INTRODUCTION

In this Annual Report onForm 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 ~~European Union(“EU”)-adopted~~International Financial Reporting Standards (“IFRS”), as issued by the International Accounting Standards Board (“IASB”) which in respect of the accounting standards applicable to the Group do not differ ~~in certain significant respects~~ from ~~generally accepted accounting principles in~~IFRS as adopted by the United States, or US GAAP. We describe these differences in “Item 5. Operating and Financial Review and Prospects — Accounting Principles”, and in note 35 to our consolidated financial statements included in “Item 17. Financial Statements” of this Annual Report.European Union (“EU”). Unless we indicate otherwise, any reference in this Annual Report to our consolidated financial statements is to the consolidated financial statements and the related notes, included elsewhere in this Annual Report.

We publish our consolidated financial statements in sterling. We have included, however, references to other currencies. In this Annual Report:


	•	references to “sterling”, “pounds”, “pence” or “£” 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~~sterling figures into US dollars at the rate of £1.00 = ~~$1.72,~~$1.98, 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 ~~30, 2005,~~31, 2007, the last business day of ~~2005.~~2007. We do not make any representation that the amounts of sterling have been, could have been or could be converted into dollars at the rates indicated. On ~~April 28, 2006~~March 31, 2008 the noon buying rate for sterling was £1.00 = ~~$1.82.~~$1.99.

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 terminology. Examples of these forward-looking statements include, but are not limited to, statements regarding the following:


	•	operations and prospects,

	•	growth strategy,

	•	funding needs and financing resources,

	•	expected financial position,

	•	market risk,

	•	currency risk,

	•	US federal and state spending patterns,

	•	debt levels, and


	•	general market and economic conditions.

These forward-looking statements 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.

PART I


ITEM 1.	*IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS*

Not applicable.


ITEM 2.	*OFFER STATISTICS AND EXPECTED TIMETABLE*

Not applicable.


ITEM 3.	*KEY INFORMATION*

Selected ~~Consolidated Financial Data~~consolidated financial data

Following the publication of SEC Release No 33-8879 “Acceptance From Foreign Private Issuers of Financial Statements Prepared in Accordance With International Financial Reporting Standards Without Reconciliation to U.S. GAAP”, the Group no longer provides a reconciliation between IFRS and U.S. GAAP.

The ~~table~~tables below shows selected consolidated financial data ~~for each of~~under IFRS as issued by the ~~years in the five-year period ended December 31, 2005.~~IASB. The selected consolidated profit and loss account data for the years ended December 31, ~~2005, 2004~~2007, 2006 and ~~2003~~2005 and the selected consolidated balance sheet data as at December 31, ~~2005, 2004~~2007 and ~~2003~~2006 have been derived from our audited consolidated financial statements included in “Item ~~17.~~18. Financial Statements” in this Annual ~~Report and have been prepared in accordance with IFRS.~~Report.

Our consolidated financial statements for the year ended December 31, 2005 have been prepared in accordance with IFRS, which differs from US GAAP in certain significant respects. See “Item 5. Operating and Financial Review and Prospects — Accounting Principles” and note 35 to the consolidated financial statements. The consolidated financial statements contain a reconciliation to US GAAP of profit/loss for the financial year, shareholders’ funds and certain other financial data.

The selected consolidated financial information should be read in conjunction with “Item 5. Operating and Financial Review and Prospects” and our consolidated financial statements and the related notes appearing elsewhere in this Annual Report. The information provided below is not necessarily indicative of the results that may be expected from future operations.

For convenience, we have translated the ~~2005~~2007 amounts into US dollars at the rate of £1.00 = ~~$1.72,~~$1.98, 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 ~~30, 2005.~~31, 2007.


	Year Ended December 31
	2007			2007			2006			2005			2004			2003
	$			£			£			£			£			£
	(In millions, except for per share amounts)

IFRS information:
Consolidated Income Statement data
Total sales		8,241			4,162			3,990			3,662			3,340			3,510
Total operating profit		1,137			574			522			497			359			386
Profit after taxation from continuing operations		667			337			444			319			232			239
Profit for the financial year		614			310			469			644			284			275
Consolidated Earnings data per share
Basic earnings per equity share(1)	$	0.70			35.6p			55.9p			78.2p			32.9p			31.7p
Diluted earnings per equity share(2)	$	0.70			35.6p			55.8p			78.1p			32.9p			31.7p
Basic earnings from continuing operations per equity share(1)	$	0.77			39.0p			52.7p			37.5p			26.4p			27.2p
Diluted earnings from continuing operations per equity shares	$	0.77			39.0p			52.6p			37.4p			26.3p			27.2p
Dividends per ordinary share	$	0.63			31.6p			29.3p			27.0p			25.4p			24.2p
Consolidated Balance Sheet data at period end
Total assets (non-current assets plus current assets)		14,438			7,292			7,213			7,600			6,578			6,736
Net assets		7,671			3,874			3,644			3,733			3,014			3,161
Long-term obligations(3)		(3,328	)		(1,681	)		(1,853	)		(2,500	)		(2,403	)		(1,982	)
Capital stock		400			202			202			201			201			201
Number of equity shares outstanding (millions of ordinary shares)		808			808			806			804			803			802

Notes:


	*~~Restatement~~*

In accordance with EU regulations, the Company has prepared the financial statements as at December 31, 2005 in accordance with EU-adopted International Financial Reporting Standards (IFRS) and International Financial Reporting Interpretations Committee interpretations (IFRIC). Consolidated financial statements of Pearson until December 31, 2004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments. See note 34 to our consolidated financial statements for an explanation of the effects of transition to IFRS.

Year Ended December 31

2005 2005 2004 2003

IFRS IFRS IFRS
IFRS £ £ £
$
(In millions, except for per share amounts)
IFRS Information:

Consolidated Profit and Loss Account Data

Statutory Measures

Total sales 7,045 4,096 3,696 3,850
Total operating profit/(loss) 922 536 404 406
Profit/(loss) after taxation from continuing operations 588 342 262 252
Profit/(loss) for the financial year 1,108 644 284 275
Basic earnings/(loss) per equity share(4) $ 1.35 78.2 p 32.9 p 31.7 p
Diluted earnings/(loss) per equity share(5) $ 1.34 78.1 p 32.9 p 31.7 p
Dividends per ordinary share $ 0.46 27.0 p 25.4 p 24.2 p
Consolidated Balance Sheet Data

Total assets (Fixed assets plus Current assets) 13,072 7,600 6,578 6,736
Shareholders funds 6,130 3,564 2,800 2,969
Long-term obligations(6) (4,300 ) (2,500 ) (2,403 ) (1,982 )
Capital stock(1) 346 201 201 201
Number of equity shares outstanding
(millions of ordinary shares) 804 804 803 802

Year Ended December 31

2005 2005 2004 2003 2002 2001

£ £ £ £ £
$
(In m illions, except for per share amounts)
US GAAP Information(7):

Consolidated Profit and Loss Account Data

Statutory Measures

Total sales 7,045 4,096 3,696 3,879 4,320 4,225
Total operating profit/(loss)(2) 746 434 260 364 453 (389 )
Profit/(loss) after taxation from continuing operations 330 192 203 198 219 (1,483 )
Profit/(loss) for the financial year(8) 707 411 182 173 189 (1,500 )
Profit/(loss) from continuing operations for the financial year(3) 299 174 166 160 221 (424 )
(Loss)/profit from discontinued operations(3) (3 ) (2 ) 16 16 (10 ) (91 )
Profit/(loss) on disposal of discontinued operations(3) 411 239 — (3 ) (1 ) (985 )
Basic earnings/(loss) per equity share(4) $ 0.89 51.5 p 22.9 p 21.8 p 23.7 p (188.6 )p
Diluted earnings/(loss) per equity share(5) $ 0.88 51.4 p 22.8 p 21.8 p 23.7 p (188.6 )p
Basic earnings/(loss) from continuing operations per equity share(1)(4) $ 0.37 21.8 p 20.9 p 20.1 p 27.8 p (53.3 )p
Diluted earnings/(loss) from continuing operations per equity shares(3)(5) $ 0.37 21.7 p 20.8 p 20.1 p 27.8 p (53.3 )p
Basic (loss)/earnings per share from discontinued operations(3)(4) $ 0.51 29.7 p 2.0 p 1.7 p (4.1 )p (135.3 )p
Diluted (loss)/earnings per share from discontinued operations(3)(5) $ 0.51 29.7 p 2.0 p 1.7 p (4.1 )p (135.3 )p
Dividends per ordinary share $ 0.46 27.0 p 25.4 p 24.2 p 22.7 p 21.9 p
Consolidated Balance Sheet Data

Total assets 13,416 7,800 7,040 7,101 6,767 8,280
Shareholders’ funds 6,601 3,838 3,218 3,333 4,155 4,155
Long-term obligations(6) (4,123 ) (2,397 ) (2,392 ) (1,951 ) (2,026 ) (2,829 )


(1)	~~Capital stock and the number of equity shares outstanding are the same under both IFRS and US GAAP.~~

~~(2)~~	Total operating profit under US GAAP includes a profit of £nil in 2005 (a profit of £14 million in 2004 and a loss of £7 million in 2003) on the sale of fixed assets and investments. Additionally, the US GAAP operating profit includes the operating profit impact of the GAAP adjustments discussed in note 35 in “Item 17. Financial Statements”.

~~(3)~~	Discontinued operations under both IFRS and US GAAP comprise the results of Recoletos Grupo de Comunicacion SA for all years presented and the results of RTL Group for 2002 and 2001. Discontinued operations under US GAAP also include the results of the Forum Corporation for 2003, 2002 and 2001.

~~(4)~~	Basic ~~earnings/loss~~earnings per equity share is based on ~~profit/loss~~profit for the financial period and the weighted average number of ordinary shares in issue during the period.

~~(5)~~ (2)		Diluted ~~earnings/loss~~earnings per equity share is based on diluted ~~earnings/loss~~earnings for the financial period and the diluted weighted average number of ordinary shares in issue during the period. Diluted ~~earnings/loss~~earnings comprise ~~earnings/loss~~earnings adjusted for the tax benefit on the conversion of share options by employees and the weighted average number of ordinary shares adjusted for the dilutive effect of share options.

~~(6)~~ (3)		Long-term obligations comprise any liabilities with a maturity of more than one year, including medium and long-term borrowings, derivative financial instruments, pension obligations and deferred income tax liabilities.

~~(7)~~ (4)	~~See note 35 to the consolidated financial statements~~	The results of Government Solutions (disposed in February 2007), Les Echos (disposed in December 2007) and Data Management (disposed in February 2008) have been included in ~~this Annual Report entitled “Summary of principal differences between International Financial Reporting Standards and United States of America generally accepted accounting principles”.~~

~~(8)~~	The loss of £1,500 million in 2001 is after charging goodwill amortization of £527 million. Since 2002, goodwill has no longer been subject to amortization under US GAAP. See note 35 in “Item 17. Financial Statements”.discontinued operations for all years presented.

