depreciation expense of £18m (2005: £19m) has been included in the income statement in cost of goods sold, £6m (2005: £7m) in distribution expenses and £53m (2005: £54m) in administrative and other expenses. In 2006 £6m (2005: £4m) relates to discontinued operations.
      The Group leases certain equipment under a number of finance lease agreements. The net carrying amount of leased plant and equipment included within property, plant and equipment was £4m (2005: £3m).

F-29


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12Intangible assets
                         
      Acquired Other Total  
      publishing intangibles intangibles  
  Goodwill Software rights acquired acquired Total
             
  (All figures in £ millions)
Cost
                        
At 1 January 2005  3,160   181   10   46   56   3,397 
Exchange differences  345   15   2   4   6   366 
Transfers     (13)           (13)
Additions     24            24 
Disposals  (6)  (10)           (16)
Acquisition through business combination  155      56   33   89   244 
                   
At 31 December 2005
  3,654   197   68   83   151   4,002 
                   
Exchange differences  (396)  (17)  (8)  (8)  (16)  (429)
Transfers     6            6 
Additions     29            29 
Disposals  (5)  (2)           (7)
Acquisition through business combination  246   4   36   117   153   403 
Adjustment on recognition of pre-acquisition deferred tax  (7)              (7)
Transfer to non-current assets held for sale  (221)  (16)           (237)
                   
At 31 December 2006
  3,271   201   96   192   288   3,760 
                   
                         
      Acquired Other Total  
      publishing intangibles intangibles  
  Goodwill Software rights acquired acquired Total
             
  (All figures in £ millions)
Amortisation
                        
At 1 January 2005     (111)     (8)  (8)  (119)
Exchange differences     (10)           (10)
Charge for the year     (18)  (5)  (6)  (11)  (29)
Disposals     10            10 
                   
At 31 December 2005
     (129)  (5)  (14)  (19)  (148)
                   
Exchange differences     13   1   2   3   16 
Transfers     (5)           (5)
Charge for the year     (23)  (11)  (17)  (28)  (51)
Disposals     1            1 
Acquisition through business combination     (1)           (1)
Transfer to non-current assets held for sale     9            9 
                   
At 31 December 2006
     (135)  (15)  (29)  (44)  (179)
                   
Carrying amounts
                        
At 1 January 2005  3,160   70   10   38   48   3,278 
At 31 December 2005  3,654   68   63   69   132   3,854 
At 31 December 2006
  3,271   66   81   163   244   3,581 
                   

F-30


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Other intangibles acquired include customer lists and relationships, software rights, technology, trade names and trademarks. Amortisation of £4m (2005: £4m) is included in the income statement in cost of goods sold and £47m (2005: £25m) in administrative and other expenses. In 2006 £3m of software amortisation (2005: £3m) relates to discontinued operations.
Impairment tests for cash-generating units containing goodwill
      Impairment tests have been carried out where appropriate as described below. The recoverable amount for each unit tested exceeds its carrying value.
      Goodwill is allocated to the Group’s cash-generating units identified according to the business segment. Goodwill has been allocated as follows:
             
  Notes    
       
    2006 2005
       
    )
    (All figures
    in £ millions
Higher Education      780   903 
School Book      683   714 
School Assessment and Testing      342   310 
School Technology      356   408 
Other Assessment and Testing      490   531 
Other Government Solutions         249 
Other Book      56   57 
          
Pearson Education total
      2,707   3,172 
          
Penguin US      156   179 
Penguin UK      114   114 
Pearson Australia      44   47 
          
Penguin total
      314   340 
          
IDC
      149   138 
          
Mergermarket  28   97    
Other FT Publishing      4   4 
FT Publishing total
      101   4 
          
Total goodwill — continuing operations
      3,271   3,654 
          
Goodwill held for sale  29   221    
          
Total goodwill
      3,492   3,654 
          
      Goodwill has been allocated for impairment purposes to 13 cash-generating units. The recoverable amount of each cash-generating unit is based on value in use calculations, with the exception of IDC which is assessed on a market value basis. Goodwill is tested for impairment annually. Following a review in 2006, the allocation of corporate items has been revised. The 2005 comparative has been revised accordingly.
      The value in use calculations use cash flow projections based on financial budgets approved by management covering a five year period. The key assumptions used by management in the value in use calculations were:
Discount rate — The discount rate is based on the risk-free rate for government bonds, adjusted for a risk premium to reflect the increased risk in investing in equities. The risk premium adjustment is assessed for each specific cash-generating unit. The average pre-tax discount rates used are in the range

F-31


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of 10.3% to 11.9% for the Pearson Education businesses, 7.8% to 10.3% for the Penguin businesses and 10.5% to 11.0% for the FT Publishing businesses.
Perpetuity growth rates — The cash flows subsequent to the approved budget period are based upon the long-term historic growth rates of the underlying territories in which the cash-generating unit operates and reflect the long-term growth prospects of the sectors in which the cash-generating unit operates. The perpetuity growth rates used vary between 2.5% and 3.5%. The perpetuity growth rates are consistent with appropriate external sources for the relevant markets.
Cash flow growth rates — The cash flow growth rates are derived from forecast sales growth taking into consideration past experience of operating margins achieved in the cash-generating unit. Historically, such forecasts have been reasonably accurate.
      The valuation of IDC is determined using an observable market price for each share. Other than goodwill there are no intangible assets with indefinite lives.
13Investments in joint ventures and associates
Joint ventures
         
  2006 2005
     
  (All figures in
  £ millions)
At beginning of year  12   14 
Exchange differences  (3)  (3)
Share of profit/(loss) after tax  3   (1)
Dividends  (4)  (4)
Additions and further investment  4   6 
       
At end of year
  12   12 
       
      Investments in joint ventures are accounted for using the equity method of accounting and are initially recognised at cost.
      The aggregate of the Group’s share in its joint ventures, none of which are individually significant, are as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Assets
        
Non-current assets  3   3 
Current assets  24   26 
       
Liabilities
        
Current liabilities  (15)  (17)
       
Net assets
  12   12 
       
Income  52   46 
Expenses  (49)  (47)
       
Profit/(loss)after income tax
  3   (1)
       

F-32


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Associates
         
  2006 2005
     
  (All figures in
  £ millions)
At beginning of year  24   33 
Exchange differences  (1)   
Share of profit after tax  21   15 
Dividends  (41)  (10)
Disposals     (14)
Distribution from associate in excess of carrying value  5    
       
At end of year
  8   24 
       
      There is no acquisition goodwill relating to the Group’s investments in associates.
      The Group’s interests in its principal associates, all of which are unlisted, were as follows:
                         
    %        
2006 Country of incorporation Interest held Assets Liabilities Revenues Profit
             
    (All figures in £ millions )    
The Economist Newspaper Ltd  England   50   64   (64)  122   18 
Other          28   (20)  48   3 
                   
Total
          92   (84)  170   21 
                   
                         
    %        
2005 Country of incorporation Interest held Assets Liabilities Revenues Profit
             
    (All figures in £ millions )    
The Economist Newspaper Ltd  England   50   79   (67)  105   12 
Other          42   (30)  49   3 
                   
Total
          121   (97)  154   15 
                   
      The interest held in associates is equivalent to voting rights.
14Deferred income tax
         
  2006 2005
     
  (All figures in £
  millions)
Deferred tax assets
        
Deferred tax assets to be recovered after more than 12 months  288   343 
Deferred tax assets to be recovered within 12 months  129   42 
       
   417   385 
       
Deferred tax liabilities
        
Deferred tax liabilities to be settled after more than 12 months  (245)  (204)
Deferred tax liabilities to be settled within 12 months      
       
   (245)  (204)
       
Net deferred tax
  172   181 
       

F-33


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Deferred tax assets to be recovered within 12 months relate to the utilisation of losses in the US. Included within the losses to be utilised in 2007 are capital and operating losses of £93m which it is anticipated will be utilised on the sale of Pearson Government Solutions.
      Deferred income tax assets and liabilities may be offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. The Group has unrecognised deferred tax assets at 31 December 2006 in respect of UK losses of £35m and has not recognised a deferred tax asset amounting to £47m on the net pension deficit on UK plans on the basis that it is not sufficiently certain that suitable future profits will arise against which to offset the liability. None of these unrecognised deferred tax assets have expiry dates associated with them.
      The recognition of the deferred tax assets is supported by management’s forecasts of the future profitability of the relevant business units.
      The movement on the net deferred income tax account is as follows:
             
  Notes 2006 2005
       
    (All figures in
    £ millions)
At beginning of year      181   220 
Transition adjustment on adoption of IAS 39         5 
Exchange differences      (16)  21 
Acquisition through business combination  28   (26)  (21)
Income statement release/(charge)  8   19   (47)
Tax benefit to equity      14   3 
          
At end of year
      172   181 
          
      The movement in deferred income tax assets and liabilities during the year is as follows:
                     
      Goodwill    
  Capital Trading and    
  losses losses intangibles Other Total
           
  (All figures in £ millions)
Deferred income tax assets
                    
At 1 January 2005     150   37   172   359 
Transition adjustment on adoption of IAS 39           5   5 
Exchange differences     16   4   18   38 
Acquisition through business combination           1   1 
Transfer between current and deferred taxation           23   23 
Income statement charge     (32)  (6)  (6)  (44)
Tax benefit to equity           3   3 
                
At 31 December 2005
     134   35   216   385 
                
Exchange differences     (17)  (4)  (21)  (42)
Income statement release/(charge)  76   12   (6)  (19)  63 
Tax benefit to equity           11   11 
                
At 31 December 2006
  76   129   25   187   417 
                

F-34


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Other deferred tax assets include temporary differences on inventory, sales returns and other provisions.
             
  Goodwill and    
  intangibles Other Total
       
  (All figures in £ millions)
Deferred income tax liabilities
            
At 1 January 2005  (59)  (80)  (139)
Exchange differences  (8)  (9)  (17)
Acquisition through business combination  (24)  2   (22)
Transfer between current and deferred taxation     (23)  (23)
Income statement (charge)/release  (26)  23   (3)
          
At 31 December 2005
  (117)  (87)  (204)
          
Exchange differences  15   11   26 
Acquisition through business combination  (20)  (6)  (26)
Income statement charge  (27)  (17)  (44)
Tax benefit to equity     3   3 
          
At 31 December 2006
  (149)  (96)  (245)
          
      Other deferred tax liabilities include temporary differences in respect of depreciation and royalty advances.
15Other financial assets
         
  2006 2005
     
  (All figures in
  £ millions)
At beginning of year  18   15 
Exchange differences  (1)  1 
Additions     4 
Disposals     (2)
       
At end of year
  17   18 
       
      Other financial assets comprise non-current unlisted securities.