Dividend ~~Information~~information

We pay dividends to holders of ordinary shares on dates that are fixed in accordance with the guidelines of the London Stock Exchange. Our board of directors normally declares an interim dividend in July or August of each year to be paid in September or October. Our board of directors normally recommends a final dividend following the end of the fiscal year to which it relates, to be paid in the following May or June, subject to shareholders’ approval at our annual general meeting. At our annual general meeting on April ~~21, 2006~~25, 2008 our shareholders ~~approved~~will be asked to approve a final dividend of ~~17.0p~~20.5p per ordinary share for the year ended December 31, ~~2005.~~2007.

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 ~~2005~~2007 fiscal year will be paid on 5 May ~~2006.~~9, 2008.

Fiscal Year Interim Final Total Interim Final Total

(Pence per ordinary share) (Cents per ordinary share)
2005
10.0 17.0 27.0 17.2 29.2 46.4
2004 9.7 15.7 25.4 18.6 30.2 48.8
2003 9.4 14.8 24.2 16.7 26.4 43.1
2002 9.1 14.3 23.4 14.7 23.0 37.7
2001 8.7 13.6 22.3 12.6 19.7 32.3


Fiscal year	Interim		Final		Total		Interim		Final			Total
	(Pence per ordinary share)						(Cents per ordinary share)

2007		11.1		20.5		31.6		22.4		40.6	*		63.0
2006		10.5		18.8		29.3		20.0		31.4			51.4
2005		10.0		17.0		27.0		17.8		29.8			47.6
2004		9.7		15.7		25.4		17.4		26.4			43.8
2003		9.4		14.8		24.2		15.6		25.5			41.1


*		As the 2007 final dividend had not been paid by the filing date, the dividend was translated into cents using the noon buying rate for sterling at December 31, 2007.

Future dividends will be dependent on our future earnings, financial condition and cash flow, as well as other factors affecting the Group.

Exchange ~~Rate Information~~rate information

The following table sets forth, for the periods indicated, information concerning the noon buying rate for sterling, expressed in dollars per pound sterling. The average rate is calculated by using the average of the noon buying rates in the city of New York on each day during a monthly period and on the last day of each month

during an annual period. On December ~~30, 2005,~~31, 2007, the noon buying rate for cable transfers and foreign currencies as certified

by the Federal Reserve Bank of New York for customs purposes for sterling was £1.00 = $1.98. On March 31, 2008 the noon buying rate for sterling was £1.00 = ~~$1.72. On April 28, 2006 the noon buying rate for sterling was £1.00 = $1.82.~~$1.99.

Month High Low

April 2006 $ 1.82 $ 1.74
March 2006 $ 1.76 $ 1.73
February 2006 $ 1.78 $ 1.73
January 2006 $ 1.79 $ 1.74
December 2005 $ 1.77 $ 1.72
November 2005 $ 1.78 $ 1.71

Year Ended December 31 Average Rate

2005 $ 1.81
2004 $ 1.84
2003 $ 1.63
2002 $ 1.51
2001 $ 1.45


Month	High		Low

March 2008	$	2.03	$	1.98
February 2008	$	1.99	$	1.94
January 2008	$	1.99	$	1.95
December 2007	$	2.07	$	1.98
November 2007	$	2.11	$	2.05
October 2007	$	2.08	$	2.03


Year Ended December 31	Average rate

2007	$	2.01
2006	$	1.84
2005	$	1.81
2004	$	1.83
2003	$	1.63

Risk ~~Factors~~factors

You should carefully consider the risk factors described below, as well as the other information included in this Annual Report. Our business, financial condition or results from operations could be materially adversely affected by any or all of these risks, or by other risks that we presently cannot identify.


	Our US educational textbook and testing businesses may be adversely affected by changes in state educational funding resulting from either general economic conditions, changes in government educational funding, programmes and legislation (both at the federal and state level), and/or changes in the state procurement process.

~~The~~Our intellectual property and proprietary rights may not be adequately protected under current laws in some jurisdictions and that may adversely affect our results ~~of our US educational textbook~~ and ~~testing business depends on the level of US and state educational funding and this funding is a significant influence on~~ our ability to grow.

With the improvement in the US economy state educational expenditure has increased as state tax receipts have increased, reducing or eliminating state budget deficits, thereby minimizing the risk that state educational expenditure is cut or deferred. Federal legislative changes can also affect the funding available for educational expenditure, e.g. the No Child Left Behind Act. These might also include changes in the procurement process for textbooks, learning material and student tests, particularly in the adoptions market. For example, changes in curricula, delays in the timing of the adoptions and changes in the student testing process can all affect these programs and therefore the size of our market in any given year.

~~There are multiple competing demands for educational funds and there is no guarantee that states will fund new textbooks or testing programs, or that we will win this business.~~


	Our newspaper businesses may be adversely affected by reductions in advertising revenues and/or circulation either due to weak general economic conditions or competing news information distribution channels, particularly online and digital formats.

Our newspaper businesses are highly geared and remain dependent on advertising revenue; relatively small changes in revenue, positive or negative, have a disproportionate affect on profitability. We are beginning to see an increase in advertising revenues compared to prior years, however any downturn in corporate and financial advertising spend would negatively impact our results.

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 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 largely comprise 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.

We cannot be sure that our proprietary rights will not be challenged, invalidated or circumvented. Our intellectual property rights in countries such as the ~~United States~~US and ~~the United Kingdom, which are the~~UK, jurisdictions ~~with~~covering the largest ~~proportions~~proportion of our operations, are well established. However, we also conduct business in other countries where the extent of effective legal protection for intellectual property rights is uncertain, and this uncertainty could affect our future growth. Moreover, despite trademark and copyright protection, third parties may copy, infringe or otherwise profit from our proprietary rights without our authorization.

These unauthorized activities may be more easily facilitated by the internet. The lack of internet-specific legislation relating to trademark and copyright protection creates an additional challenge for us in protecting our proprietary rights relating to our online business processes and other digital technology rights. The loss or diminution in value of these proprietary rights or our intellectual property could have a material adverse effect on our business and financial performance. In that regard, Penguin Group (USA) Inc. and Pearson Education have joined three other major US publishers in a suit brought under the auspices of the Association of American Publishers to challenge Google’s plans to copy the full text of all books ever published without permission from the publishers or ~~the~~ authors. This lawsuit seeks to demarcate the extent to which search engines, ~~and~~ other internet operators 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~~on-line~~ online users of their intellectual property. If the lawsuit is unsuccessful, publishers and authors may ~~not~~ be ~~able~~unable to control copying of their content for purposes of ~~on-line~~online searching, which could have an adverse impact on our business and financial performance.

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 all operate in highly competitive markets, which are constantly changing in response to competition, technological innovations and other factors. A common trend facing all our businesses is the digitization of content and proliferation of distribution channels, either over the internet, or via other electronic means, replacing traditional print formats. If we do not adapt rapidly to these changes we may lose business to ‘faster’ more ‘agile’ competitors, who increasingly are nontraditional competitors, making their identification all the more difficult.

Illustrations of the competitive threats we face at present include:


	*~~The contracting risks associated~~—*	Students seeking cheaper sources of content, e.g. online, used books or re-imported textbooks.

	—	Competition from major publishers and other educational material and service providers, including not for profit organizations, in our US educational textbook and assessment businesses.

	—	Penguin: authors’ advances in consumer publishing. We compete with other publishing businesses to purchase the rights to author manuscripts. Our competitors may bid to a level at which we could not generate a sufficient return on our investment, and so, typically, we would not purchase these rights.

	—	FT: we face competitive threats both from large media players and from smaller businesses, online portals and news redistributors operating in the digital arena and providing alternative sources of news and information.

	—	People: the investments we make in our employees, combined with our ~~Professional division within Pearson Education~~employment policies and practices, we believe are ~~complex~~critical factors enabling us to recruit and ~~could adversely affect~~retain the very best people in our ~~financial results and growth prospects.~~business sectors.

Our ~~Professional division provides services ranging~~US educational textbook and assessment businesses may be adversely affected by changes in state educational funding resulting from ~~call center operations to complete outsourcing of administrative functions. Customers are~~either general economic conditions, changes in government ~~agencies~~educational funding, programs and ~~professional organizations, mainly~~legislation (both at the federal and state level), and/or changes in the ~~USA~~state procurement process.

The results and growth of our US educational textbook and assessment business is dependent on the level of federal and state educational funding, which in turn is dependent on the robustness of state finances and the ~~UK,~~level of funding allocated to educational programs. State finances could be adversely affected by a US recessionand/or fallout from the sub-prime mortgage crisis reducing property values and ~~commercial businesses. These services are provided under contracts with values that vary significantly, from a few million to several hundred million pounds over~~hence state property tax receipts.

Federaland/or state legislative changes can also affect the ~~term~~funding available for educational expenditure, e.g. the No Child Left Behind Act.

Similarly changes in the state procurement process for textbooks, learning material and student tests, particularly in the adoptions market can also affect our markets. For example, changes in curricula, delays in the timing of the ~~contract, which~~adoptions and changes in the student testing process can ~~run from one to ten years in length. The results~~all affect these programs and therefore the size of our ~~Professional division can be significantly dependent on a small number of large contracts.~~

Asmarket in any ~~long-term contracting~~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.

Failure to generate anticipated revenue growth, synergies and/or costs savings from recent acquisitions could lead to goodwill and intangible asset impairments.

We continually acquire and dispose of businesses to achieve our strategic objectives. We recently completed two relatively large acquisitions, i.e. the Harcourt Assessment and Harcourt Education International business ~~there~~for $950m and the acquisition of eCollege for $491m. If we are ~~inherent risks~~unable to generate the anticipated revenue growth, synergiesand/or cost savings associated with these acquisitions there is a risk the ~~bidding process, operational performance, contract compliance (including penalty clauses), indemnification (if available)~~goodwill and ~~contract re-bidding, which~~intangible assets acquired (estimated at £430m) could be impaired in future years.

Our newspaper businesses may be adversely ~~affect our financial performance~~affected by reductions in advertising revenues and/or ~~reputation. In addition, US government contracts~~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 sourcesand/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 ~~subject~~operationally highly geared and still rely significantly on print advertising revenue despite moves to ~~audit~~other business models; relatively small changes in revenue, positive or negative, have a disproportionate effect on profitability; therefore any downturn in corporate and ~~investigation by the applicable contracting government entity and may otherwise be investigated by the government, and this can~~financial advertising spend would negatively impact our results.

A control breakdown in our school assessment businesses could result in ~~payment delays~~financial loss and ~~in certain circumstances, reductions in the amounts received, penalties or other sanctions.~~reputational damage.


	*~~A control breakdown in our school testing businesses could result in financial loss and reputational damage.~~*

There are inherent risks associated with our school ~~testing~~assessment businesses, both in the USA and the UK. A breakdown in our testing and assessment products and processes could lead to a mis-grading of student testsand/or late delivery of test results to students and their schools. In either event we may be subject to legal claims, penalty charges under our contracts, non-renewal of contracts ~~and in the case of our UK testing business,~~and/or the suspension or withdrawal of our ~~accreditation.~~accreditation to conduct tests. It is also possible that such events would result in adverse publicity, which may affect our ability to retain existing contractsand/or obtain new customers.

~~We have recently experienced adverse publicity as a result~~

Our professional services and school assessment businesses involve complex contractual relationships with both government agencies and commercial customers for the provision of various testing services. Our financial results, growth prospects and/or reputation may be adversely affected if these contracts and relationships are not managed.