F-35


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16Derivative financial instruments
      The Group’s approach to the management of financial risks is set out in Item 11 of this Form 20-F. The Group’s outstanding derivative financial instruments are as follows:
             
  2006
   
  Gross  
  notional  
  amounts Assets Liabilities
       
  (All figures in £ millions)
Interest rate derivatives — in a fair value hedge relationship  953   20   (17)
Interest rate derivatives — not in a hedge relationship  1,026   9   (2)
Cross currency rate derivatives — in a net investment hedge relationship  230   40    
Cross currency rate derivatives — not in a hedge relationship  180   17    
          
Total
  2,389   86   (19)
          
Analysed as expiring:
            
In less than one year  976   50    
Later than one year and not later than five years  1,005   26   (4)
Later than five years  408   10   (15)
          
Total
  2,389   86   (19)
          
             
  2005
   
  Gross  
  notional  
  amounts Assets Liabilities
       
  (All figures in £ millions)
Interest rate derivatives — in a fair value hedge relationship  1,109   31   (16)
Interest rate derivatives — not in a hedge relationship  1,330   18   (6)
Cross currency rate derivatives — in a net investment hedge relationship  230   13    
Cross currency rate derivatives — not in a hedge relationship  180   21    
          
Total
  2,849   83   (22)
          
Analysed as expiring:
            
In less than one year  250   4    
Later than one year and not later than five years  1,823   57   (8)
Later than five years  776   22   (14)
          
Total
  2,849   83   (22)
          
      The carrying value of the above derivative financial instruments equals their fair value. Fair values are determined by using market data and the use of established estimation techniques such as discounted cash flow and option valuation models.
      At the end of 2006, the currency split of themark-to-market values of rate derivatives, including the exchange of principal on cross currency rate derivatives, was US dollar £(247)m, euro £157m and sterling £157m (2005: US dollar £(269)m, euro £166m and sterling £164m).
      The fixed interest rates on outstanding rate derivative contracts at the end of 2006 range from 3.02% to 7.00% (2005: 3.02% to 7.23%) and the floating rates are based on LIBOR in US dollar, sterling and euro(EURIBOR).

F-36


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The Group’s portfolio of rate derivatives is diversified by maturity, counterparty and type. Natural offsets between transactions within the portfolio and the designation of certain derivatives as hedges significantly reduce the risk of income statement volatility.
      The following sensitivity analysis of derivative financial instruments to interest rate movements is based on the assumption of a 1% change in interest rates for all currencies and maturities, with all other variables held constant.
             
  2006
   
  Net carrying 1% rate 1% rate
  amount increase decrease
       
  (All figures in £ millions)
Interest rate derivatives — in a fair value hedge relationship  3   (28)  31 
Interest rate derivatives — not in a hedge relationship  7   1   (1)
Cross currency rate derivatives — in a net investment hedge relationship  40       
Cross currency rate derivatives — not in a hedge relationship  17   (1)  1 
          
Total
  67   (28)  31 
          
Effect of fair value hedge accounting     28   (31)
Sensitivity after the application of hedge accounting  67       
          
      Counterparty exposure from all derivatives is managed, together with that from deposits and bank account balances, within credit limits that reflect published credit ratings to ensure that there is no significant risk to any one counterparty. No single derivative transaction had a market value (positive or negative) at the balance sheet date that exceeded 3% of the Group’s consolidated total equity.
      At the year end the Group held an amount of £29m equivalent as collateral under amark-to-market agreement. This reflected the amount, at market rates prevailing at the end of October 2006, owed to the Group by a counterparty for a set of three related rate derivatives. Under these derivatives the Group is due to exchange $209m for204m at the beginning of February 2007,with the repayment of the591m bond. There are no restrictions on the Group’s use of these funds, which have been recorded in borrowings as a current bank loan.
      In accordance with IAS 39 ‘Financial Instruments: Recognition and Measurement’, the Group has reviewed all of its material contracts for embedded derivatives that are required to be separately accounted for if they do not meet certain requirements, and has concluded that there are no material embedded derivatives.

F-37


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
17Intangible assets — pre-publication
         
  2006 2005
     
  (All figures in
  £ millions)
Cost
        
At beginning of year  1,357   1,109 
Exchange differences  (148)  112 
Transfers  6    
Additions  213   222 
Disposals  (280)  (113)
Acquisition through business combination  4   27 
       
At end of year
  1,152   1,357 
       
Amortisation
        
At beginning of year  (931)  (753)
Exchange differences  111   (87)
Charge for the year  (210)  (192)
Disposals  280   113 
Acquisition through business combination     (12)
       
At end of year
  (750)  (931)
       
Carrying amounts
        
At end of year
  402   426 
       
      Included in the above are pre-publication assets amounting to £243m (2005: £261m)which will be realised in more than 12 months.
      Amortisation is included in the income statement in cost of goods sold. There was no amortisation relating to discontinued operations in 2006 and 2005.
18Inventories
         
  2006 2005
     
  (All figures in
  £ millions)
Raw materials  26   23 
Work in progress  28   43 
Finished goods  300   307 
       
   354   373 
       
      The cost of inventories, all relating to continuing operations, recognized as an expense and included in the income statement in cost of goods sold amounted to £820m (2005: £767m). In 2006 £46m (2005: £42m) of inventory provisions were charged in the income statement. None of the inventory is pledged as security.

F-38


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19Trade and other receivables
         
  2006 2005
     
  (All figures in £
  millions)
Current
        
Trade receivables  768   825 
Royalty advances  91   124 
Prepayments and accrued income  34   38 
Other receivables  58   42 
Receivables from related parties  2   2 
       
   953   1,031 
       
Non-current
        
Royalty advances  80   67 
Prepayments and accrued income  4   4 
Other receivables  40   37 
       
   124   108 
       
      Trade receivables are stated net of provisions for bad and doubtful debts and anticipated future sales returns of £284m (2005: £313m). The carrying amounts are stated at their fair value. Concentrations of credit risk with respect to trade receivables are limited due to the Group’s large number of customers, who are internationally dispersed.
20Cash and cash equivalents (excluding overdrafts)
         
  2006 2005
     
  (All figures in
  £ millions)
Cash at bank and in hand  421   393 
Short-term bank deposits  171   509 
       
   592   902 
       
      Short-term bank deposits are invested with banks and earn interest at the prevailing short-term deposit rates.
      At the end of 2006 the currency split of cash and cash equivalents is US dollars 31% (2005: 31%), sterling 35% (2005: 38%), euros 21% (2005: 24%) and other 13% (2005: 7%).
      Cash and cash equivalents have fair values that approximate to their carrying amounts due to their short-term nature.
      Cash and cash equivalents include the following for the purpose of the cash flow statement:
         
  2006 2005
     
  (All figures in
  £ millions)
Cash and cash equivalents  592   902 
Bank overdrafts  (61)  (58)
       
   531   844 
       

F-39


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
21Financial liabilities — Borrowings
      The Group’s current and non-current borrowings are as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Non-current
        
6.125% Euro Bonds 2007 (nominal amount591m)
     436 
10.5% Sterling Bonds 2008 (nominal amount £100m)  105   107 
4.7% US Dollar Bonds 2009 (nominal amount $350m)  178   203 
7% Global Dollar Bonds 2011 (nominal amount $500m)  266   307 
7% Sterling Bonds 2014 (nominal amount £250m)  251   250 
5.7% US Dollar Bonds 2014 (nominal amount $400m)  206   238 
4.625% US Dollar notes 2018 (nominal amount $300m)  139   161 
Finance lease liabilities  3   1 
       
   1,148   1,703 
       
Current
        
Due within one year or on demand:
        
Bank loans and overdrafts  173   102 
7.375% US Dollar notes 2006     152 
6.125% Euro Bonds 2007 (nominal amount591m)
  421    
Finance lease liabilities  1   2 
       
   595   256 
       
Total borrowings
  1,743   1,959 
       
Included in the non-current borrowings above is £12m of accrued interest (2005: £35m).
Included in the current borrowings above is £22m of accrued interest (2005: £3m).
All of the Group’s borrowings are unsecured. In respect of finance lease obligations (2006: £4m; 2005: £3m) the rights to the leased asset revert to the lessor in the event of default.
The maturity of the Group’s non-current borrowing is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Between one and two years  107   437 
Between two and five years  445   310 
Over five years  596   956 
       
   1,148   1,703 
       

F-40


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      As at 31 December 2006 the exposure of the borrowings of the Group to interest rate changes when the borrowings re-price is as follows:
                 
      One to More than
  Total One year five years five years
         
  (All figures in £ millions)
Carrying value of borrowings  1,743   595   552   596 
Effect of rate derivatives     629   (221)  (408)
             
   1,743   1,224   331   188 
             
      The carrying amounts and market values of non-current borrowings are as follows:
                     
    Carrying Market Carrying Market
  Effective amount value amount value
  interest Rate 2006 2006 2005 2005
           
    (All figures in £ millions)
6.125% Euro Bonds 2007  6.18%        436   419 
10.5% Sterling Bonds 2008  10.53%  105   106   107   113 
4.7% US Dollar Bonds 2009  4.86%  178   176   203   200 
7% Global Dollar Bonds 2011  7.16%  266   269   307   310 
7% Sterling Bonds 2014  7.20%  251   265   250   282 
5.7% US Dollar Bonds 2014  5.88%  206   203   238   234 
4.625% US Dollar notes 2018  4.69%  139   135   161   155 
Finance lease liabilities  n/a   3   3   1   1 
                
       1,148   1,157   1,703   1,714 
                
      The market values are based on clean market prices at the year end or, where these are not available, on the quoted market prices of comparable debt issued by other companies. The effective interest rates above relate to the underlying debt instruments.
      The carrying amounts of the Group’s borrowings are denominated in the following currencies:
         
  2006 2005
     
  (All figures in
  £ millions)
US dollar  966   1,165 
Sterling  356   357 
Euro  421   437 
       
   1,743   1,959 
       
      The maturity of the Group’s finance lease obligations is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Finance lease liabilities — minimum lease payments
        
Not later than one year  1   2 
Later than one year and not later than five years  3   1 
Later than five years      
Future finance charges on finance leases      
Present value of finance lease liabilities  4   3 
       

F-41


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The present value of finance lease liabilities is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Not later than one year  1   2 
Later than one year and not later than five years  3   1 
Later than five years      
       
   4   3 
       
      The carrying amount of the Group’s lease obligations approximates their fair value.
      The Group has the following undrawn committed borrowing facilities as at 31 December:
         
  2006 2005
     
  (All figures in
  £ millions)
Floating rate
        
— expiring within one year      
— expiring beyond one year  894   786 
       
   894   786 
       
      During the year, the Group renegotiated its revolving credit facility which increased the amount and extended the maturity date.
      In addition to the above facilities, there are a number of short-term facilities that are utilised in the normal course of business.
22Provisions for other liabilities and charges
                         
  Deferred   Re-      
  consideration Integration organizations Leases Other Total
             
  (All figures in £ millions)
At 1 January 2006  26   3   5   12   18   64 
Exchange differences           (2)  (2)  (4)
Charged to consolidated income statement
                        
— Additional provisions        1   4   7   12 
— Unused amounts reversed  (9)     (2)     (4)  (15)
On acquisition  17            3   20 
Utilised during year  (9)  (1)  (3)  (2)  (10)  (25)
                   
At 31 December 2006
  25   2   1   12   12   52 
                   
         
  2006 2005
     
  (All figures in
  £ millions)
Analysis of provisions
        
Non-current  29   31 
Current  23   33 
       
   52   64 
       

F-42


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
     SSAP 24 accountingDeferred consideration — Additional deferred consideration of £17m was incurred during the year relating to the acquisition of Mergermarket.
Lease commitments — These relate primarily to onerous lease contracts, acquired through business combinations, which have various expiry dates up to 2010. The provision is based on current occupancy estimates.
23Trade and other liabilities
         
  2006 2005
     
  (All figures in
  £ millions)
Trade payables  343   348 
Social security and other taxes  18   21 
Accruals  345   363 
Deferred income  276   237 
Other liabilities  178   156 
       
   1,160   1,125 
       
Less: non-current portion
        
Accruals  24   15 
Deferred income  47   51 
Other liabilities  91   85 
       
   162   151 
       
Current portion
  998   974 
       
      The carrying value of the Group’s trade and other liabilities approximates their fair value.
      The deferred income balances comprise:
      • multi-year obligations to deliver workbooks to adoption customers in school businesses;
      • advance payments in contracting businesses;
      • subscription income in school, newspaper and market pricing businesses; and
      • advertising income relating to future publishing days in newspaper businesses.
24Employee benefits
Retirement benefit obligations
The Group operates a number of pension schemesretirement benefit plans throughout the world, the principal ones being in the UK and US. The major schemesplans are self-administered with the schemes’plans’ assets being held independently of the Group. PensionRetirement benefit costs are assessed in accordance with the advice of independent qualified actuaries. The UK schemeGroup plan is a hybrid schemeplan with both defined benefit and defined contribution sections but, predominantly, consisting of defined benefit liabilities. There are a number of defined contribution schemes,plans, principally overseas.
      The costmost recent actuarial valuation 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 schemeplan 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)completed as measured in accordance with SSAP 24 (see note 22).at 1 January 2006.

F-21F-43


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      A full actuarial valuation of the UK Group scheme was performed as at 1 January 2004 using the projected unit method of valuation. 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 usedplan are shown below. Weighted average assumptions have been shown for the other schemes.plans.
                         
  2004 2003 2002
       
  UK Group Other UK Group Other UK Group Other
  scheme schemes scheme schemes scheme schemes
             
  (All figures in percentages)
Inflation  2.80   3.00   2.75   3.00   2.25   3.00 
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    
Rate used to discount scheme liabilities  5.40   5.85   5.50   6.10   5.70   6.75 

F-22


NOTES TO THE ACCOUNTS (Continued)
      The assets of the UK Group scheme and the expected rate of return on these assets, and the assets of the other defined benefit schemes and the expected rate of return on these assets shown as a weighted average, are as follows:
                         
  Long-term   Long-term   Long-term  
  rate of return   rate of return   rate of return  
  expected at Value at expected at Value at expected at Value at
  31 Dec 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)
                   
Note The measurement of the deficit in the scheme for FRS 17 follows a different approach to SSAP 24. The FRS 17 measurement date is 31 December 2004. Although the rise in stock markets in 2004 increased the market value of the UK Group scheme assets, this is more than offset by the increase in the present value of the UK Group scheme liabilities. 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.

F-23


NOTES TO THE ACCOUNTS (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)        
                
                         
  2006 2006 2005 2005 2004 2004
  UK Group Other UK Group Other UK Group Other
% plan plans plan plans plan plans
             
Inflation  3.00   2.91   2.80   2.95   2.80   2.98 
Expected rate of increase in salaries  4.70   4.37   4.50   4.43   4.80   4.44 
Expected rate of increase for pensions in payment and deferred pensions  2.10 to 4.60      2.50 to 4.00      2.80 to 4.00    
Rate used to discount plan liabilities  5.20   5.70   4.85   5.54   5.40   5.84 
Expected return on assets  6.40   7.18   6.40   7.31   6.60   7.23 
                   
      Following the 1 January 2004 actuarial valuation for funding purposes,Assumptions regarding future mortality experience are set based on advice, published statistics and experience in each territory. In 2006, the Group has agreed to pay contributions of 14.8% of pensionable salaries, plus contributions in respect ofused 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 revealed by the funding valuation.

F-24


NOTES TO THE ACCOUNTS (Continued)
                     
    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)        
                
      The contribution rate for 2003PMFA92 (medium-cohort) series mortality tables for the UK Group scheme was 17.1% of pensionable salaries, plus £1m in respectplan modified for age-rating adjustments to recalibrate the tables against observed experience of the new Money Purchase section introduced withplan, and allowing for the future improvement effect from 1 January 2003. In addition, a one-off contribution of £5m was paid into this scheme to improve the funding position.medium cohort approach.

F-25


NOTES TO THE ACCOUNTS (Continued)
                     
    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)        
                
      The contribution rate for 2002remaining average life expectancy in years of a pensioner retiring at age 65 on the balance sheet date is as follows for the UK Group scheme was 17.1% of pensionable salaries.plan:
         
  2006 2005
     
Male  20.9   19.5 
Female  21.3   21.5 
       
      The experience gains and lossesremaining average life expectancy in years of botha pensioner retiring at age 65, 20 years after the balance sheet date, is as follows for the UK Group scheme and other schemes are shown below:plan:
             
  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)% 
         
  2006 2005
     
Male  22.2   20.2 
Female  22.5   22.1 
       

F-26


NOTES TO THE ACCOUNTS (Continued)
      If the aboveThe 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).
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,income statement are as follows:
             
  2004 2003 2002
       
  (All figures in £ millions)
Other post-retirement benefits  6   5   5 
                     
    Defined      
  UK Group benefit   Defined 2006
  plan other Sub Total contribution Total
           
  (All figures in £ millions)
Current service cost  27   2   29   36   65 
                
Total operating costs
  27   2   29   36   65 
                
Expected return on plan assets  (85)  (7)  (92)     (92)
Interest on pension scheme liabilities  78   7   85      85 
                
Net finance income
  (7)     (7)     (7)
                
Net income statement charge
  20   2   22   36   58 
                
Actual return on plan assets
  153   13   166      166 
                
(All figures in
percentages)
Inflation3.0
Initial rate of increase in healthcare rates12.0
Ultimate rate of increase in healthcare rates (2008)5.0
Rate used to discount scheme liabilities6.1
      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-27


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 ACCOUNTS (Continued)
12TANGIBLE FIXED ASSETS
                 
      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 
Freehold and leasehold property — Net book value includes freehold 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).

F-30


NOTES TO THE ACCOUNTS (Continued)
Other notes — The net book value of 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).
13JOINT VENTURES
                 
  2004 2003
     
  Valuation Book value Valuation Book value
         
  (All figures in £ millions)
Unlisted joint ventures  7   7   6   6 
             
Note The valuations of unlisted joint ventures 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 commitments to subscribe for further capital or loan stock.
             
  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-31


NOTES TO THE ACCOUNTS (Continued)
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 
             
Note Principal associates are listed in note 34. The valuations of unlisted associates 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 commitments to subscribe for further capital or loan stock.
                         
  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-32


NOTES TO THE ACCOUNTS (Continued)
                         
  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 
          
      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 value is based on market values or, where these are not available, on the quoted market prices of comparable debt issued by other companies. Interest rate swaps: the fair value of interest rate swaps is based on market values. At 31 December 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 end of the year. It also shows the amount of such gains and losses which have been included in the profit and loss account for the year and those gains and losses which are expected to be included in next year’s or later profit and loss accounts.
             
      Unrecognised
  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 ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (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 
       
                     
    Defined      
  UK Group benefit Sub Defined 2005
  plan other Total contribution Total
           
  (All figures in £ millions)
Current service cost  25   2   27   35   62 
Curtailments     (2)  (2)     (2)
                
Total operating costs
  25      25   35   60 
                
Expected return on plan assets  (75)  (6)  (81)     (81)
Interest on pension scheme liabilities  79   6   85      85 
                
Net finance costs
  4      4      4 
                
Net income statement charge
  29      29   35   64 
                
Actual return on plan assets
  214   7   221      221 
                
                     
    Defined      
  UK Group benefit Sub Defined 2004
  plan other Total contribution Total
           
  (All figures in £ millions)
Current service cost  22   2   24   32   56 
                
Total operating costs
  22   2   24   32   56 
                
Expected return on plan assets  (71)  (6)  (77)     (77)
Interest on pension scheme liabilities  72   6   78      78 
                
Net finance costs
  1      1      1 
                
Net income statement charge
  23   2   25   32   57 
                
Actual return on plan assets
  135   9   144      144 
                
The total operating charge is included in administrative and other expenses.
NoteThe consideration receivedamounts recognised in respect of shares issued during the year was £4m (2003: £5m).balance sheet are as follows:
                 
    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         
             
                                 
  2006 2006 2006   2005 2005 2005  
  UK Other Other   UK Other Other  
  Group funded unfunded 2006 Group funded unfunded 2005
  plan plans plans Total plan plans plans Total
                 
  (All figures in £ millions)
Fair value of plan assets  1,528   105      1,633   1,390   110      1,500 
Present value of defined benefit obligation  (1,683)  (115)  (12)  (1,810)  (1,661)  (131)  (11)  (1,803)
                         
Net pension liability
  (155)  (10)  (12)  (177)  (271)  (21)  (11)  (303)
                         
Other post-retirement medical benefit obligation              (48)              (60)
Other pension accruals              (25)              (26)
                         
Total retirement benefit obligations
              (250)              (389)
                         

F-45


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (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         
             
     
NoteThe subscription pricesfollowing gains/(losses) have been rounded up torecognised in the nearest whole penny.statement of recognised income and expense:
             
  2006 2005 2004
       
  (All figures in £ millions)
Amounts recognised for defined benefit plans  102   21   (60)
Amounts recognised for post-retirement medical benefit plans  5   5   (1)
          
Total recognised in year
  107   26   (61)
          
Cumulative amounts recognised
  44   (63)  (89)
          
      The figuresfair value of plan assets comprises the following:
                         
  2006 2006   2005 2005  
  UK Other   UK Other  
  Group funded 2006 Group funded 2005
% plan plans Total plan plans Total
             
Equities  46.6   3.9   50.5   47.4   4.3   51.7 
Bonds  23.8   2.1   25.9   24.7   2.0   26.7 
Properties  9.2      9.2   8.9      8.9 
Other  14.0   0.4   14.4   11.7   1.0   12.7 
      The plan assets do not include replacement options granted to employeesany of Dorling Kindersley and the Family Education Network following their acquisition. The discretionary share option plans include all options granted underGroup’s own financial instruments, nor any property occupied by the Pearson Executive Share Option Plans, the Pearson Reward Plan, the Pearson Special Share Option Plan and the Pearson Long Term Incentive Plan.Group.

F-46


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      Changes in the values of plan assets and liabilities are as follows:
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)
       
                         
  2006 UK     2005 UK    
  Group 2006 2006 Group 2005 2005
  plan Other Total plan Other Total
             
  (All figures in £ millions)
Fair value of plan assets
                        
Opening fair value of plan assets  1,390   110   1,500   1,198   82   1,280 
Exchange differences     (12)  (12)     9   9 
Expected return on plan assets  85   7   92   75   6   81 
Actuarial gains and losses  68   6   74   139   1   140 
Contributions by employer  43   2   45   35   10   45 
Contributions by employee  7      7   6      6 
Benefits paid  (65)  (8)  (73)  (63)  (6)  (69)
Acquisition through business combination              8   8 
                   
Closing fair value of plan assets
  1,528   105   1,633   1,390   110   1,500 
                   
Present value of defined benefit obligation
                        
Opening defined benefit obligation  (1,661)  (142)  (1,803)  (1,502)  (113)  (1,615)
Exchange differences     15   15      (12)  (12)
Current service cost  (27)  (2)  (29)  (25)  (2)  (27)
Curtailment              2   2 
Interest cost  (78)  (7)  (85)  (79)  (6)  (85)
Actuarial gains and losses  25   3   28   (112)  (7)  (119)
Contributions by employee  (7)     (7)  (6)     (6)
Benefits paid  65   8   73   63   6   69 
Acquisition through business combination     (2)  (2)     (10)  (10)
                   
Closing defined benefit obligation
  (1,683)  (127)  (1,810)  (1,661)  (142)  (1,803)
                   
      The history of the defined benefit plans is as follows:
                 
  2006 2005 2004 2003
         
  (All figures in £ millions)
Fair value of plan assets  1,633   1,500   1,280   1,164 
Present value of defined benefit obligation  (1,810)  (1,803)  (1,615)  (1,454)
             
Net pension liability
  (177)  (303)  (335)  (290)
             
Experience adjustments on plan assets  74   140   67   88 
Experience adjustments on plan liabilities  28   (119)  (127)  (113)
             
     
The expected rates of return on categories of plan assets are determined by reference to relevant indices. The overall expected rate of return is calculated by weighting the individual rates in accordance with the anticipated balance in the plan’s investment portfolio.
Note Cumulative goodwill relating      The Group expects to acquisitions made priorcontribute approximately £150m to 1998,its defined benefit plans in 2007, which was deducted from reserves, amounts to £915m (2003: £961m). Included in exchange differences are exchange gainsincludes an additional contribution 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£100m 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.UK Group plan.