These businesses are characterized by multi-million pound sterling contracts spread over several years. As in any contracting business, there are inherent risks associated with the bidding process,start-up, operational performance and contract compliance (including penalty clauses) which could adversely affect our financial performanceand/or reputation. Failure to retain these contracts at the end of the ~~rescoring~~contract term could adversely impact our future revenue growth.

At Edexcel, our UK Examination board and testing business, any change in UK Government policy to examination marking — for example, introduction of ~~the October 2005 Scholastic Aptitude Test,~~ new qualifications — could have a significant impact on our present business model.

At Penguin, changes in product distribution channels, increased book returns and/or ~~SAT, in the USA. We provide answer sheet scanning services for the College Board, which administers the SAT. We rescanned approximately 1.5 million tests taken in October 2005 through January 2006~~customer bankruptcy may restrict our ability to grow and ~~as a result, the College Board reissued higher scores for about 4,400 out of~~

~~approximately 495,000 tests taken in October. We have also been named along with the College Board as a defendant in a class action lawsuit filed as a result of the revised scores.~~affect our profitability.


	*~~Changes in the Penguin business may restrict our ability to grow and 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.~~ models, potentially impacting both sales volumes and pricing.

Penguin’s financial performance can also be negatively affected if book return rates ~~increase.~~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 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,~~which are dependent on Information Technology (IT) systems and technological innovations and other factors. To remain competitive we continue to invest in our authors, products and services. There is no guarantee that these investments will generate the anticipated returns or protect us from being placed at a competitive disadvantage with respect to scale, resources and our ability to develop and exploit opportunities. Specific competitive threats we face at present include:change.


	•	Students seeking cheaper sources of content, e.g. on-line, used books or imported textbooks. To counter this trend we introduced our own on-line format (called SafariX) and are providing students with a greater choice and customization of our products.

	•	~~Competition from major publishers and other educational material and service providers in our US educational textbook and testing businesses.~~

	•	Penguin — Authors’ advances in consumer publishing. We compete with other publishing businesses for the rights to author manuscripts. In certain instances author advances can be bid up to a level at which we cannot generate a sufficient return on our investment.


	*~~We operate in markets which are dependent on Information Technology systems and technological change.~~*

All our businesses, to a greater or lesser extent, are dependent on information technology. We either provide softwareand/or internet services to our customers or we use complex ~~information technology~~IT systems and products to support our business activities, particularly in business information publishing, back-office processing and infrastructure.

We face several technological risks associated with software product development and service delivery in our educational businesses, information technology security (including virus and hacker attacks),e-commerce, enterprise resource planning system implementations and ~~upgrades~~upgrades. 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 ~~continuity in the event of~~caused by a major disaster and/or external threats could restrict our ability to supply products and services to our customers.

Across all our businesses, we manage complex operational and logistical arrangements including distribution centers, data centers and large office facilities as well as relationships with third party print sites. 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 a pandemic, terrorist attacks, strikes etc, could all affect our business and employees, disrupting our daily business activities.

A major data ~~center.~~privacy breach may cause reputational damage to our brands and financial loss.


	*~~Our reported earnings may be adversely affected by changes in our pension costs and funding requirements due to poor investment returns and/or changes in pension regulations.~~*

Across our businesses we hold increasingly large volumes of personal data including that of employees, customers and, in our assessment businesses, students and citizens. Failure to adequately protect personal data could lead to penalties, significant remediation costs, reputational damage, potential cancellation of some existing contracts and inability to compete for future business.

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 markets.

Our reported earnings and cash flows may be adversely affected by changes in our pension costs and funding requirements.

We operate a number of pension ~~schemes~~plans throughout the world, the principal ones being in the UK and US. The major ~~schemes~~plans 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 ~~scheme~~plan is adequately funded, over time, to meet its ongoing and future liabilities. Our earnings and cash flows may be adversely affected by ~~lower~~the need to provide additional funding to eliminate pension fund deficits in our defined benefit plans. Our greatest exposure relates to our UK defined benefit pension plan. Pension fund deficits may arise because of inadequate investment returns, ~~due to a general deterioration~~increased 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~~and minimum funding requirements.

The latest valuation of our UK defined benefit pension plan has been completed and future funding arrangements have been agreed between the Company and the pension fund trustee. Additional payments amounting to £100m were made by the Company in 2007. We review these arrangements every three years.

We generate a substantial proportion of our revenue in foreign currencies particularly the US dollar, and foreign exchange rate fluctuations could adversely affect our ~~pension costs~~earnings and ~~funding status.~~the strength of our balance sheet.


	*~~Sarbanes-Oxley (SOX) 404 Compliance cost~~*

Beginning with our 2006 fiscal year, we will be required to comply with section 404 of SOX relating to internal control over financial reporting. Our SOX 404 implementation project commenced in 2003 and we believe we are on track to be compliant. However, the cost of complying with SOX 404 may reduce our earnings.


	*~~We generate a substantial proportion of our revenue in foreign currencies, particularly the US dollar, and foreign exchange rate fluctuations could adversely affect our earnings.~~*

As with any international business our earnings can be materially affected by exchange rate movements. We are particularly exposed to movements in the US dollar to sterling exchange rate as approximately ~~65%~~60% of our revenue is generated in US dollars. ~~We estimate that if 2004~~Sales for 2007, translated at 2006 average rates, ~~had prevailed in 2005, sales for 2005~~ would have been ~~£46 million~~£223m or ~~1% lower.~~ 6% 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. ~~We estimate that a five cent~~

Pearson generates about 60% of its sales in the US and each 5¢ change in the average £:$ exchange rate ~~between~~for the ~~US dollar~~full year (which in 2007 was £1:$2.00) would have an impact of 1p on adjusted earnings per share and ~~sterling~~affect shareholders’ funds by approximately £55m.

Changes in ~~any year could~~our tax position can significantly affect our reported earnings ~~per share by approximately 1 pence.~~

~~ITEM 4.~~~~INFORMATION ON THE COMPANY~~and cash flows.

Changes in corporate tax ratesand/or other relevant tax laws in the UKand/or the US could have a material impact on our future reported tax rateand/or our future tax payments.


ITEM 4.	*INFORMATION ON THE COMPANY*

Pearson

Pearson is ~~a global publishing~~an international media and education company with its principal operations in the education, business information and consumer publishing markets. ~~We have significant operations in the United States, where we generate over 65% of our revenues, and in the United Kingdom and continental Europe.~~ We create and manage intellectual property, which we promote and sell to our customers under well-known brand names, to inform, educate and entertain. We deliver our content in a variety of forms and through a variety of channels, including books, newspapers and ~~internet~~online services. We increasingly offer services as well as content, from test creation, administration and processing to ~~training.~~teacher development and school software. Though we operate in 60 countries around the world, today our largest markets are the US (59% of sales) and Europe (26% of sales) on a continuing basis.

Pearson was incorporated and registered in 1897 under the laws of England and Wales as a limited company and re-registered under the UK Companies Act as a public limited company in 1981. We conduct our operations primarily through our subsidiaries and other affiliates. Our principal executive offices are located at 80 Strand, London WC2R 0RL, United Kingdom (telephone: +44 (0) 20 7010 2000).
Overview of ~~Operating Divisions~~operating divisions
~~Although our businesses increasingly share markets, brands, processes and facilities, they consist~~
Pearson consists of three ~~core operations:~~major worldwide businesses:

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 learning materials and electronic education programs for ~~elementary~~teachers and ~~secondary school, higher education~~students of all ages, and ~~business and professional markets worldwide. We also~~we play a major role in the testing and certification of school students and ~~professionals, mainly in the US but increasingly in the UK.~~professionals. In 2007, Pearson Education ~~consists of the following~~operated through three ~~operating segments:~~worldwide segments, which we refer to as “ School”, “Higher Education” and “Professional”:
• ~~School — publisher, provider of testing and software services for primary and secondary schools~~
• ~~Higher Education — publishes textbooks and related course materials for colleges and universities~~
• ~~Professional — publishes texts, reference and interactive products for industry professionals. Provides various testing and service arrangements for government departments and professional bodies.~~
The FT Group ~~consists~~is 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 is the~~~~Financial Times,~~ ~~published internationally and known for its premium editorial content and international scope both in newspaper and internet formats. The FT Group comprises the following operating segments:~~online. It has two major parts:
• FT Publishing ~~— publishes~~includes theFinancial Times~~, other~~and FT.com, one of the world’s premier sources of business ~~newspapers, magazines~~information, alongside a portfolio of financial magazines. It also includes an online financial information business Mergermarket, which provides early stage intelligence to financial institutions and ~~specialist information~~corporates, as well as several joint ventures and associates including 50% of both The Economist Group and the FTSE index business.

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• Interactive Data ~~(“IDC”) —~~ provides specialist financial ~~and business information~~data to financial institutions and retail investors. Pearson owns a 62% interest in Interactive Data, which is publicly listed on the New York Stock Exchange (NYSE:IDC).

The Penguin Groupis one of the ~~premier~~world’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 and reference titles under imprints including Penguin, Hamish Hamilton, Putnam, Berkley, Viking and ~~illustrated works.~~Dorling Kindersley.
Our ~~Strategy~~strategy
~~Since 1997,~~
Over the past decade we have ~~reshaped~~transformed Pearson by ~~divesting~~focusing on companies which provide ’education’ in the broadest sense of the word: companies that educate, inform and entertain. Through a ~~range~~combination of ~~non-core interests~~organic investment and ~~investing over $7 billion in education, consumer publishing and business information companies. Each~~acquisitions, we have built each one of our businesses into a leader in its market, and we have integrated our operations so that our businesses can share assets, brands, processes, facilities, technology and central services.
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~~aims~~
Our goal is to ~~benefit from educating, informing~~produce sustainable growth on our three key financial measures — adjusted earnings per share, cash flow and ~~entertaining people~~return on invested capital — which we believe are, together, good indicators that we are building 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, through intellectual property;~~past five years, for example, we have invested $1.7bn in new content in our education business alone.

• ~~to provide a combination~~Technology and services: We invested early and consistently in technology, believing that, in the digital world, content alone would not be enough. We now generate more than $1bn in sales from technology products and services, and our testing and assessment businesses, serving school students and professionals, make more than $1.2bn of ~~publishing, both in print and online, and related services that make our publishing more valuable and take us into new, faster-growing markets;~~sales, up from around $200m eight years ago.

• ~~to continue to invest in the growth~~International markets: Though we currently generate approximately 60% of our ~~businesses, including:~~
• extending our lead in education publishing, investing in new programs for students in School and Higher Education and in testing and software services that help educators to personalize the learning process, 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.