F-47


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The reclassificationeffect 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 adjustmentone percentage point increase and decrease 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.discount rate is as follows:
         
  2006 2006
  1% increase 1% decrease
     
  (All figures in £ millions)
Effect on:
        
(Decrease)/increase in defined benefit obligation  (242)  297 
      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 meetOther post-retirement 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 anumber of post-retirement medical benefit plans, principally in the US. These plans are unfunded. The method of accounting and the frequency of valuations are similar schemeto those used for US employees that allowsdefined benefit pension plans.
      The principal assumptions used are shown below:
             
% 2006 2005 2004
       
Inflation  3.00   3.00   3.00 
Initial rate of increase in healthcare rates  10.00   10.00   12.00 
Ultimate rate of increase in healthcare rates  5.00   5.00   5.00 
Rate used to discount scheme liabilities  5.85   5.60   5.60 
      The amounts recognised in the grant of share options at a discount to the market price of the option granted.income statement are as follows:
             
  2006 2005 2004
       
  (All figures in £ millions)
Current service cost  1   1   1 
          
Past service cost  (2)      
          
Total operating (income)/costs
  (1)  1   1 
          
Interest cost  3   3   4 
          
Net income statement charge
  2   4   5 
          
      The Group has made use of the exemption under UITF 17 not to recognise any compensation chargecurrent and past service costs have been included in respect of these options.administrative and other expenses.
         
  2006 2005
     
  (All figures in
  £ millions)
Opening defined benefit obligation  (60)  (58)
Exchange differences  8   (7)
Reclassifications  (3)   
Current service cost  (1)  (1)
Past service cost  2    
Interest cost  (3)  (3)
Benefits paid  4   4 
Actuarial gains and losses  5   5 
       
Closing defined benefit obligation
  (48)  (60)
       

F-48


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The effect of a one percentage point increase and decrease in the assumed medical cost trend rates is as follows:
                         
  2006 2006 2005 2005 2004 2004
  1% increase 1% decrease 1% increase 1% decrease 1% increase 1% decrease
             
  (All figures in £ millions)
Effect on:
                        
Increase/(decrease) of aggregate of service cost and interest cost  0.1   (0.1)  0.2   (0.2)  0.2   (0.2)
(Decrease)/increase in defined benefit obligation  (4.7)  5.1   (4.7)  4.1   (4.1)  3.7 
Share-based payments
      The Group recognised the following charges in the income statement in respect of its equity-settled share-based payment plans:
             
  2006 2005 2004
       
  (All figures in £ millions)
Pearson plans  18   13   15 
IDC plans  7   10   10 
          
Total share-based payment costs
  25   23   25 
          
      The Group operates the following equity-settled employee option and share plans:
25ACQUISITIONS
      All acquisitions have been consolidated applying acquisition accounting principles.
Worldwide Save for Shares Plan — Since 1994, the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee’s participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.
a.Acquisition of subsidiaries
         
  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)
       
Note The fair 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 acquisitions are provisional and will be finalised in the 2005 financial statements.
b.Cash flow from acquisitionsEmployee Stock Purchase Plan — In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the US to save a portion of their monthly salary over six month periods. At the end of the period, the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.
Long-Term Incentive Plan — This plan was introduced in 2001 and renewed in 2006 and consists of two parts: share options and/or restricted shares.
      Options were granted under this plan in 2001 based on a pre-grant earnings per share growth test and are not subject to further performance conditions on exercise. The options became exercisable in tranches and lapse if they remain unexercised at the tenth anniversary of the date of grant.
      The vesting of restricted shares is normally dependent on continuing service and/or upon the satisfaction of corporate performance targets over a three-year period. These targets may be based on market and/or non-market performance criteria. Restricted shares awarded to senior management in October 2006 vest dependent on relative shareholder return, return on invested capital and a combination of earnings per share growth. The award was split equally across all three measures. Other restricted shares awarded in 2006 vest depending on continuing service over a three-year period.
             
  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-49


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
26DISPOSALSAnnual Bonus Share Matching Plan — This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held more than three years and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for every one held after five years.
      In addition to the above, share options remain outstanding under Executive Share Option, Reward and Special Share Option Plans. These are legacy plans which were replaced with the introduction of the Long-Term Incentive Plan in 2001.
      The number and weighted average exercise prices of share options granted under the Group’s plans are as follows:
a.Disposal of subsidiaries
             
  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)
          
                 
  2006 2006 2005 2005
  Number of Weighted Number of Weighted
  share average share average
  options exercise options exercise
  000s price £ 000s price £
         
Outstanding at beginning of year  21,677   13.15   26,179   13.62 
Granted during the year  837   6.30   606   4.92 
Exercised during the year  (1,396)  5.36   (324)  6.01 
Forfeited during the year  (1,828)  15.39   (4,352)  15.75 
Expired during the year  (429)  6.72   (432)  9.17 
             
Outstanding at end of year
  18,861   13.36   21,677   13.15 
             
Options exercisable at end of year
  15,595   14.14   17,420   13.90 
             
      Options were exercised regularly throughout the year. The weighted average share price during the year was £7.45 (2005: £6.52). Early exercises arising from redundancy, retirement or death are treated as an acceleration of vesting and the Group therefore recognises in the income statement the amount that otherwise would have been recognised for services received over the remainder of the original vesting period.
b.Cash flow from disposals
      The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:
             
  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 
          
                 
  2006 2006 2005 2005
  Number of Weighted Number of Weighted
  share average share average
Range of exercise prices options contractual options contractual
£ 000s life years 000s life years
         
0 — 5  1,649   1.94   2,773   2.32 
5 — 10  5,254   3.85   5,555   4.57 
10 — 15  7,638   3.63   8,237   4.64 
15 — 20  1,050   2.88   1,168   3.81 
20 — 25  424   3.19   930   3.80 
>25  2,846   3.22   3,014   4.22 
             
   18,861   3.42   21,677   4.19 
             
      In 2006 and 2005 options were granted under the Worldwide Save for Shares Plan. The weighted average estimated fair value for the options granted was calculated using a Black-Scholes option pricing model.

F-50


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:
         
  2006 2005
  Weighted Weighted
  average average
     
Fair value  £1.92   £2.41 
Weighted average share price  £7.66   £6.54 
Weighted average exercise price  £6.30   £5.08 
Expected volatility  23.12%  35.47%
Expected life  4.0 years   4.1 years 
Risk free rate  4.42%  4.48%
Expected dividend yield  3.52%  3.93%
Forfeiture rate  5.0%  6.3%
       
      The expected volatility is based on the historic volatility of the Company’s share price over the previous three to seven years depending on the vesting term of the options.
      The following shares were granted under restricted share arrangements:
                 
  2006 2006   2005
  Number Weighted 2005 Weighted
  of shares average Number average
  000s fair value of shares fair value
    £ 000s £
         
Annual Bonus Share Matching Plan  90   6.27   71   5.57 
Long-Term Incentive Plan  3,585   6.96   3,987   5.05 
      In 2005, the fair value of restricted shares awarded under the Annual Bonus Share Matching Plan and the Long-Term Incentive Plan was determined using a Black-Scholes model to reflect dividends foregone using a dividend yield of 3.85%. From 2006 onwards, participants of the Long-Term Incentive Plan are entitled to dividends during the vesting period. Following a review of the accounting policies for share-based payments in 2006, the restricted shares granted in 2006 under the Annual Bonus Share Matching Plan are valued using the share price at the date of grant discounted by the dividend yield (3.66%) to take into account any dividends foregone. The fair value of shares granted under the Long-Term Incentive Plan that vest unconditionally was determined using the share price at the date of grant. The number of shares to vest was adjusted based on historical experience to account for any potential forfeitures. Restricted shares with a market performance condition were valued by an independent actuary using a Monte Carlo model. Restricted shares with a non-market performance condition were fair valued based on the share price at the date of grant. Non-market performance conditions were considered by adjusting the number of shares expected to vest based on the most likely outcome of the relevant performance criteria.
Subsidiary share option plans
      IDC, a 62% subsidiary of the Group, operates the following share-based payment plans:
27NOTES TO CONSOLIDATED CASH FLOW STATEMENT2001 Employee Stock Purchase Plan In 2001, IDC adopted the 2001 Employee Stock Purchase Plan for all eligible employees worldwide. The 2001 Employee Stock Purchase Plan allows employees to purchase stock at a discounted price at specific times.
2000 Long-Term Incentive Plan Under this plan, the Compensation Committee of the Board of Directors can grant share-based awards representing up to 20% of the total number of shares of common stock outstanding at the date of grant. The plan provides for the discretionary issuance of share-based awards to directors, officers and employees of IDC, as well as persons who provide consulting or other services to IDC. The exercise price for all options granted to date has been equal to the market price of
                                     
  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 within other creditors in the balance sheet (see note 20).

F-51


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.
      In addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of IDC. The awarded shares are available for distribution, at no cost, at the end of a three-year vesting period. No performance criteria are attached to shares granted under this plan.
      The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan are as follows:
             
  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)
          
                         
    2006     2005  
  2006 Weighted 2006 2005 Weighted 2005
  Number average Weighted Number average Weighted
  of share exercise average of share exercise average
  options price exercise options price exercise
  000s $ price £ 000s $ price £
             
Outstanding at beginning of year  10,068   15.16   8.37   9,832   13.46   7.36 
Granted during the year  1,835   20.58   10.52   1,940   21.38   11.80 
Exercised during the year  (1,252)  12.88   6.58   (1,412)  11.57   6.39 
Forfeited during the year  (139)  19.02   9.72   (292)  16.86   9.31 
Expired during the year  (6)  11.46   5.86          
                   
Outstanding at end of year
  10,506   16.33   8.34   10,068   15.16   8.37 
                   
Options exercisable at end of year
  6,547   14.11   7.21   6,052   12.58   6.94 
                   
      The options outstanding at the end of the year have a weighted average remaining contractual life and exercise price as follows:
                 
  2006 2006 2005 2005
  Number Weighted Number Weighted
  of share average of share average
Range of exercise prices options contractual options contractual
$ 000s life years 000s life years
         
0 — 4.4  30   3.1   33   4.2 
4.4 — 7.5  157   2.3   206   3.6 
7.5 — 12  2,164   4.4   2,685   5.3 
12 — 20  4,640   6.4   5,243   7.4 
>20  3,515   9.0   1,901   9.5 
             
   10,506   6.8   10,068   5.4 
             
      During the year IDC granted the following shares under restricted share arrangements:
                         
    2006        
  2006 Weighted 2006   2005 2005
  Number average Weighted 2005 Weighted Weighted
  of shares fair value average Number average average
  000s $ fair value of shares fair value fair value
      £ 000s $ £
             
2000 Long-Term Incentive Plan  196   20.82   10.64   148   20.57   11.35 
2001 Employee Stock Purchase Plan  206   3.98   2.03   178   3.68   2.03 
      Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant. The fair value of the options granted under the Long-Term Incentive Plan and

F-52


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated using a Black-Scholes model. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:
                 
  Long-Term Incentive Plan Employee Stock Purchase Plan
     
  2006 2005 2006 2005
  Weighted Weighted Weighted Weighted
  average average average average
         
Fair value  $ 6.57   $ 5.56   $ 3.98   $ 3.68 
Weighted average share price  $20.58   $21.38   $15.58   $15.46 
Weighted average exercise price  $20.58   $21.38   $15.58   $15.46 
Expected volatility  25.90%  24.50%  18.32%  20.00%
Expected life  4.7 years   4.0 years   0.5 years   0.5 years 
Risk free rate  4.56% to 5.11%  3.86%  3.66% to 5.22%  2.33%
Expected dividend yield  0.0%  0.0%  0.0%  0.0%
Forfeiture rate  0.0%  0.0%  0.0%  0.0%
             
      The expected volatility is based on the historic volatility of IDC’s share price over the vesting term of the options.
25Share capital and share premium
             
  Number Ordinary Share
  of shares shares premium
  000s £m £m
       
At 1 January 2005  803,250   201   2,473 
Issue of ordinary shares — share option schemes  770      4 
          
At 31 December 2005
  804,020   201   2,477 
          
Issue of ordinary shares — share option schemes  2,089   1   10 
          
At 31 December 2006
  806,109   202   2,487 
          
      The total authorised number of ordinary shares is 1,190m shares (2005: 1,186m shares) with a par value of 25p per share (2005: 25p per share). All issued shares are fully paid. All shares have the same rights.
26Treasury shares
                     
  Pearson plc IDC Total
       
  Number   Number    
  of shares   of shares    
  000s £m 000s £m £m
           
At 1 January 2005  4,623   105   3,145   27   132 
Purchase of treasury shares  626   5   1,407   16   21 
                
At 31 December 2005
  5,249   110   4,552   43   153 
                
Purchase of treasury shares  4,700   36   1,500   16   52 
Release of treasury shares  (1,188)  (16)        (16)
                
At 31 December 2006
  8,761   130   6,052   59   189 
                
      The Group holds its own shares in trust to satisfy its obligations under its restricted share plans (see note 24). These shares are held as treasury shares and have a par value of 25p per share.
      IDC hold their own shares in respect of share buy-back programmes. These shares are held as treasury shares and have a par value of $0.01.

F-53


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The nominal value of Pearson plc treasury shares amounts to £2.2m (2005: £2.1m). The nominal value of IDC treasury shares amounts to £0.3m (2005: £0.3m).
      At 31 December 2006 the market value of Pearson plc treasury shares was £67.6m (2005: £36.2m) and the market value of IDC treasury shares was £74.3m (2005: £60.2m).
27Other reserves and retained earnings
                     
        Total  
    Translation Fair value other Retained
  Notes reserve reserve reserves earnings
           
  (All figures in £ millions)
At 1 January 2005      (491)     (491)  749 
Net exchange differences on translation of foreign operations      327      327    
Cumulative translation adjustment disposed      (14)     (14)   
Profit for the year attributable to equity holders of the Company               624 
Dividends paid to equity holders of the Company  10            (205)
Equity settled transactions  24            23 
Actuarial gains on post-retirement plans  24            26 
Taxation on items charged to equity  8            12 
Transition adjustment on adoption of IAS 39      3      3   (15)
                
At 31 December 2005
      (175)     (175)  1,214 
                
Net exchange differences on translation of foreign operations      (417)     (417)   
Profit for the year attributable to equity holders of the Company               446 
Dividends paid to equity holders of the Company  10            (220)
Equity settled transactions  24            25 
Actuarial gains on post-retirement plans  24            107 
Treasury shares released under employee share plans  26            (16)
Taxation on items charged to equity  8            12 
                
At 31 December 2006
      (592)     (592)  1,568 
                
      The translation reserve includes exchange differences arising from the translation of the net investment in foreign operations and of borrowings and other currency instruments designated as hedges of such investments.
28CONTINGENT LIABILITIESBusiness combinations
      On 30 September 2006, the Group acquired 100% of the voting rights of Mergermarket, a financial information company providing information to financial institutions, corporations and their advisers. In addition, several other businesses were acquired in the current year including Promissor, Paravia Bruno Mondadori (PBM), National Evaluation Systems (NES), PowerSchool and Chancery in the Education business and Quote.com in IDC. None of these other acquisitions were individually material to the Group. In 2005, the amounts shown below mainly relate to the acquisition of AGS Publishing.

F-54


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The assets and liabilities arising from acquisitions are as follows:
                             
    2006 2005
       
    Mergermarket Mergermarket   Other Total Total
    Carrying Fair value Mergermarket Fair Fair Fair
  Notes amount adjs Fair value value value value
               
  (All figures in £ millions)
Property, plant and equipment  11   1      1   12   13   7 
Intangible assets  12      34   34   122   156   89 
Intangible assets — Pre-publication  17            4   4   15 
Inventories               14   14   10 
Trade and other receivables      11      11   13   24   32 
Cash and cash equivalents      14      14   14   28   3 
Trade and other liabilities      (21)     (21)  (31)  (52)  (42)
Financial liabilities — Borrowings               (3)  (3)   
Deferred income tax liabilities  14      (10)  (10)  (16)  (26)  (21)
Retirement benefit obligations  24            (2)  (2)  (2)
Provisions for other liabilities and charges  22            (3)  (3)  (1)
Equity minority interest               (9)  (9)  8 
                      
Net assets acquired at fair value
      5   24   29   115   144   98 
                      
Goodwill
              97   149   246   155 
                      
Total
              126   264   390   253 
                      
Satisfied by:
                            
Cash              (109)  (273)  (382)  (249)
Deferred consideration              (17)     (17)  (5)
Net prior year adjustments                 9   9   1 
Total consideration
              (126)  (264)  (390)  (253)
                      
Book value of net assets acquired              5   43   48   58 
Fair value adjustments              24   72   96   40 
                      
Fair value to the Group
              29   115   144   98 
                      
      The fair value adjustments relating to the acquisition of Mergermarket are provisional and will be finalised during 2007. They include the valuation of intangible assets and the related deferred tax effect. Adjustments to 2005 provisional fair values largely relate to the acquisition of AGS Publishing.
      Net cash outflow on acquisition:
             
  2006 2005 2004
       
  (All figures in £ millions)
Cash — Current year acquisitions  (382)  (249)  (39)
Deferred payments for prior year acquisitions and other items  (9)     (2)
Cash and cash equivalents acquired  28   3    
          
Cash outflow on acquisition
  (363)  (246)  (41)
          
      The goodwill arising on the acquisition of Mergermarket is attributable to the profitability of the acquired business and the significant synergies expected to arise.
      Mergermarket contributed £9m of sales and £2m to the Group’s profit before tax between the date of acquisition and the balance sheet date. Other businesses acquired contributed £15m to the Group’s profit before tax between the date of acquisition and the balance sheet date.

F-55


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      If the acquisitions had been completed on 1 January 2006, Group sales for the period would have been £4,199m and profit before tax would have been £478m.
29  Non-current assets classified as held for sale
      As described in note 3, on 11 December 2006 the Group announced the disposal of Pearson Government Solutions. This disposal was completed on 15 February 2007 (see note 35). The major classes of assets and liabilities comprising the operations classified as held for sale at the balance sheet date are as follows:
         
  Notes 2006
     
    (All figures in
    £ millions)
Property, plant and equipment  11   9 
Intangible assets — Goodwill  12   221 
Intangible assets — Other  12   7 
Inventories      1��
Trade and other receivables      56 
       
Non-current assets classified as held for sale
      294 
       
Other liabilities      (26)
       
Liabilities directly associated with non-current assets classified as held for sale
      (26)
       
Net assets classified as held for sale
      268 
       
30Disposals
             
  2006 2005 2004
       
  (All figures in £ millions)
Disposal of subsidiaries
            
Property, plant and equipment     (48)   
Investments in associates     (3)   
Deferred income tax assets     8    
Other financial assets     (2)   
Inventories     (4)   
Trade and other receivables     (59)  (4)
Trade and other liabilities  (1)  71   2 
Provisions for other liabilities and charges     3    
Cash and cash equivalents     (134)  1 
Equity minority interests  (4)  54   (4)
Attributable goodwill  (5)  (104)  (4)
Currency translation adjustment     14     
          
Net assets disposed of
  (10)  (204)  (9)
          
Proceeds received  10   513   8 
Costs     (3)  (2)
          
Profit on sale
     306   (3)
          

F-56


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
  2006 2005 2004
       
Cash flow from disposals
            
Cash — Current year disposals  10   513   8 
Costs paid     (3)  (2)
Cash and cash equivalents/net debt disposed of     (134)  1 
          
Net cash inflow
  10   376   7 
          
      The 2006 disposal relates to share options exercised in IDC.
      2005 disposals relate mainly to the disposal of the Group’s 79% interest in Recoletos Grupo de Communicación S.A..
31  Cash generated from operations
                 
  Notes 2006 2005 2004
         
    (All figures in £ millions)
Net profit      469   644   284 
Adjustments for:
                
Tax      19   125   70 
Depreciation  11   77   80   84 
Amortisation of purchased intangible assets  12   28   11   5 
Adjustment on recognition of pre-acquisition deferred tax  12   7    —    
Amortisation of other intangible assets  12   23   18   20 
Investment in pre-publication assets  17   (213)  (222)  (181)
Amortisation of pre-publication assets  17   210   192   168 
Loss on sale of property, plant and equipment      2    —   4 
Profit on sale of investments            (16)
Net finance costs      74   70   76 
Share of results of joint ventures and associates  13   (24)  (14)  (10)
(Profit)/loss on sale of subsidiaries and associates         (346)  3 
Net foreign exchange(losses)/gains from transactions      (37)  39   (15)
Share-based payment costs  24   25   23   25 
Inventories      (16)  (17)  (12)
Trade and other receivables      (60)  (4)  (18)
Trade and other liabilities      54   71   61 
Provisions      (17)  (17)  (24)
          
Cash generated from operations
      621   653   524 
          
      Following a review of accounting presentation in 2006, the Group has chosen to reclassify investment in pre-publication assets as cash generated from operations. This aligns the classification in the cash flow with the treatment of comparable items in other industries and provides more relevant information on the Group cash flow. The impact of this change is to reduce cash generated from operations by £222m in 2005 (£181m in 2004) and increase net cash (used in)/generated from investing activities by £222m in 2005 (£181m in 2004).