• ~~developing our fast-growing contracting businesses, which provide testing and other services~~Efficiency: We’ve invested to ~~corporations and government agencies;~~
• ~~building the international reach of the~~~~Financial Times~~ ~~— both in print~~become a leaner, more efficient company, through ~~its four editions worldwide and online through FT.com — and enhancing the market positions of our network of national business newspapers around the world; and~~
• ~~growing our position in consumer publishing, balancing our investment across our stable of best-selling authors, new talent and our own home-grown content;~~
• ~~to foster a collaborative culture which facilitates greater productivity and innovation by sharing processes, costs, technology, talent and assets across our business;~~
• ~~to capitalize on the growth prospects~~savings in our ~~markets~~individual businesses and onthrough a strong centralized operations structure. Over the past three years, we have increased our ~~leaner operations~~operating profit margins from 10.8% to ~~improve profits,~~15.0% and reduced average working capital as a percentage of sales in Pearson Education and Penguin from 29.4% to 25.6%, freeing up cash ~~flows and returns on invested capital.~~
~~Operating Divisions~~
~~Pearson Education~~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 in the value of the Company.
Operating divisions
Pearson Education
Pearson Education is one of the ~~world’s~~ largest publishers of textbooks and online teaching ~~materials based on published sales figures and independent estimates of sales. Pearson Education~~materials. It serves the growing demands of teachers, students, parents and professionals throughout the world for stimulating and effective education ~~programs. With federal~~programs in print and state governments increasingly required to measure academic progress against clear objective standards, the market for educational testing services in the United States has grown significantly, as have markets around the world. Our integrated approach to education has helped us grow faster because of our breadth.online.

We report Pearson Education’s performance by the three market segments it serves: School, Higher Education and Professional. In ~~2005,~~2007, Pearson Education had sales of ~~£2,663 million~~£2,628m or ~~65%~~63% of Pearson’s ~~total~~total. Of these, £1.9bn (70%) were generated in North America and £0.8bn (30%) in the rest of the world. Pearson Education generated 63% of Pearson’s operating profit.

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School
Our School business contains a unique mix of publishing, testing and technology products for the elementary and secondary school markets, which are increasingly integrated. It generates around two-thirds of its sales ~~(63%~~ in ~~2004).~~
~~School~~
      In the ~~United States,~~US. The major customers of our School business ~~includes publishing, testing~~are state education boards and ~~software operations. Outside of the United States, we have a growing English Language Teaching business and we also publish~~local school ~~and college materials in local languages in a number of countries.~~ districts.
In the ~~United States,~~US, 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 secondary school imprint, Pearson Prentice Hall School, publish high quality curriculum programs for school students covering subjects such as reading, literature, math, 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 approximately 40 million tests each year. Its capabilities will be further enhanced through the integration of the recently acquired Harcourt Assessment business. We are also ~~publish supplementary teaching aids~~a leading provider of electronic learning programs for ~~both~~schools, and of ’Student Information Systems’ technology which enables elementary and secondary schools and ~~teacher-written activity books.~~school districts to record and manage information about student attendance and performance.
Outside the US, we publish elementary and secondary school materials in local languages in a number of countries. We are one of the world’s leading provider of English Language Teaching materials for children and adults, published under the well-known Longman imprint. We bolstered our position further in international markets through the recent acquisition of Harcourt Education International business. We are also a leading ~~publisher in online~~provider of testing, assessment and ~~digital courseware through Pearson Digital Learning, whose offerings~~qualification services. Our key markets outside the US include ~~SuccessMaker, NovaNet~~Canada, the UK, Australia, New Zealand, Italy, Spain, South Africa, Hong Kong and the Waterford Early Reading Program. Through Pearson Achievement Solutions, we provide professional development for teachers in kindergarten through 12th grade with the use of the latest technologies and software tools to improve classroom teaching.Middle East.
In the US, Pearson’s assessments & testing operations are leading service providers in the markets for test development, processing and scoring and the provision of enterprise software solutions to schools. We score and process some 40 million student tests across the United States each year.
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      Pearson School Systems provides 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 20% of schools nationwide and we are the provider of the newest technologies for benchmark testing and student progress analysis.Higher Education
Over 90% of education spending for kindergarten through 12th grade in the United States is financed at the state or local level, with the remainder coming from 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 sell directly to the school districts. In the states without adoptions, called “open territories”, local school districts choose education programs from the entire range available. We actively sell to school districts in open territories as well.
      In 2004, Edexcel won a five year contract for the administration and marking of “Key Stage” testing for 11 and 14 year old students in the UK. Edexcel also began electronic scanning and marking of GCSE and A-level exams in 2004. 4 million scripts were marked electronically in 2005.
~~Higher Education~~
Pearson ~~Education~~ is the ~~United States’~~ largest publisher ~~by sales,~~ of textbooks and related course materials for colleges and ~~universities.~~universities in the US. We publish across all of the main fields of study with imprints such as ~~Pearson~~ Prentice Hall, ~~Pearson~~ Addison Wesley, ~~Pearson~~ Allyn & Bacon and ~~Pearson~~ Benjamin Cummings. ~~Our sales forces call on college educators, who choose~~Typically, professors or other instructors select or ’adopt’ the ~~textbooks~~text books and online resources ~~to be purchased~~they recommend for their students, which students then purchase either in a bookstore or online. Today the majority of our textbooks are accompanied by ~~their students. In 2005, 1.8 million college students registered for our~~ online ~~offerings,~~services which include homework and assessment ~~products, online~~tools, 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 formats such as downloadable audio study guides and electronic textbooks which are sold on subscription. In addition, ~~our~~we 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 2007, our Higher Education business generated approximately 77% 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, Korea, Taiwan and Malaysia.
~~Professional~~
Professional
~~We publish text, reference,~~
Our Professional education business publishes educational materials and ~~interactive products~~provides 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 ~~(IT professional imprints)~~(for IT professionals), Peachpit Press and New Riders Press (graphics and design ~~imprints)~~professionals), Que/Sams (consumer and professional imprint) and Prentice Hall Financial Times ~~(business imprint)~~and Wharton School Publishing (for the business education market). We ~~also generate revenues through our own website — InformIT, and through Safari Books Online (a joint venture with O’Reilly Media). We also provide services to~~have a fast-growing professional ~~markets, managing several commercial~~testing business, Pearson VUE, which manages major long-term contracts to ~~implement and execute~~provide qualification and assessment ~~systems for individual professions, including IT professionals and nurses.~~
      ~~Our Government Solutions group manages and processes student loan applications on behalf~~services through its network of test centers around the ~~US Department of Education. It also provides a number ofnon-education~~ ~~and other testing and service-related contracts with various government agencies both within and outside the US.~~
      ~~We also provide a range of data collection and management services, including scanners, to a wide range of customers. We also provide corporate training courses to professionals.~~
      ~~Contracts~~world. Key customers include ~~a seven year contract to develop and deliver~~major technology companies, the Graduate Management Admissions ~~Test (GMAT) worldwide, beginning~~Council, the Financial Industry Regulatory Authority and the UK’s Driving Standards Agency. With the sale of Government Solutions in ~~January 2006~~2007 and ~~a nine year,non-exclusive~~ ~~contract to deliver the National Association of Security Dealers exams.~~Data Management in 2008, our Professional business is focused on publishing for professionals in businesses and technology, and on testing and certifying professionals.

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The FT Group
~~The FT Group~~

The FT Group ~~one of the world’s leading business information sources, aims to provide~~provides a broad range of data, analysis and services to an audience of internationally-minded business ~~people.~~people and financial institutions. In ~~2005,~~2007, the FT Group had sales of ~~£629 million,~~£688m, or ~~15%~~16% of Pearson’s total sales ~~(16%~~(15% in ~~2004). The~~2006), and contributed 24% of Pearson’s operating profit.
It has two major parts: FT ~~Group’s business is global,~~
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~~producing~~Publishing, a combination of ~~news, data, comment, analysis~~theFinancial Times, FT.com and ~~context. In addition to professional~~a portfolio of financial magazines and ~~business consumers, individuals worldwide are demanding such strategic business information.~~online financial information companies; and Interactive Data, our 62%-owned financial information company.
~~FT Publishing~~
FT Publishing

TheFinancial Timesis aone of the world’s leading international daily business ~~newspaper.~~newspapers. Its six month average ~~daily~~ circulation of ~~439,563~~approximately 440,000 copies inat December ~~2005,~~2007, as reported by the Audit Bureau of Circulation, ~~gives the~~~~Financial Times~~ ~~the second largest circulation of any English language business daily in the world. The~~~~Financial Times~~ ~~derived approximately 67% of its revenue in 2005 from advertising and approximately 33% from print and online content sales. The geographic distribution of the~~~~Financial Times~~ ~~average daily circulation in 2005 was:~~is split as follows:

United ~~Kingdom/ Republic of Ireland~~ 32 %
~~Continental Europe, Africa and Middle East~~Kingdom 31 %
~~Americas~~Europe, Middle East and Africa 29 %
US 30 %
Asia 810 %
~~The~~~~Financial Times~~ ~~is printed on contract in 23 cities around the world and our~~
Its main sources of revenue are from 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, the~~Financial Times~~ ~~uses computer-driven communications and printing technology for timely delivery of the various editions~~ of the newspaper, ~~to the appropriate geographic markets. The~~~~Financial Times~~ ~~is distributed through independent newsagents~~advertising and ~~direct delivery to homes and institutions.~~
conferences. The FT ~~seeks to make its~~also 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~~which 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~~new FT.com access model was successfully introduced in 2007 and is based on frequency of use and is intended to drive usage and accelerate advertising growth, while providing greater value and ~~selling subscriptions. At the end of December 2005, FT.com had 84,000~~services to its premium paying ~~subscribers and an average of 3.2 million unique monthly users.~~customers.
~~Our other business publishing interests include France’s leading business newspaper,~~~~Les Echos~~ ~~with an average daily 2005 circulation of 119,000 and lesechos.fr, its internet service.~~
FT Publishing also includes: FT Business, ~~produces~~which publishes specialist information on the retail, personal and institutional finance industries ~~and publishes the UK’s premier personal finance magazine,~~through titles includingInvestors Chronicle ~~together with~~,Money Management,Financial ~~Advisor~~AdviserandThe Banker;and Mergermarket, our online financial data and intelligence provider.
Mergermarket provides early stage proprietary intelligence to financial institutions and corporates. Its key products includeMergermarket,Debtwire,dealReporter,Wealthmonitor and~~The Banker~~Pharmawire ~~for professional advisers and financial sector professionals.~~(which was launched in 2007).
~~Interactive Data Corporation~~
Interactive Data
~~Through our 62% interest in~~
Interactive Data ~~Corporation (“Interactive Data”), we are one of the world’s~~is a leading ~~global providers~~provider of financial market data, analytics and related services to financial institutions, active traders and individual investors. Interactive Data supplies time-sensitive pricing, dividend, corporate action, and descriptive information for more than 3.5 million securities traded around the world, including hard-to-value instruments. Customers subscribeThe company’s customers use its offerings to ~~Interactive Data’s services and use the company’s analytical tools in~~ support of their ~~trading, analysis,~~ portfolio management and valuation, research and analysis, trading, sales and marketing, and client service activities. We own 62% of Interactive Data; the remaining 38% is publicly traded on the NYSE.
~~Recoletos~~
Les Echos
On
The sale of Les Echos to LVMH for €240m (£174m) was completed in December ~~14, 2004, the~~2007.
Joint Ventures and Associates
The FT Group ~~announced that we had accepted an offer from Retos Catera S.A. to sell our 79% stake in Recoletos, a publicly quoted Spanish media group that we built with its Spanish founding shareholders over~~also has a number of ~~years, for gross proceeds of~~€743 million. The consortium of investors behind Retos Cartera included members of the Recoletos management team, individual Spanish investors and the Banesto banking group. We decided to accept the offer as Recoletos’ strategy in sport, lifestyle and general publications had taken it further away from Pearson’s core focus on financial and business news and information. The sale became unconditional in February, 2005 and net cash proceeds of £371 million were received on April 8, 2005 resulting in a profit on disposal of £306 million.
~~Joint Ventures and Associates~~
      ~~As at 2005 year end, the FT Group also had a number of other~~ associates and joint ventures, including:
A
• 50% interest in The Economist Group, publisher of one of the world’s leading weekly business and current affairs magazines.
• 50% interest in FTSE International, a joint venture with the London Stock Exchange, which publishes a wide range of global indices, including the FTSE index.
• 50% interest in~~FT Deutschland,~~ ~~launched in February 2000, in partnership with Gruner + Jahr.~~~~FT Deutschland~~ ~~is a German language newspaper with a fully integrated online business news, analysis and data service. Its circulation grew by 6% in 2005 to 102,000 copies.~~
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      A 50% interest in The Economist Group, which publishes the world’s leading weekly business and current affairs magazine. Its circulation increased by 10% to 1,038,519 for the January to June 2005 period.
      ~~A 50% interest in FTSE International, a joint venture with the London Stock Exchange, which publishes a wide range of global indices, including the important FTSE index.~~
      ~~A 33% interest in~~~~Vedomosti,~~ ~~a leading Russian business newspaper and a partnership venture with Dow Jones and IMH Media Ltd.~~
      ~~A 50% interest in~~Business DayandFinancial Mail, publishers of one of South Africa’s leading financial ~~newspaper~~newspapers and ~~magazine.~~magazines.
• 33% interest inVedomosti,a leading Russian business newspaper.