F-57


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      In the cash flow statement, proceeds from sale of property, plant and equipment comprise:
         
  2006 2005
     
  (All figures in
  £ millions)
Net book amount  10   3 
Loss on sale of property, plant and equipment  (2)   
       
Proceeds from sale of property, plant and equipment
  8   3 
       
      The principal non-cash transactions are movements in finance lease obligations of £4m (2005: £nil).
32  Contingencies
      There are contingent Group 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.
33  Commitments
29COMMITMENTS UNDER LEASES
Capital commitments
      At 31 December 2004Capital expenditure contracted for at the balance sheet date but not yet incurred is as follows:
         
  2006 2005
     
  (All figures in
  £ millions)
Property, plant and equipment     1 
       
      The Group 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 
       
         
  2006 2005
     
  (All figures in
  £ millions)
Not later than one year  123   132 
Later than one year and not later than two years  113   117 
Later than two years and not later than three years  103   108 
Later than three years and not later than four years  90   97 
Later than four years and not later than five years  83   81 
Later than five years  857   915 
       
   1,369   1,450 
       

F-58


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
30RELATED PARTIES
34  Related party transactions
     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.
35  Events after the balance sheet date
      On 15 February 2007 the Group completed the disposal of Pearson Government Solutions, its Government services business, to Veritas Capital. Sale proceeds consist of $560m in 2004.
31POST BALANCE SHEET EVENTS
      In December 2004, Pearson announced its intentioncash, $40m in preferred stock and 10% of the equity of the business. The Group expects to dispose of its 79% interest in Recoletos Grupo de Comunicaciòn, S.A. to Retos Cartera,make a consortium of investors,post-tax loss on the disposal as part of a tender offerthe capital gain for all of Recoletos. The transaction was approved by the Spanish regulatory authorities in February 2005 andtax purposes will close in the early part of 2005. In January 2005 Pearson sold its 22% stake in MarketWatch to Dow Jones & Co for $101m.exceed any book gain.

F-52F-59


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
3236COMPANY BALANCE SHEET AS AT 31 DECEMBER 2004
             
      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 have been restated for the adoption of UITF38 (see note 24).
The financial statements were approved by the board of directors on 27 February 2005 and signed on its behalf by
Dennis Stevenson, Chairman                                         Rona Fairhead, Chief Financial Officer

F-53


NOTES TO THE ACCOUNTS (Continued)
33     NOTES TO THE COMPANY BALANCE SHEET
(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
Note Shares are stated at cost less provisions for diminution in 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 
                
Note The special reserve represents the cumulative effect of cancellation of the company’s share premium account. As permitted by section 230(4) of the Companies Act 1985, only the Group’s profit and loss account has been presented.
34.SUMMARY OF PRINCIPAL DIFFERENCES BETWEEN UNITED KINGDOM AND UNITED STATES OF AMERICA GENERALLY ACCEPTED ACCOUNTING PRINCIPLESSummary of principal differences between International Financial Reporting Standards and United States of America generally accepted accounting principles
      The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United KingdomEU-adopted International Financial Reporting 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.
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 2006 2005 2004
         
    £m £m £m
Profit for the financial year under IFRS
      446   624   262 
US GAAP adjustments:                
 Intangible amortization  (i)   (50)  (60)  (74)
 Discontinued operations  (iii)   (71)     (2)
 Leases  (v)   (5)     3 
 Disposal adjustments  (iv)      (119)   
 Pensions and other post-retirement benefits  (vi)   (19)  (26)  (23)
 Share-based payments  (vii)      (4)  (13)
 Derivative financial instruments  (viii)   (11)  (12)  (23)
 Acquisition adjustments  (xii)   (3)  1    
 Partnerships and associates  (x)   (1)  (2)   
 Minority interests  (xi)   1   2    
 Other      (2)  (9)  (1)
 Taxation effect of US GAAP adjustments  (xiv)   56   16   53 
             
Total US GAAP adjustments      (105)  (213)  (80)
             
Net income under US GAAP
      341   411   182 
             
Profit from continuing operations (less (benefit from)/charge for applicable taxes 2006: £(45)m, 2005: £100m, 2004: £2m)      398   164   153 
(Loss)/profit from discontinued operations (less charge for applicable taxes 2006: £8m; 2005: £8m, 2004: £15m)      (57)  8   29 
Profit on disposal of discontinued operations (less charge for applicable taxes 2006: £nil; 2005: £1m, 2004: £nil)         239    
             
Net income under US GAAP
      341   411   182 
             

F-55F-60


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
             
   Year ended December 31
                    
     Restated   Year ended December 31
          
 Note 2004 2003 2002 Note 2006 2005 2004
                
Presentation of earnings per equity share under US GAAP
  (xv)            (xiii)          
Earnings per equity share     (p)  (p)  (p)
Earnings/(loss) per equity share     (p)  (p)  (p)
Basic:                          
Continuing operations     20.9  20.1  27.1      49.9  20.5  19.2 
Discontinued operations     2.0  1.7  (0.8)     (7.2)  31.0  3.6 
Cumulative effect of change in accounting principle         (2.6)
                  
Total     22.9  21.8  23.7      42.7  51.5  22.8 
                  
Diluted:                          
Continuing operations     20.8  20.1  27.1      49.8  20.5  19.2 
Discontinued operations     2.0  1.7  (0.8)     (7.2)  30.9  3.6 
Cumulative effect of change in accounting principle         (2.6)
                  
Total     22.8  21.8  23.7      42.6  51.4  22.8 
                  
Average shares outstanding (millions)     795.6  794.4  796.3      798.4  797.9  795.6 
Dilutive effect of stock options (millions)     1.1  0.9  0.4      1.5  1.1  1.1 
                  
Average number of shares outstanding assuming dilution (millions)     796.7  795.3  796.7      799.9  799.0  796.7 
                  
Reconciliation of consolidated shareholders’ funds
              
    Year ended
    December 31
     
  Note 2006 2005
       
    £m £m
Shareholders’ funds under IFRS
      3,476   3,564 
US GAAP adjustments:            
 Goodwill  (i)   76   81 
 Intangibles  (i),(ii)   158   231 
 Discontinued operations  (iii)   (64)  7 
 Leases  (v)   (5)   
 Pensions and other post-retirement benefits  (vi)      61 
 Derivative financial instruments  (viii)   5   15 
 Share-based payments  (vii)   (3)   
 Acquisition adjustments  (xii)   24   26 
 Partnerships and associates  (x)   9   15 
 Minority interests  (xi)   (26)  (30)
 Other      (8)  (6)
 Taxation effect of US GAAP adjustments  (xiv)   (61)  (126)
          
Total US GAAP adjustments      105   274 
          
Shareholders’ funds under US GAAP
      3,581   3,838 
          

F-56F-61


NOTES TO THE ACCOUNTS (Continued)
Reconciliation of consolidated shareholders’ funds
              
    Year ended
    December 31
     
      Restated
       
  Note 2004 2003
       
    £m £m
Shareholders’ funds under UK GAAP
      2,603   2,893 
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 
 Derivatives  (viii)  11   21 
 Capitalized costs  (ix)      
 Acquisition adjustments  (x)  19   24 
 Partnerships and associates  (xi)  11   (5)
 Ordinary dividends  (xii)  125   119 
 Interest in own shares  (xiii)      
 Minority interests  (xiv)  (20)  (18)
 Other      (5)   
 Taxation effect of US GAAP adjustments  (v)  (71)  (152)
          
Total US GAAP adjustments      615   440 
          
Shareholders’ funds under US GAAP
      3,218   3,333 
          
Restatements
      The Company has restated its UK GAAP shareholders’ funds for the financial years ended December 31, 2003 and 2002 for 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 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.

F-57


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      A summary of the principal differences and additional disclosures applicable to the Group are set out below:
     (i) Goodwill and intangibles
(i) Goodwill and other 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, prior to the implementation of FRS 10
Goodwill and Intangible Assets”,is tested for periods ending prior to January 1, 1998, the Group has written off goodwill directly to the profit and loss reserveimpairment on an annual basis in the year of acquisition. If a subsidiary or a business is subsequently sold or closed, previously written off goodwill which was the result of the initial acquisition is taken into account in determining the profit or loss on sale or closure.accordance with IFRS 3‘Business Combinations’.
      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 reporting units were impaired.
      Under UK GAAP, before the transition to IFRS on January 1, 2003, intangible assets (other than goodwill) could only be recognized where they could be disposed of separately from the businesses to which they related. Consequently the Group 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,other than goodwill 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
      Following      GAAP differences between IFRS and US GAAP arise from the following factors. In respect of acquisitions prior to January 1, 1998, goodwill has remained as a strategic review of the business, the Group approved and announced,deduction to reserves under IFRS 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 provisionstransition rules of SFAS 144“Accounting for the Impairment or DisposalIFRS 1 but has been capitalized under US GAAP. In respect of Long-Lived Assets”the results of Recoletosacquisitions between January 1, 1998 and December 31, 2002, no acquired intangible assets other than goodwill 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 recognized when paid (see acquisition adjustments (xii) below).

F-58F-62


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The movement of the US GAAP adjustments to goodwill and intangibles in the years ended December 31, 2006 and 2005 is as follows:
         
  Goodwill Intangible assets
     
  £m £m
Year ended December 31, 2004  129   267 
Foreign exchange differences  (9)  28 
Amortization     (60)
Net movement in deferred consideration  (39)   
Acquisitions     (4)
       
Year ended December 31, 2005  81   231 
       
Foreign exchange differences  1   (25)
Amortization     (50)
Net movement in deferred consideration  (4)   
Acquisitions  (2)  2 
       
Year ended December 31, 2006  76   158 
       
(ii) Pre-publication assets
In connectionaccordance with IAS 1 ‘Presentation of Financial Statements’ the decisionGroup classifies its pre-publication assets as current intangibles under IFRS, as they are expected to disposebe consumed within their normal identifiable operating cycle. Under IFRS an asset shall be disclosed as current when it is expected to be realized in, or is intended for sale or consumption in, the entity’s normal operating cycle, provided that the operating cycle is clearly identifiable. Where the operating cycle is not clearly identifiable its duration is assumed to be twelve months. Under US GAAP, these assets are classified as long-term assets, as the benefit will accrue to several future annual periods, in accordance with ARB 43 ‘Restatement & Revision of ForumAccounting Research Bulletin (Working Capital)’. As a result of this difference in 2002, a loss on disposal was bookedclassification, non-current intangible assets are £402m higher under US GAAP reflecting the excess of the carrying value of the investment over the disposal proceeds. The goodwill associated with the Forum business was deemed to be impairedin 2006 than under IFRS (2005: £426m higher) and current intangible assets under US GAAP prior toare £nil for all periods presented.
      The Company determines a normal operating cycle under IFRS separately for each entity/ cash generating unit within the salegroup with distinct economic characteristics. Each of its education businesses has an operating cycle which is clearly identifiable. The duration of the business. The GAAP differencecycle is primarily based on the loss on sale reflectsexpected period over which the difference ineducational programs and titles will generate cash flows, and also takes account of the carrying value of goodwill attime it takes to produce the disposal date and provisions for future operating losses being removededucational programs. The pre-publication assets are amortized from the disposal calculationdate of first delivery of the program. The normal operating cycle commences when pre-publication activity starts and typically ends 5 years after the date of first delivery for the School, Higher Education and Professional segments, and 4 years after the date of first delivery for the Penguin segment.
      Under US GAAP, the Company’s investment in pre-publication assets has been classified as an investing activity, whereas under IFRS, investment in pre-publication assets has been classified as an operating activity. Consequently under US GAAP.GAAP, net cash generated from operations, in respect of this item, is £213m higher in 2006 than under IFRS (£222m higher in 2005 and £181m higher in 2004) while the cash flow from investing activities in 2006 is £213m lower than under IFRS (£222m lower in 2005 and £181m lower in 2004).
(iii) Discontinued operations
      Discontinued operations comprise the differences between IFRS and US GAAP in respect of Pearson Government solutions for 2006, 2005 and 2004 and Recoletos for 2005 and 2004.