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      A
• 14% interest inBusiness Standard, ~~India’s third largest daily financial newspaper.~~
~~The Penguin Group~~
      ~~Penguin is~~ one of ~~the premier English language book publishers in the world. We publish~~India’s leading business newspapers.
On March 27, 2008, Financial Times International Publishing Ltd sold its 50% partnership interest in Financial Times Deutschland GmbH & Co KG to Gruner & Jahr AG & Co KG.
The Penguin Group
Penguin is one of the world’s premier English language book publishers. It publishes an extensive backlist and frontlist of titles, including fiction and non-fiction, literary prize winners, commercial bestsellers, classics and children’s titles. It ranks in the top three consumer publishers, based upon sales, in all major English speaking and related markets — the US, the UK, Australia, New Zealand, Canada, India and South Africa.
Penguin publishes under many imprints including, in the adult market, Allen Lane, Avery, Berkley, Dorling Kindersley (DK), Dutton, Hamish Hamilton, Michael Joseph, Plume, Putnam, Riverhead and Viking. Its leading children’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2007, Penguin had sales of £846m, representing 21% of Pearson’s total sales (22% in 2006) and contributed 12% of Pearson’s operating profit. Its largest market is the US, which generated around 55% of Penguin’s sales in 2007. The Penguin Group earns around 99% of its revenues from the sale of hard cover and paperback books. The balance comes from audio books ande-books.
Penguin sells 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. It also sells through online retailers such as Amazon.com, as well as Penguin’s own website.
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 extensive backlist and frontlist of titles, including some of the very best new fiction and non-fiction, literary prize winners and commercial bestsellers. Our titles range from history and science to essential reference. We are also one of the pre-eminent classics publishers and publish some of the most highly prized and enduring brands in children’s publishing, featuring popular characters such as Spot, Peter Rabbit and Madeline, as well as the books of Roald Dahl. We rank in the top three consumer publishers, based upon sales, in all major English speaking and related markets — the United States, the United Kingdom, Australia, New Zealand, Canada, India and South Africa.
      Penguin publishes under many imprints including, in the adult market, Allen Lane, Avery, Berkley Books, Dorling Kindersley, Dutton, Hamish Hamilton, Michael Joseph, Plume, Putnam, Riverhead and Viking. Our leading children’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2005, Penguin’s US imprints placed 129 titles on~~The New York Times~~ bestseller list. In the United Kingdom, 54 Penguin titles featured on the Nielsen Bookscan top ten 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 2005, Penguin had sales of £804 million, representing 20% of Pearson’s total sales (21% in 2004). Revenues are balanced between frontlist and backlist titles. The Penguin Group earns over 95% of its revenues from the sale of hard cover and paperback books. The balance comes from audio books and from the sale and licensing of intellectual property rights, such as the Beatrix Potter series of fictional characters, and acting as a book distributor for a number of smaller publishing houses.
      We sell directly to bookshops and through wholesalers. Retail bookshops normally maintain relationships with both publishers and wholesalers and use the channel that best serves the specific requirements of an order. We also sell online through third parties such as Amazon.com.
      The Penguin Group’s gateway internet site, Penguin.com, provides access to its focused websites in the United States, Canada, United Kingdom and Australia. Websites have also been developed to target certain niche audiences. For example, Penguinclassics.com has an entire online service for the classics, with anthologies, original essays, interviews and discussions and links to other classics sites.
~~Competition~~
      ~~All of Pearson’s businesses operate in highly competitive environments.~~
      Pearson Education competes with other publishers and creators of educational materials and services. These companies include some small niche players and some large international companies, such as McGraw-Hill, Reed Elsevier, Houghton Mifflin and Thomson. Competition is based on the ability to deliver quality products and services that address the specified curriculum needs and appeal to the school boards, educators and government officials making purchasing decisions.
      ~~The FT Group’s newspapers and magazines compete with newspapers and other information sources, such as~~~~The Wall Street Journal,~~ ~~by offering timely and expert journalism. It competes for advertisers with~~
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~~other forms of media based on the ability to offer an effective means for advertisers to reach their target audience. The efficiency of its cost base is also a competitive factor.~~
      The Penguin Group competes with other publishers of fiction and non-fiction books. Principal competitors include Random House, HarperCollins, and Hachette Livre. Publishers compete by developing a portfolio of books by established authors and by seeking out and promoting talented new writers.
~~Intellectual Property~~
      ~~Our principal intellectual property assets consist of our trademarks and other rights in our brand names, particularly the~~~~Financial Times~~ and the various imprints of Penguin and Pearson Education, as well as all copyrights in our content and our patents held in the testing business in the name of Pearson NCS. We believe we have taken all appropriate available legal steps to protect our intellectual property in all relevant jurisdictions.
~~Raw Materials~~
      Paper is the principal raw material used by each of Pearson Education, the FT Group and the Penguin Group. We purchase most of our paper through our central purchasing department located in the United States. We have not experienced and do not anticipate difficulty in obtaining adequate supplies of paper for our operations, with sourcing available from numerous suppliers. While local prices fluctuate depending upon local market conditions, we have not experienced extensive volatility in fulfilling paper requirements. In the event of a sharp increase in paper prices, we have a number of alternatives to minimize the impact on our operating margins, including modifying the grades of paper used in production.
~~Government Regulation~~
      The manufacture of certain of our products in various markets is subject to governmental regulation relating to the discharge of materials into the environment. Our operations are also subject to the risks and uncertainties attendant to doing business in numerous countries. Some of the countriesadoption cycle in which ~~we conduct these operations maintain controls on the repatriation of earnings~~major state education boards ‘adopt’ programs and ~~capital and restrict the means available~~provide funding to usschools for hedging potential currency fluctuation risks. The operations that are affected by these controls, however, are not material to us. Accordingly, these controls have not significantly affected our international operations. Regulatory authorities may have enforcement powers that could have an impact on us. We believe, however, that we have taken and continue to take measures to comply with all applicable laws and governmental regulations in the jurisdictions where we operate so that the risk of these sanctions does not represent a material threat to us.
~~Licenses, Patents and Contracts~~
      We are not dependent upon any particular licenses, patents or new manufacturing processes that are material to our business or profitability. Likewise, we are not materially dependent upon any contracts with suppliers or customers, including contracts of an industrial, commercial or financial nature.
~~Recent Developments~~
      ~~On January 9, 2006 Pearson announced~~ the purchase of ~~1,130,739 shares~~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 ~~Interactive Data from an individual shareholder~~line with the release of new editions or new technology offerings. The Company renews its pre-publication assets to meet the typical demand for ~~$21.67 per share in cash. This purchase brings Pearson’s total holding in Interactive Data~~new editions of, or revisions to, ~~almost 62%.~~
      ~~On January 23, 2006 Pearson announced~~educational programs. Analysis of historical data shows that the ~~acquisition~~average life cycle of ~~Promissor, a leading professional testing business from Houghton Mifflin Company for $42m in cash.~~
      ~~On April 25, 2006 Pearson announced~~Higher Education content is 5 years. Again the ~~acquisition of National Evaluation Systems, Inc, a leading teacher certification testing company in~~operating cycle mirrors the ~~US.~~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 Professional and the Penguin segment are more specialized in nature as they relate to educational or heavy reference products released into smaller markets (e.g. the financial training, IT and travel sectors). Nevertheless, in these markets, there is still a regular cycle of product renewal, in line with demand which management monitor. Typically the life cycle is 5 years for Professional content and 4 years for Penguin content.

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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 large international companies, such as McGraw-Hill and Houghton Mifflin Harcourt, 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.
FT Publishing competes with newspapers and other information sources, such as The Wall Street Journal, by offering timely and expert journalism. 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. Interactive Data competes with Bloomberg, Reuters and Thomson Financial on a global basis for the provision of financial data to the back office of financial institutions. In Europe, Telekurs is also a direct competitor for these services. Smaller, more specialized vendors also compete with Interactive Data in certain market segments and in certain geographic areas.
The Penguin Group competes with other publishers of fiction and non-fiction books. Principal competitors include Random House, HarperCollins, and Hachette Group. Publishers compete by developing a portfolio of books by established authors and by seeking out and promoting talented new writers.
Intellectual property
Our principal intellectual property assets consist of our trademarks and other rights in our brand names, particularly theFinancial Timesand the various imprints of Penguin and Pearson Education, as well as all copyrights for our content and our patents held in the testing business in the name of Pearson NCS. We believe we have taken all appropriate available legal steps to protect our intellectual property in all relevant jurisdictions.
Raw materials
Paper is the principal raw material used by each of Pearson Education, the FT Group and the Penguin Group. We purchase most of our paper through our Global Sourcing department located in the United States. We have not experienced and do not anticipate difficulty in obtaining adequate supplies of paper for our operations, with sourcing available from numerous suppliers. While local prices fluctuate depending upon local market conditions, we have not experienced extensive volatility in fulfilling paper requirements. In the event of a sharp increase in paper prices, we have a number of alternatives to minimize the impact on our operating margins, including modifying the grades of paper used in production.
Government regulation
The manufacture of certain of our products in various markets is subject to governmental regulation relating to the discharge of materials into the environment. Our operations are also subject to the risks and uncertainties attendant to doing business in numerous countries. Some of the countries in which we conduct these operations maintain controls on the repatriation of earnings and capital and restrict the means available to us for hedging potential currency fluctuation risks. The operations that are affected by these controls, however, are not material to us. Accordingly, these controls have not significantly affected our international operations. Regulatory authorities may have enforcement powers that could have an impact on us. We believe, however, that we have taken and continue to take measures to comply with all applicable laws and governmental regulations in the jurisdictions where we operate so that the risk of these sanctions does not represent a material threat to us.
Licenses, patents and contracts
We are not dependent upon any particular licenses, patents or new manufacturing processes that are material to our business or profitability. Likewise, we are not materially dependent upon any contracts with suppliers or customers, including contracts of an industrial, commercial or financial nature.

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Recent developments
On January 2, 2008, the Group completed its acquisition of Money-Media, a US-based company offering online news and commentary for the money management industry, for $64m.
On January 30, 2008, the Group completed its $647m acquisition of Harcourt Assessment from Reed Elsevier, after receiving clearance from the US Department of Justice. On March 27, 2008, the Group disposed of its 50% interest in Financial Times Deutschland to its joint venture partner, Gruner + Jahr.
On February 22, 2008, the Group completed the sale of its Data Management (Scanners) business to M & F Worldwide Corp. for $225m.
Organizational structure
Pearson plc is a holding company which conducts its business primarily through subsidiaries and other affiliates throughout the world. Below is a list of our significant subsidiaries as at December 31, 2007, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.
      ~~On May 5, 2006 Pearson announced the acquisition of an 80% stake in Paravia Bruno Mondadori, one of Italy’s leading educational publishing companies.~~
~~Organizational Structure~~
      Pearson plc is a holding company which conducts its business primarily through subsidiaries and other affiliates throughout the world. Below is a list of our significant subsidiaries as at December 31, 2005, including name, country of incorporation or residence, proportion of ownership interest and, if different, proportion of voting power held.
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~~Percentage~~
~~Interest/ Voting~~
~~Name~~ ~~Country of Incorporation/ Residence~~ ~~Power~~
~~Pearson Education~~
~~Pearson Education Inc~~ ~~United States (Delaware)~~ ~~100%~~
~~Pearson Education Ltd~~ ~~England and Wales~~ ~~100%~~
~~NCS Pearson Inc~~ ~~United States (Minnesota)~~ ~~100%~~
~~FT Group~~
~~The Financial Times Limited~~ ~~England and Wales~~ ~~100%~~
~~Financial Times Business Ltd~~ ~~England and Wales~~ ~~100%~~
~~Interactive Data Corporation~~ ~~United States (Delaware)~~ ~~61%~~
~~Les Echos SA~~ ~~France~~ ~~100%~~
~~The Penguin Group~~
~~Penguin Group (USA) Inc~~ ~~United States (Delaware)~~ ~~100%~~
~~The Penguin Publishing Co Ltd~~ ~~England and Wales~~ ~~100%~~
~~Dorling Kindersley Holdings Ltd~~ ~~England and Wales~~ ~~100%~~
Percentage
interest/voting
~~Property, Plant~~Name
Country of incorporation/residencepower
Pearson Education
Pearson Education Inc. United States (Delaware)100%Pearson Education Ltd. England and ~~Equipment~~Wales100%Edexcel Ltd. England and Wales100%NCS Pearson Inc. United States (Minnesota)100%
FT Group
The Financial Times LimitedEngland and Wales100%Mergermarket Ltd. England and Wales100%Interactive DataUnited States (Delaware)62%
      ~~Our headquarters is~~The Penguin Group
Penguin Group (USA) Inc. United States (Delaware)100%The Penguin Publishing Co Ltd. England and Wales100%Dorling Kindersley Holdings LtdEngland and Wales100%
Property, plant and equipment
Our headquarters are located at leasehold premises in London, England. We own or lease 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 & Testing businesses, one of which was sold as part of the February 2008 Data Management sale. These operations provide short-run andprint-on-demand products, typically custom client applications.

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We own the following principal properties at December 31, 2007:
General use of property
Location Area in square feet
Warehouse/Office Kirkwood, New York, USA 524,000
Warehouse/Office Pittston, Pennsylvania, USA 406,000
Office Iowa City, Iowa, USA 310,000
Warehouse/Office Old Tappan, New Jersey, USA 210,112
Warehouse/Office Cedar Rapids, Iowa, USA 205,000
Office Southwark, London, ~~England. We own or lease approximately 650 properties in more than 50 countries worldwide, the majority of which are located in the United Kingdom and the United States.~~
      ~~All of the properties owned and leased by us are suitable for their respective purposes and are in good operating condition.~~
      ~~We own the following principal properties:~~
~~General Use of Property~~ ~~Location~~ ~~Area in Square Feet~~
~~Warehouse~~ ~~Pittstown, Pennsylvania, USA~~ ~~510,000~~
~~Warehouse~~ ~~Kirkwood, New York, USA~~ ~~409,000~~
~~Offices~~ ~~Iowa City, Iowa, USA~~ ~~310,000~~
~~Offices~~ ~~Old Tappan, New Jersey, USA~~ ~~210,100~~
~~Warehouse/ office~~ ~~Cedar Rapids, Iowa, USA~~ ~~205,000~~
~~Offices~~ ~~Reading, Massachusetts, USA~~ ~~177,800~~
~~Offices~~ ~~London, UK~~ ~~155,000~~
~~Printing/ Processing~~ ~~Owatonna, Minnesota, USA~~ ~~128,000~~
~~Printing/ Processing~~ ~~Columbia, Pennsylvania, USA~~ ~~121,400~~
~~Offices~~UK 155,000
Office Hadley, Massachusetts, USA 136,570
Printing Owatonna, Minnesota, USA 128,000
Printing Columbia, Pennsylvania, USA 121,370 *
Office Eagan, Minnesota, USA 109,500
~~Offices~~
* Sold subsequently to year-end.
We lease the following principal properties at December 31, 2007:
~~Mesa, Arizona, USA~~ ~~96,000~~
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      ~~We lease the following principal properties:~~General use of property
~~General Use of Property~~ ~~Location~~ ~~Area in Square Feet~~
~~Warehouses/ Offices~~ ~~Lebanon, Indiana, USA~~ ~~1,091,400~~
~~Warehouse/ Offices~~ ~~Cranbury, New Jersey, USA~~ ~~886,700~~
~~Warehouse~~ ~~Indianapolis, Indiana, USA~~ ~~737,850~~
~~Warehouse/ Offices~~ ~~Newmarket, Ontario, Canada~~ ~~518,128~~
~~Offices~~ ~~Upper Saddle River, New Jersey, USA~~ ~~474,801~~
~~Warehouse/ Offices~~ ~~Rugby, UK~~ ~~446,000~~
~~Offices~~ ~~London, UK~~ ~~375,000~~
~~Offices~~ ~~Hudson St., New York, USA~~ ~~302,000~~
~~Warehouse/ Offices~~ ~~Austin, Texas, USA~~ ~~226,100~~
~~Offices~~ ~~Boston, Massachusetts, USA~~ ~~225,299~~
~~Warehouse~~ ~~Scoresby, Victoria, Australia~~ ~~215,820~~
~~Offices~~ ~~Boston, Massachusetts, USA~~ ~~191,360~~
~~Offices~~ ~~Glenview, Illinois, USA~~ ~~187,500~~
~~Offices~~ ~~Bloomington, Minnesota, USA~~ ~~151,056~~
~~Offices~~ ~~Parsippany, New Jersey, USA~~ ~~143,800~~
~~Offices~~ ~~Harlow, UK~~ ~~137,900~~
~~Offices~~ ~~Chester, Virginia, USA~~ ~~123,200~~
~~Warehouse~~ ~~San Antonio Zomeyucan, Mexico~~ ~~113,638~~
~~Offices~~ ~~London, UK~~ ~~112,000~~
~~Offices~~ Location Area in square feet
Warehouse/Office Lebanon, Indiana, USA 1,091,435
Warehouse/Office Cranbury, New Jersey, USA 886,747
Warehouse/Office Indianapolis, Indiana, USA 737,850
Warehouse/Office Newmarket, Ontario, Canada 518,128
Office Upper Saddle River, New Jersey, USA 474,801
Warehouse/Office Rugby, UK 446,077
Office New York City, New York, USA 430,738
Office London, UK 282,917
Warehouse/Office Austin, Texas, USA 226,076
Office Boston, Massachusetts, USA 225,299
Warehouse Scoresby, Victoria, Australia 215,820
Office Boston, Massachusetts, USA 191,360
Office Glenview, Illinois, USA 187,500
Office Bloomington, Minnesota, USA 153,240
Office Parsippany, New Jersey, USA 143,777
Office Harlow, UK 137,857
Office Chandler, Arizona, USA 135,460
Warehouse San Antonio Zomeyucan, Mexico 113,638
Office London, UK 112,000
Office New York City, New York, USA 107,939
~~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 IFRS, which differs in certain significant respects from US GAAP. Note 35 to our consolidated financial statements, included in “Item 17. Financial Statements”, provides a description of the significant differences between IFRS and US GAAP as they relate to our business and provides a reconciliation to US GAAP. These consolidated financial statements are the Group’s first financial statements to be prepared in accordance with IFRS, as adopted by the EU. Consolidated financial statements of Pearson up to and including December 31, 2004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments. Note 34 included in “Item 17. Financial Statements”, describes how, in preparing the consolidated financial statements, the Group has applied accounting standards as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1.
~~General Overview~~
~~Introduction~~
      Sales increased from £3,696 million in 2004 to £4,096 million in 2005, an increase of 11%. The increase reflected growth across all the businesses with a particularly strong performance at Pearson Education. The year on year growth was impacted by exchange rates but less so than in previous years. The average US dollar exchange rate strengthened slightly in 2005, which had the effect of increasing reported sales in 2005 by £46 million when compared to the equivalent figure at constant 2004 rates. Reported operating profit increased by 33% from £404 million in 2004 to £536 million in 2005. Pearson Education benefited from strong sales growth and improved margins in the School and Higher Education businesses. FT Group benefited from improved profits largely as a result of increases in advertising revenues at FT Publishing and IDC’s continued strong organic growth and synergies from the integration of recent acquisitions. Penguin profits benefited from
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the effect of exchange rates but still improved from the prior year, with margins increasing despite only a small increase in sales. Included within operating profit in 2005 was the profit on the sale of MarketWatch of £40 million. Equivalent sales of businesses and investments in 2004 saw a profit of £9 million. Reported operating profit in 2005 was £12m higher than the equivalent figure reported at constant 2004 exchange rates.
      Profit before taxation in 2005 of £466 million compares to a profit before taxation of £325 million in 2004. The increase of £141 million reflects the improved operating performance and a reduction in net finance costs. Net finance costs reduced from £79 million in 2004 to £70 million in 2005. Net interest payable benefited from the reduction in average net debt following receipt of the proceeds from the sale of Recoletos and MarketWatch and good cash generation from the businesses. Partially offsetting this effect was an increase in the group’s average net interest rate payable driven principally by the strong rise in US dollar interest rates in the year. As at January 1, 2005 we adopted IAS 39~~‘Financial Instruments: Recognition and Measurement’~~ in our financial statements. This has had the effect of introducing increased volatility into the net finance cost and in 2005 the adoption of IAS 39 reduced net finance costs by £14 million. There was no equivalent benefit in 2005 to the one-off credit of £9 million for interest on a repayment of tax that occurred in 2004.
      In April 2005, Pearson 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 became unconditional on approval from the Spanish regulatory authorities in February 2005. The results of Recoletos have been consolidated for the period to February 28, 2005 and have been shown as discontinued operations in the consolidated income statement for 2005, 2004 and 2003.
      Net cash generated from operating activities increased to £709 million in 2005 from £562 million in 2004 with very strong cash generation across all the businesses. Cash flow in 2004 benefited from collection of the $151 million receivable in respect of the Transportation Security Administration (“TSA”) contract, a contract to create a qualification, assessment, staffing and placement system for security screeners at airports in the US. The relative strength of the US dollar also increased the value of our cash flows in Sterling. Capital expenditure was down from 2004 following the up-front expenditure on professional testing contracts in that year but investment in pre-publication increased. On an average basis, the use of working capital continued to improve. The net cash inflow from disposals net of acquisitions was £175 million in 2005 compared to a net cash outflow of £4 million in 2004. Dividends paid of £222 million in 2005 (including £17 million paid to minority interests) compares to £197 million in 2004 and, after an adverse currency movement of £121 million, overall net borrowings fell 18% from £1,221 million at the end of 2004 to £996 million at the end of 2005.
~~Outlook~~
      We expect 2006 to be another good year for Pearson as we anticipate increasing margins and growth ahead of our markets. We expect to achieve strong earnings growth, good cash generation and a further significant improvement in return on invested capital.
~~Pearson Education~~
      We expect Pearson Education to achieve sales growth in the 3-5% range, with similar rates of growth in each of its three worldwide businesses (School, Higher Education and Professional). We expect margins to improve in School and Professional and remain stable in the Higher Education business. School testing is strengthened by 2005 contract wins with a lifetime value of $700 million (including Texas, Virginia, Michigan and Minnesota) and the US School new adoption market is expected to grow strongly over the period 2007 to 2009.
      We expect our US Higher Education business to continue to benefit from its scale, the strength of its publishing and its lead in technology. 2006 is expected to be a strong year for first editions, with major new titles in statistics, algebra, psychology, economics, health and writing. We plan to launch online homework and assessment programs in new curriculum areas including economics, psychology and development writing and to extend our highly successful customized print publishing model to online curriculum and course management programs.
      We expect our Professional business to deliver sustained growth on the basis of long-term contracts in Government Solutions and Professional Testing and to improve margins after the successful start-up of major new contracts in 2004 and 2005. We also expect to maintain our leading market share in professional
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~~publishing with a stronger schedule of releases in the professional and consumer technology market in 2006 and a strong list within the business publishing imprints.~~
~~FT Group~~
      ~~We expect further profit improvement at the FT Group. The~~~~Financial Times~~ continues to show good momentum with circulation up 4% and advertising revenues continue to show double digit growth in the early part of 2006. IDC expects another good year, benefiting from similar business conditions to 2005, strong organic growth and the contribution of recent acquisitions.
~~The Penguin Group~~
      Penguin is expected to grow at a similar rate in 2006 to 2005 with continued investment in new markets and international talent and with a strong list of new titles from best selling authors. Margins are expected to improve steadily as we benefit from efficiency gains.
~~Exchange rates~~
      We generate around two-thirds of total sales in the US and a five cent change in the average exchange rate for the full year (which in 2005 was £1: $1.81) will have an impact of approximately 1p on earnings per share.
~~Sales Information by Operating Division~~
      ~~The following table shows sales information for each of the past three years by operating division:~~