F-63


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The operating profits,(loss)/profit before tax, assets and liabilities in respect of discontinued operations under US GAAP are set outas follows:
             
  2006 2005 2004
       
  £m £m £m
Total (loss)/profit before tax in respect of discontinued operations  (49)  17   49 
Assets in respect of discontinued operations  240   388   729 
Liabilities in respect of discontinued operations  (27)  (51)  (183)
      Under US GAAP, the Company has included the Cumulative Translation Adjustment (CTA) relating to the assets held for sale in relation to Government Solutions in its impairment analysis as required by EITF 01-05. As the resulting carrying value exceeds the fair value less cost to sell, the Group has recognized an impairment loss of £70m in its US GAAP income statement for the year ended December 31, 2006. The CTA will be released to net income upon the completion of the disposal of Government Solutions in 2007.
      Under IFRS, the Group has measured its assets and liabilities that have been classified as held for sale at the lower of its carrying amount and fair value less costs to sell. IFRS does not require the CTA to be included in the table below:carrying value when assessing an asset held for disposal for impairment. As a result, there is no impairment loss recognized in the Group’s financial statements under IFRS in 2006.
             
  2004 2003 2002
       
  £m £m £m
Total operating profit in respect of discontinued operations  21   27   22 
Assets in respect of discontinued operations  413   402     
Liabilities in respect of discontinued operations  (148)  (147)    
     (iii) Disposal adjustments
(iv) Disposal adjustments
      In 2004, 20032005 and 20022004 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. There were no corresponding disposal adjustments in 2006.
      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, whereasbusiness. However, a GAAP difference arises on disposals of entities acquired before the adoption of IFRS as the translation reserve was reset to zero at the date of the adoption of IFRS in accordance with the transitional provisions in IFRS 1. Under US GAAP, the translation reserve runs from the date of acquisition.
      The reconciling items between IFRS and US GAAP in respect of disposals are summarized as follows:
             
  2006 2005 2004
       
  £m £m £m
Difference in carrying value on disposal     (86)   
Cumulative translation adjustment     (33)   
          
Total US GAAP differences in respect of disposals
     (119)   
          
(v) Leases
      During the year, the Group disposed of one of its properties in a sale and lease back transaction. The resulting lease qualifies under UKboth IFRS and US GAAP this is not required.
      Differences can ariseas an operating lease. A GAAP difference arises as under US GAAP any gain that arises on the treatmentsale is deferred and spread over the remaining life of property disposals and sale and leaseback transactions. The timing of recognition of profits or lossesthe lease. In accordance with IAS 17, the gain on these transactions can differ between UK GAAP and US GAAP.disposal was recognized immediately in the income statement as the transaction was established at fair value.

F-64


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
     (iv) Pensions and other post-retirement benefits
     (vi) Pensions and other post-retirement benefits
      The Group operates defined benefit pension plans for its employees and former employees throughout the world. The largest defined benefit schemeplan is a funded schemeplan operated in the UK.
      Under UK GAAP the cost of providing pension benefits is expensed over the average expected service lives of eligible employees in accordance with the provisions of Statement of Standard Accounting Practice (“SSAP”) 24“Accounting for Pension Costs”. SSAP 24 aims to produce an estimate of cost based on long-term actuarial assumptions. Variations from the regular pension cost arising from, for example, experience deficiencies or surpluses, are charged or credited to the profit and loss account over the expected average remaining service lives of current employees in the schemes.
      Under US GAAP, the annual pension cost comprises the estimated cost of benefits accruing in the period as determined in accordance with SFAS 87“Employers Accounting for Pensions”, which requires readjustment of the significant actuarial assumptions annually to reflect current market and economic conditions. Therefore, different assumptions are used in the SFAS 87 calculation of pensions. Additionally, under US GAAP, where an accumulated benefit obligation exists in excess of plan assets and a prepaid pension asset has been recognized, an additional minimum pension liability has been booked with the offset as a reduction to

F-59


NOTES TO THE ACCOUNTS (Continued)
equity. Under UK GAAP, there is no requirement to recognize a minimum pension liability in respect of the unfunded accumulated benefit obligation.
      Under SFAS 87,In 2006, the Group has recognised an asset in respect of pensionsadopted FAS 158 ‘Employers’ accounting for defined benefit pension and other post retirement plans’, this applies in conjunction with FAS 87 ‘Employers’ Accounting for Pensions’. FAS 87 has been applied during 2004 and 2005.
      Under IFRS, the expense of defined benefit pension plan and other post-retirement benefits is charged to the majorityincome statement as an operating expense over the periods benefiting from the employee’s services. The charge is based on actuarial assumptions reflecting market conditions at the beginning of which is attributable to prior acquisitions. Thethe financial year.
      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 December 31, 2005 and December 31, 2006. Actuarial gains and losses, i.e. the difference between this assetthe expected development of the assets and liabilities and the plans’ funded status (the difference between plan assetsactual development, are recognized immediately through the statement of recognized income and liabilities) is held as unrecognisedexpenses.
      Under both FAS 158 and spreadFAS 87, in addition to the pension expense items recognized under IFRS, actuarial gains and losses in excess of the corridor are recognized over the employees’average remaining service lifetimes.life of employees. 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 to change the measurement date of its defined benefit plans under Under US GAAP from 30 September to 31 December. As a resultthis results in an £19m increase in the 2002 profit and losspension charge under US GAAP for pension plans includes a pre-tax chargein 2006 (2005: £26m; 2004: £23m).
      Under FAS 87, the accrual or prepayment recognized in the balance sheet in respect of £30 million reflectingpensions represents the cumulative effectincome statement charges net of contributions to the scheme since transition to the standard. In addition to this changeamount, FAS 87 requires that an additional minimum liability is recorded for any plan where the accumulated benefit obligation exceeds the fair value of the plan assets by an amount greater than the liability recognized in accounting principle.
     (v) Deferred taxationthe balance sheet.
      Under FRS 19FAS 158, the recognition criteria for deferred taxprovision or surplus recognized on the balance sheet represents the difference between the fair value of plan assets changed resultingand the projected benefit obligation.
      The adoption of FAS 158 resulted in the recognition of a pension obligation representing the excess of the defined benefit obligation over the fair value of assets. The effect was an increase in the pension liability under US GAAP of £44m. At December 31, 2006 there is no difference between the pension liabilities under IFRS and US GAAP. For the year ended December 31, 2005 the Group had recognized prepaid pension costs amounting to £57m and a minimum pension liability of £298m in respect of pensions and accrued pension costs amounting to £49m in respect of post-retirement benefit plans in line with FAS 87.
     (vii) Share-based payments
      Under both IFRS and US GAAP, the share-based payment charge is determined based on the fair value of the award at the grant date and is spread over the vesting period.
      Under both IFRS and US GAAP, the fair value of awards is determined at the date of grant using whichever of the Black-Scholes, Binomial and Monte Carlo model is most appropriate to the award. These models require assumptions to be made regarding share price volatility, dividend yield, risk-free rate of return and expected option lives.
      The Group adopted FAS 123(R) as at January 1, 2006 using the ‘Modified Prospective Application’ transition method. In 2006, differences between US GAAP and IFRS relate to the treatment of dual-indexed awards which are considered equity-settled under IFRS. Under US GAAP these awards are classified as liabilities and revalued to their fair value at each balance sheet date. On adoption the Group reclassified £1.2m relating to dual-indexed awards from equity to liabilities and revalued them. The revaluation of these awards

F-65


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
on adoption and at year-end resulted in an increase of the share-based payment charge by £1m. This increase was offset by differences in the IFRS and US GAAP charge due to the different treatment of forfeitures in prior years.
      In 2005, differences between the US GAAP and IFRS charge were mainly due to the different treatment of options with graded vesting features. Under IFRS the charge is recognized as the options gradually vest, whereas under US GAAP the charge is recognized on a straight-line basis over the vesting period resulting in an additional cost of £5m (2004: £13m). The remainder of the adjustment in 2005 relates to the treatment of forfeitures.
      Differences also arise between US GAAP and IFRS on the calculation of deferred tax asseton share-based payments. Whereas under UKIFRS the deferred tax benefit is calculated based on the intrinsic value of the option/share at the balance sheet date, FAS 123(R) requires the tax benefit to be calculated based on the compensation expense recognized during the year.
     (viii) Derivative financial instruments
      Prior to the adoption of IAS 39‘Financial Instruments: Recognition and Measurement’ on January 1, 2005, the Group’s derivatives were recorded as hedging instruments. Amounts payable or receivable in respect of interest rate swaps were accrued with net interest payable over the period of the contract. Unrealized gains and losses on currency swaps and forward currency contracts were deferred and recognized when paid. Following the adoption of IAS 39, derivatives are required to be recognized at fair value using market prices or established estimation techniques such as discounted cash flow or option valuation models.
      For both IFRS and US GAAP, the Group designates certain of the derivative financial instruments in its portfolio to be hedges of the fair value of its bonds (fair value hedges) or hedges of net investment in foreign operations (net investment hedges). Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the change in fair value of the hedged assets or liability attributable to the hedged risk. The effective portion of changes in the fair value of derivatives that are designated and qualify as net investment hedges are recognized in equity. Gains and losses accumulated in equity are included in the income statement when the corresponding foreign operation is disposed of. Gains or losses relating to the ineffective portion are recognized immediately in the income statement. Changes in the fair value of derivatives not in hedging relationships are recognized in the income statement.
      Under US GAAP, certain of the Group’s financial instruments met the designation and testing requirements for hedge accounting from January 1, 2004. Under IFRS, hedge accounting has only been available from the date of adoption of IAS 39, on January 1, 2005. This additional year of hedge accounting under US GAAP gives rise to a difference between IFRS and US GAAP in respect of US tax losses and other timing differences that are regarded as more likely thanshareholders’ funds.
      On adoption of IAS 39 on January 1, 2005, certain of the Group’s derivative financial instruments were deemed to be in fair value hedging relationships for the purposes of calculating the transition adjustment. The Group has elected not to designate all of these derivatives as hedges on an ongoing basis. In this circumstance, the transitional adjustment to the carrying value of those bonds deemed to be recoverable against future profits.in fair value hedging relationships is being amortized over the life of the corresponding derivative financial instrument. This gives rise to a difference between IFRS and US GAAP, as this amortization is included in the income statement under IFRS with no corresponding entry under US GAAP.
     (ix) Revenue recognition
      The adoptionGroup recharges some of FRS 19its freight revenue to its customers. As this income is incidental to the Group’s main revenue generating business, this income is classified as other income under IFRS as disclosed in note 5 to these financial statements. Under US GAAP freight recharges should be recognized as revenue in accordance with EITF 00-10 ‘Accounting for Shipping and Handling Fees and Costs’. The Group has also had

F-66


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
reclassified distribution and subrights income to revenue for all years presented. This resulted in an increase in sales under US GAAP of £94m in 2006 (2005: £84m; 2004: £83m).
     (x) Partnerships and associates
      There is no difference between IFRS and US GAAP in the accounting for partnerships and associates. However, the accounts of partnerships and associates must be adjusted from IFRS to US GAAP, which has an impact on capitalizedthe 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, sincepensions and derivatives.
(xi) Minority interests
      Under IFRS, when less than 100% of a subsidiary has been acquired, minority interest in a business combination is stated at the restatementminority’s proportion of deferred tax balancesthe net fair value of acquired had a corresponding effect uponassets, liabilities and contingent liabilities assumed. Under US GAAP, the goodwill recognized on those acquisitions. A prior year adjustmentminority interest is valued at historical book value. In the years ended December 31, 2006, 2005 and 2004, there was madeno difference between IFRS and US GAAP in the 2002 financial statements to reflectrecognition of minority interest. In all years, minority interests represent the adoptionminority share of FRS 19 and comparative figures were restated.US GAAP adjustments.
      Under UKIFRS, minority interest is classified as a component of shareholders’ equity. Under US GAAP, a provisionminority interest 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.classified outside of equity.
(xii) Acquisition adjustments
      Under US GAAP, deferred taxation is provided forconsideration related to the acquisition of businesses contingent on a full liability basis.future event such as achieving specific earnings levels in future periods, that is treated as additional purchase price is recorded only when the specified conditions are met and the consideration determinable, in accordance withSFAS 141 “Business Combinations.”Consideration related to the acquisition of a business contingent on a future event that is treated as compensation expense is recorded over the period in which the compensation is earned. Under IFRS, contingent consideration is treated as part of the full liability method,purchase price on the date of acquisition, if it is probable that the contingent consideration will be paid and can be measured reliably.
(xiii) Presentation of earnings per equity share
      Under US GAAP an entity must present basic and diluted EPS for discontinued operations or the cumulative effect of an accounting change. Accordingly, the Group has presented EPS for income from continuing operations, discontinued operations and net income.
(xiv) Deferred taxation
      Under IFRS, IAS 12“Income Taxes”, deferred tax assets or liabilities areis recognized for differences betweenif it is probable that sufficient taxable profit is available against which the financial and taxation basis of assets and liabilities and fortemporary difference can be utilized. Under US GAAP, deferred tax loss carry forwards at the statutory rate at each reporting date. Ais recognized in full but then reduced by a valuation allowance is established whenif it is more likely than not that some portion or all of the deferred taxation assetstax asset will not be realized.

F-67


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
      The reconciling items in 2004, 20032006, 2005 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 2006 2006 2005 2005 2004
                  
 £m £m £m £m £m £m £m £m £m
Tax effect of GAAP adjustments on:
                             
Goodwill and intangible amortization  (23)  (108)  29  (128)  20  (94)  18  (121)  17 
Derivatives  38  (3)  (21)  (41)
Derivative financial instruments  3  (1)  3  (5)  38 
Options, pensions, disposals and other adjustments  31  40  7  17   33  34  (6)    (2)
                    
Total taxation effect of US GAAP adjustments
  46  (71)  15  (152)  56  (61)  15  (126)  53 
                    
      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.
      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 hasValuation allowances have previously been recognized in respect of the tax loss carryforwards. The Group continually reviews the adequacylosses carried forward. Following a review of the valuation allowancetax position in the US and is recognizing these benefits only as reassessment indicates that it is morethe likely than not that the benefits will be realized.
      The deferred tax item in 2003 also incorporates the effectutilization of a change in estimate in respect of deferred tax assets relating to a purchase business combination in prior years, which was recorded through the profit and loss account under UK GAAP, but which was required to be adjusted against goodwill under US GAAP.
     (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,operating losses, the Group has certain leases for which the classification is operating under UK GAAP and finance (capital) under US GAAP.
      Differences can also arisereleased its valuation allowance in respect of the timing of recognition of lease incentivesdeferred tax asset relating to its US share-based payment plans amounting to £38m in 2006. These plans are not in the money and, future fixed market-based rent escalations. Under UK GAAP lease incentives areconsequently, a deferred tax asset has not been recognized in line with IAS 12. FAS 123(R) only permits a valuation allowance where there are insufficient future taxable profits to utilize 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 termsreversal 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.temporary difference.
     (vii) Options
      Under UK GAAP, the Group does not recognize compensation costs under share option schemes that have not been approved by the Inland Revenue unless the exercise price is at a discount to the open market value at date of grant.
      Under US GAAP, the compensation expense associated with all stock-based awards is recognized in accordance with SFAS 123,“Accounting For Stock-Based Compensation”. Under SFAS 123, compensation expense is determined based upon the fair value at the grant date for awards, and has been estimated using the Black Scholes model. Such compensation cost is recognized over the service life of the awards. Under US 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 options and the weighted average assumptions used in the

F-61


NOTES TO THE ACCOUNTS (Continued)
Black Scholes model for determining the fair values of options issued under the Company option schemes for each 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, compensation cost is charged to the income statement with the offsetting amount recorded as either a reduction of the own shares held as an asset on the balance sheet or a liability that is transferred to shareholders’ funds upon exercise or expiration of the option. Under US GAAP, compensation cost is charged to the income statement with the offsetting amount recorded directly to shareholders’ funds.
     (viii) Derivatives
      Under UK GAAP, the Group’s derivatives are recorded as hedging instruments. Amounts payable or receivable in respect of interest rate swaps are accrued with net interest payable over the period of the contract. Unrealized gains and losses on currency swaps and forward currency contracts are deferred and recognized when paid.
      Under US GAAP, the Group is required to record all derivative instruments on the balance sheet at fair value. Derivatives not classified as hedges are adjusted to fair value through earnings. Movements in the fair value of 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 movement in the fair value of the underlying bond or asset. Any movements on the ineffective portion of derivatives that are classified as hedges are immediately recognized in earnings.
      In 2003 and 2002, 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. Consequently, for those years, the Group has recorded the changes in the fair values of these derivative contracts through earnings under US GAAP. In line with the Group’s treasury policy, these are not trading instruments and are transacted solely to match underlying financial exposures. In 2004 the Group met the prescribed designation requirements 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 set

F-62


NOTES TO THE ACCOUNTS (Continued)
do not necessarily exactly match those of the borrowings that are being hedged. The Group believes that its portfolio of such swaps is an efficient economic hedge 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 licences 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 periods 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 earnings under US GAAP. These are reflected as adjustments to the purchase price under UK GAAP.
     (xi) Partnerships and associates
      There is no difference under UK and US GAAP in the accounting for partnerships and associates. However, the accounts of partnerships and associates must be adjusted from UK 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: goodwill amortization, pensions, derivatives, and goodwill impairment charges.
      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
      Under UK GAAP, ordinary dividends proposed are provided for in the year in respect of which they are recommended by the board of directors although approval of the final dividend will not take place until the Annual General Meeting subsequent to the year-end. Under US GAAP, such dividends are provided for in the year in which they are declared and approved by the board of directors.
     (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
      Minority interests represent the minority share of US GAAP adjustments.
     (xv) 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
     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)
             
Other disclosures required by US GAAP
     Consolidation
      The consolidated financial statements include the accounts of the Group and majority-owned and controlled subsidiaries. Under UK GAAP,IFRS, the investments in companies in which the Group is unable to exercise control but has the ability to exercise significant influence over operating and financial policies are accounted for by the equity method, which is consistent with the equity method under US GAAP. Accordingly, the Group’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
      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
      The consolidated financial statements do not constitute “statutory accounts” within the meaning of the Companies Act 1985 of Great Britain for any of the periods presented. Statutory accounts for the years ended December 31, 2003, 2002 and 2001 have been filed with the United Kingdom’s Registrar of Companies. The auditors have reported on these accounts. Their reports were unqualified and did not contain statements under Section 237 (2) or (3) of that Act.
      These consolidated financial statements include all material disclosures required by generally accepted accounting principles in the United Kingdom including those Companies Act 1985 disclosures relating to the profit and loss account and balance sheet items.

F-66F-68


NOTES TO THE ACCOUNTSCONSOLIDATED FINANCIAL STATEMENTS (Continued)
     Recently issued accounting standardsU.S. Accounting Pronouncements
      In December 2003,July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 46R “Consolidation48”), an Interpretation of Variable Interest Entities — an interpretation of ARBFASB Statement 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.109. 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 that48 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 SFAS No. 151, “Inventory Costs-An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 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, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15,2005.December 15, 2006 with the cumulative effect of a change in accounting principle recorded as an adjustment to opening retained earnings. The Group is currently evaluating the effectprovisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. FIN 48 requires that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material impact.
      In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non monetary Assets-An Amendment of APB Opinion No. 29, Accounting for Non monetary Transactions” (“SFAS 153”). SFAS 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 monetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. SFAS 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. SFAS 153 is effective for the fiscal periods beginning after June 15, 2005. The Group is currently evaluating the effect that the adoption of SFAS 153 will have but does not expect it to have a material impact.
      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognizedrecognizes 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

F-67


NOTES TO THE ACCOUNTS (Continued)
under SFAS 123 no longer will be an alternative to financial statement recognition. The Group is currently evaluating the impact of adoptiona tax position, if that position is more likely than not of SFAS 123Rbeing sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognizing, classification, interest and penalties, accounting in interim periods, disclosure, and transition attributable to the tax position. Management is currently assessing the impact of FIN 48 on the Group.
International Accounting Pronouncements
      IFRS 7 ‘Financial Instruments: Disclosures’ (effective from January 1, 2007). IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specific minimum disclosures about credit risk, liquidity risk and market risk. Management is currently assessing the impact of IFRS 7 on the Group’s financial statements.
      A complementary amendment to IAS 1 ‘Presentation of Financial Statements — Capital Disclosures’ (effective from 1 January 2007). The amendment to IAS 1 introduces disclosures about the level and the management of the capital of an entity. Management is currently assessing the impact of the complementary amendment to IAS 1 on the Group’s financial statements
      IFRS 8 ‘Operating Segments’ (effective January 1, 2009). IFRS 8 requires an entity to adopt the ‘management approach’ to reporting on the financial performance of its operating segments, revise explanations of the basis on which the segment information is prepared and provide reconciliations to the amounts recognized in the income statement and balance sheet. Management is currently assessing the impact of IFRS 8 on the Group’s financial statements.
      IFRIC 8 ‘Scope of IFRS 2’ (effective for annual periods beginning on or after May 1, 2006). IFRIC 8 requires consideration of transactions involving the issuance of equity instruments — where the identifiable consideration received is less than the fair value of the equity instruments issued — to establish whether or not they fall within the scope of IFRS 2. The Group will apply IFRIC 8 from January 1, 2007, but it is not expected to have any impact on the Group’s accounts.
      IFRIC 10 ‘Interim Financial Reporting and Impairment’ (effective for annual periods beginning on or after November 1, 2006). IFRIC 10 prohibits impairment losses recognized in an interim period on goodwill, investments in equity instruments and investments in financial assets carried at cost to be reversed at a subsequent balance sheet date. The Group will apply IFRIC 10 from January 1, 2007 but because it already appliesis not expected to have a significant impact on the Group’s accounts.
      IFRIC 7 ‘Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies’ (effective for annual reporting periods beginning on or after March 1, 2006). IFRIC 7 provides guidance on how to apply the requirements SFAS 123 itof IAS 29 in a reporting period in which an entity identifies the existence of hyperinflation in the economy of its functional currency, when the economy was not hyperinflationary in the prior period. As none of the Group entities have a currency of a hyperinflationary economy as their functional currency, IFRIC 7 is not relevant to the Group’s operations.
      IFRIC 9 ‘Reassessment of Embedded Derivatives’ (effective for annual periods beginning on or after June 1, 2006). IFRIC 9 requires an entity to assess whether an embedded derivative is required to be separated from the host contract and accounted for as a derivative when the entity first becomes a party to the contract. Subsequent reassessment is prohibited unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract, in which case reassessment is required. The Group does not expect adoption of the new standardIFRIC 9 to have a material impact.

F-68F-69


SIGNATURES
      The registrant hereby certifies that it meets all the of the requirements for filing on Form 20-F and that it has caused and authorized the undersigned to sign this annual report on its behalf.
 Pearson plc
 
 /s/ Rona FairheadRobin Freestone
  
 Rona FairheadRobin Freestone
 Chief Financial Officer
Date: June 27, 2005April 30, 2007

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