Year Ended December 31

2005 2004 2003

£m £m £m
Education: ��
School 1,295 1,087 1,149
Higher Education 779 729 770
Professional 589 507 503
FT Group:
FT Publishing 332 318 315
IDC 297 269 273
Penguin 804 786 840

Total 4,096 3,696 3,850

~~Sales Information by Geographic Market supplied~~
      ~~The following table shows sales information for each of the past three years by geographic region:~~

Year Ended December 31

2005 2004 2003

£m £m £m
European countries 963 835 768
North America 2,717 2,504 2,742
Asia Pacific 300 263 255
Other countries 116 94 85

Pearson Group 4,096 3,696 3,850

~~Exchange Rate Fluctuations~~
      We earn a significant proportion of our sales and profits in overseas currencies, principally the US dollar. Sales and profits are translated into sterling in the consolidated financial statements using average rates. The average rate used for the US dollar was $1.81 in 2005, $1.83 in 2004 and $1.63 in 2003. Fluctuations in exchange rates can have a significant impact on our reported sales and profits. The Group generates approximately 65% of its sales in US dollars and a five cent change in the average exchange rate for the full year has an impact of approximately 1 pence on earnings per share. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for more information.
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~~Critical Accounting Policies~~
      Our consolidated financial statements, included in Item 17. “Financial Statements”, are prepared based on the accounting policies described in note 1 to the consolidated financial statements which are in accordance with IFRS, which differs in certain significant respects from US GAAP.
      The preparation of our consolidated financial statements in accordance with IFRS, and the reconciliation of these financial statements to US GAAP as described in note 35, requires management to make estimates and assumptions that affect the carrying value of assets and liabilities at the date of the consolidated financial statements and the reported amount of sales and expenses during the periods reported in these financial statements. Certain of our accounting policies require the application of management judgment in selecting assumptions when making significant estimates about matters that are inherently uncertain. Management bases its estimates on historical experience and other assumptions that it believes are reasonable.
      We believe that the following are the more critical accounting policies used in the preparation of our consolidated financial statements that could have a significant impact on our future consolidated results of operations, financial position and cash flows. Actual results could differ from estimates.
~~Revenue Recognition~~
      Revenue comprises the fair value of the consideration received or receivable for the sale of goods and services net of value-added tax and other sales taxes, rebates and discounts, and after eliminating sales within the Group. Revenue is recognized as follows:
      Revenue from the sale of books is recognized when title passes. A provision for anticipated returns is made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period.
      ~~Circulation and advertising revenue is recognized when the newspaper or other publication is published. Subscription revenue is recognized on a straight-line basis over the life of the subscription.~~
      Where a contractual arrangement consists of two or more separate elements that can be provided to customers either on a stand-alone basis or as an optional extra, such as the provision of supplementary materials with textbooks, revenue is recognized for each element as if it were an individual contractual arrangement.
      Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognized as performance occurs. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated as long-term contracts with revenues recognized on a percentage of completion basis. Losses on contracts are recognized in the period in which the loss first becomes foreseeable. Contract losses are determined to be the amount by which estimated direct and indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. The assumptions, risks and uncertainties inherent in long-term contract accounting can affect the amounts and timing of revenue and related expenses reported.
      On certain contracts, where the Group acts as agent, only commissions and fees receivable for services rendered are recognized as revenue. Any third party costs incurred on behalf of the principal that are rechargeable under the contractual arrangement are not included in revenue.
~~Pre-publication Costs~~
      Pre-publication costs represent direct costs incurred in the development of educational programs and titles prior to their publication. These costs are carried forward in current intangible assets where the title will generate probable future economic benefits and costs can be measured reliably. These costs are amortized upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected life cycle of the title, usually with a higher proportion of the amortization taken in the earlier years. The investment in pre-publication has been disclosed as part of the investing activities in the cash flow statement. The assessment of useful life and the calculation of amortization involve a significant amount of estimation and management judgment based on historical trends and management estimation of their future potential sales. The overstatement of useful lives could result in excess amounts being carried forward in
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~~intangible assets that would otherwise have been written off to the profit and loss account in an earlier period. Reviews are performed regularly to estimate recoverability of pre-publication costs.~~
~~Royalty Advances~~
      Advances of royalties to authors are included within trade and other receivables when the advance is paid less any provision required to bring the amount down to its net realizable value. The royalty advance is expensed at the contracted royalty rate as the related revenues are earned. Royalty advances which will be consumed within one year are held in current assets. This represents the operating cycle of consumer publishing titles. Royalty advances which will be consumed after one year are held in non-current assets. The realizable value of royalty advances relies on a degree of management judgement in determining the profitability of individual author contracts. If the estimated realizable value of author contracts is overstated then this will have an adverse effect on operating profits as these excess amounts will be written off.
~~Defined Benefit 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.
      Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognized immediately in the statement of recognized income and expense.
      The service cost, representing benefits accruing over the year, is included as an operating cost and the unwinding of the discount rate on the scheme liabilities and the expected return on scheme assets as a financing charge or financing income.
      ~~Obligations for contributions to defined contribution pension plans are recognized as an expense in the income statement as incurred.~~
      The determination of the pension cost and defined benefit obligation of the Group’s defined benefit pension schemes depends on the selection of certain assumptions (see note 24 in “Item 17 — Financial Statements”) 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.
~~Income Taxes~~
      The Group is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
      Deferred income tax is provided, using the liability method on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. Deferred income tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realized or the deferred income tax liability is settled.
      ~~Deferred tax assets are recognized to the extent that it is probable that future taxable profit 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.~~
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~~Goodwill~~
      Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the date of acquisition. Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisitions of associates is included in investments in associates. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. 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 IFRS, which differs in certain significant respects from US GAAP. Profit attributable to equity holders of the Company and equity shareholders’ funds under IFRS and US GAAP were as follows for the respective period:

December 31, 2005 December 31, 2004 December 31, 2003

£m £m £m
Profit for the financial year

IFRS 624 262 252
US GAAP 411 182 173
Equity shareholders’ funds

IFRS 3,564 2,800
US GAAP 3,838 3,218
      The main differences between IFRS and US GAAP relate to goodwill and intangible assets, acquisition and disposal adjustments, derivatives, pensions, stock based compensation and taxation. These differences are discussed in further detail under “— Accounting Principles” and in note 35 to the consolidated financial statements.
~~Results of Operations~~
~~Year ended December 31, 2005 compared to year ended December 31, 2004~~
Call Center Lawrence Kansas, Kansas, USA 105,000
Capital Expenditures
See Item 5. “Operating and Financial Review and Prospects — Liquidity and Capital Resources” for description of the Company’s capital expenditure.
ITEM 4A. UNRESOLVED STAFF COMMENTS
~~Consolidated Results of Operations~~
~~Sales~~
      Our total sales increased by £400 million, or 11%, to £4,096 million in 2005, from £3,696 million in 2004. Sales growth was due to strong performance in our markets, helped in part by a favourable exchange rate impact. We estimate that had the 2004 average rates prevailed in 2005, sales would have been approximately £4,050 million.
The Company has not received, 180 days or more before the end of the 2007 fiscal year, any written comments from the Securities and Exchange Commission staff regarding its periodic reports under the Exchange Act which remain unresolved.

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      Pearson Education had a strong year with an increase in sales of 15%. The School and Professional businesses were the biggest contributors to this growth with increases of 19% and 16% respectively. Higher Education growth was 5% in total and 6% in the US. Pearson’s US Higher Education business has grown faster than the industry for seven straight years. The School publishing business benefited from a large share of the new adoption market in the US and testing sales were up more than 20% as the business made significant market share gains and benefited from mandatory state testing in the US under No Child Left Behind. In the Professional business, Professional testing and Government Solutions sales were both up by more than a third on last year with the successful start-up of major new contracts. Worldwide sales of technology-related books were again lower than the previous year although weakness in the professional markets was partly offset by growth in consumer technology publishing.
      ~~The FT Group sales were 7% ahead of last year. FT Publishing sales were up by 4% driven by higher advertising revenues at the~~~~Financial Times~~ and IDC sales were up by 10% with organic growth at all its businesses aided by a full year contribution from FutureSource, acquired in September 2004, and the strength of the US dollar. Penguin’s sales grew by 2% with successful format innovation helping to offset the weakness in the mass market category in the US, down a further 4% for the industry in 2005.
      Pearson Education, our largest business sector, accounted for 65% of our sales in 2005, compared to 63% in 2004. North America continued to be the most significant source of our sales although sales there decreased, as a proportion of total sales, to 66% in 2005, compared to 68% in 2004.
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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 IFRS as issued by the IASB.
General overview
Introduction
Sales from continuing operations increased from £3,990m in 2006 to £4,162m in 2007, an increase of 4%. The bulk of the increase was in the School business and at FT Publishing due to acquisitions made in both 2006 and 2007. The year on year growth was significantly impacted by exchange rates, in particular the US dollar. The average US dollar exchange rate weakened in 2007, which had the effect of reducing reported sales in 2007 by £223m when compared to the equivalent figure at constant 2006 rates. When measured at constant 2006 exchange rates, all of Pearson’s businesses reported year on year growth.
Reported operating profit increased by 10% from £522m in 2006 to £574m in 2007. Reported operating profit in 2007 was £34m lower than the equivalent figure reported at constant 2006 exchange rates. When measured at constant rates, all parts of the Group contributed to the operating profit increase through a combination of good sales growth and improved margins which more than offset an increased charge for intangible amortization.
Profit before taxation in 2007 of £468m compares to a profit before taxation of £448m in 2006. The increase of £20m reflects the improved operating performance offset by an increase in net finance costs. Net finance costs increased from £74m in 2006 to £106m in 2007. The Group’s net interest payable increased by only £1m in 2007 but exchange losses of £17m in 2007 compare to a net exchange gain of £19m in 2006. The losses in 2007 principally relate to exchange losses on legacy euro denominated debt held to hedge euro denominated proceeds from the sale of Les Echos. In 2006, euro borrowings and cross currency swaps that were not designated as net investment hedges contributed to overall net exchange gains. Partially offsetting this effect was finance income relating to post retirement plans of £10m in 2007 compared to an income of £4m in 2006.
On February 22, 2008 the Group completed the sale of its Data Management (Scanners) business and this business has been included in discontinued operations for the full year in 2007, 2006 and 2005.
On December 24, 2007, the Group completed the sale of its French newspaper business, Les Echos. Pearson’s Government contracting business, Government Solutions, was disposed of on February 15, 2007. The results of Les Echos and Government Solutions have been included in discontinued operations for 2007, 2006 and 2005 and have been consolidated up to the date of sale.
In 2005 the Group sold its 79% interest in Recoletos Grupo de Comunicacion S.A. The results of Recoletos have been consolidated for the period to February 28, 2005 and have been shown as discontinued operations in the consolidated income statement for 2005.
Net cash generated from operating activities increased to £659m in 2007 from £621m in 2006. The improved cash generation in 2007 was in spite of a special contribution of £100m to the UK Group pension plan. On an average basis, the use of working capital continued to improve. Average working capital comprises the average of the monthly carrying values over the relevant 12 month period for inventory, pre-publication costs, debtors and creditors. Net interest paid increased by £8m to £90m in 2007 compared to £82m in 2006. Tax paid in 2007 was £87m compared to £59m in 2006, the bulk of the increase was due to payments relating to the sale of Government Solutions. Net capital expenditure after proceeds from sales increased from £63m in 2006 to £74m in 2007. The net cash outflow in respect of businesses acquired increased from £363m in 2006 to £472m in 2007 whilst net proceeds from the disposal of businesses increased from £10m in 2006 to £469m in 2007. Dividends from joint ventures and associates decreased by £13m largely due to smaller special dividends received from the Economist in 2007 compared to 2006. Dividends paid of £248m in 2007 (including £10m paid to minority interests) compares to £235m in 2006. After a favorable currency movement of £11m, overall net borrowings decreased by 8% from £1,059m at the end of 2006 to £973m at the end of 2007.

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Outlook
In recent years we have significantly changed the shape of Pearson, building and diversifying our education company, shifting our financial information businesses towards recurring revenue streams and becoming more efficient through a centralized operations organization. These moves have made Pearson a more profitable, more cash generative and more resilient company, and we expect to make further progress on our financial goals in 2008.
At this stage, our outlook for 2008 is:
Pearson Education
We expect another year of good profit growth, benefiting once again from the unique breadth of our education business — from pre-school to adult learning; across publishing, testing and technology; and in the US and around the world.
In our School business, integration of our recently-acquired Harcourt businesses is progressing well. In 2008, we expect School margins to be similar to 2007, after expensing integration costs relating to the acquisition. In 2009, we expect School margins to rise to around 15% as the majority of the integration costs fall away and as we realize the financial benefits of the acquisition. Including the Harcourt contribution, we expect our School business to grow sales well into double digits in 2008 at constant currency. Excluding Harcourt, we expect underlying sales growth in the low single digits, as US market growth of 3-4% is partly offset by our lower participation rate in new US adoptions and the conclusion of our UK key stage testing contract.
In Higher Education, we expect our underlying sales to grow in the mid single digits, a little ahead of the industry. We expect margins to be stable, as we continue to invest in expanding our adaptive learning technologies and in taking our recently-acquired eCollege platform into new segments and geographic markets.
In Professional, we expect sales to increase in the low single digits in underlying terms with underlying margins improving once again.
FT Group
The FT Group is expected to continue its profit growth. We have substantially increased our digital and subscription revenues and reduced our exposure to print advertising in recent years. At FT Publishing, advertising revenues have continued to grow in the early part of the year, but future advertising trends remain difficult to predict. However, as a result of our revenue diversification and cost actions we expect further profit improvement at FT Publishing this year, even without any growth in advertising revenues. We expect Interactive Data to achieve its forecast revenue growth in the 7-9% range and operating profit growth in the 9-11% range (headline growth under US GAAP).
The Penguin Group
The Penguin Group is expected to improve margins further and into double digits. Penguin’s good publishing and trading performance has continued into the early part of 2008.

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Sales information by operating division
The following table shows sales information for each of the past three years by operating division:

Year Ended December 31
2007 2006 2005
£m £m £m

Education:
School 1,537 1,455 1,295
Higher Education 793 795 779
Professional 298 280 238
FT Group:
FT Publishing 344 280 249
Interactive Data 344 332 297
Penguin 846 848 804

Total 4,162 3,990 3,662

Sales information by geographic market supplied
The following table shows sales information for each of the past three years by geographic region:

Year Ended December 31
2007 2006 2005
£m £m £m

European countries 1,102 1,003 868
North America 2,591 2,585 2,388
Asia Pacific 351 295 300
Other countries 118 107 106

Total 4,162 3,990 3,662

Exchange rate fluctuations
We earn a significant proportion of our sales and profits in overseas currencies, principally the US dollar. Sales and profits are translated into sterling in the consolidated financial statements using average rates. The average rate used for the US dollar was $2.00 in 2007, $1.84 in 2006 and $1.81 in 2005. Fluctuations in exchange rates can have a significant impact on our reported sales and profits. In 2007, Pearson generated 59% of its sales in the US (2006: 61%; 2005: 62%). We estimate that a five cent change in the closing exchange rate between the US dollar and sterling in any year could affect our reported earnings per share by 1p and shareholders’ funds by approximately £55m. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for more information. The year-end US dollar rate for 2007 was £1:$1.99 compared to £1:$1.96 for 2006. In terms of the year end rate, the weakening of the US dollar in 2007 was not as significant as in previous years and although the weaker US dollar had the effect of decreasing shareholders’ funds this was outweighed by strength in other currencies, principally the Canadian dollar and the Euro. The net effect of movement in all currencies in 2007 was an increase in our shareholders’ funds of £25m (see also note 29 of “Item 18. Financial Statements”). The year-end rate for the US dollar in 2006 was £1:$1.96 compared to £1:$1.72 for 2005 which was the main reason for a decrease in shareholders’ funds due to exchange movements of £417m in 2006.
Critical accounting policies
Our consolidated financial statements, included in “Item 18. Financial Statements”, are prepared based on the accounting policies described in note 1 to the consolidated 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

22
historical experience and other assumptions that it believes are reasonable. These policies are described in note 1a(3) in “Item 18. Financial Statements”.
Results of operations
Year ended December 31, 2007 compared to year ended December 31, 2006
Consolidated results of operations
Sales
Our total sales from continuing operations increased by £172m, or 4%, to £4,162m in 2007, from £3,990m in 2006. The increase reflected growth, on a constant exchange rate basis, across all the businesses together with additional contributions from acquisitions made in both 2006 and 2007. The year on year growth was impacted by movements in exchange rates, particularly in the US dollar. 2007 sales, translated at 2006 average exchange rates, would have been £4,385m.
Pearson Education had another year of growth with an increase in sales of 4%. The School business was the biggest contributor to this growth with an increase of 6%. Some of the School increase was due to a full year contribution from acquisitions made in 2006 and to additional contribution from the Harcourt acquisition in 2007. We estimate that after excluding these acquisitions the growth would have been 6% at constant last year exchange rates. US School publishing sales were up 3.5% compared to an industry increase of 2.7% (source: Association of American Publishers) as the business benefited from sustained investment in new basal programs and innovative digital services. There was also faster growth in international school publishing. School testing sales increased in double digits both in the US and UK benefiting from further contract wins, market share gains and strength in on-line assessment. Higher Education sales were flat year on year on a headline basis, but would have been 5% ahead of the previous year at constant last year exchange rates and after taking account of portfolio changes. Pearson’s US Higher Education business grew faster than the industry for the ninth successive year with growth of 6% in US dollar terms. In the Professional business, Professional testing sales were up by 10% in 2007 as approximately 5.8m secure online tests were delivered in more than 5,000 testing centers worldwide. Professional publishing sales increased in 2007 by 7%, after a number of years of decline in the professional publishing markets, as it benefited from a focused and refreshed front list, a favorable software release schedule and sales from Safari Books Online, our electronic publishing platform (a joint venture with O’Reilly Media).
The FT Group sales were 12% ahead of last year with a full year contribution from Mergermarket acquired in the second half of 2006. FT Publishing sales were up by 23% or 12% after excluding the contribution from acquisitions made in 2006 and 2007. FT Publishing growth was driven by a 10% increase in advertising revenues, circulation up 2% and a strong contribution from FT.com. Interactive Data sales were up by 4% (8% at constant last year exchange rates and before the contribution from acquisitions) driven by strong sales to both existing and new institutional customers and a renewal rate of approximately 95% within the institutional services sector.
Penguin’s sales were flat year on year but would have increased by 3% translated at 2006 average exchange rates as a result of its successful global publishing performance and another outstanding year for bestsellers in the US and UK.
Pearson Education, our largest business sector, accounted for 63% of our continuing business sales in both 2007 and 2006. North America continued to be the most significant source of our sales and as a proportion of total continuing sales contributed 62% in 2007 and 65% in 2006.

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Cost of goods sold and operating expenses
The following table summarizes our cost of sales and net operating expenses:

Year Ended December 31
2007 2006
£m £m
��
Cost of goods sold 1,910 1,841
Distribution costs 264 288
Administration and other expenses 1,538 1,462
Other operating income (101 ) (99 )

Total 1,701 1,651

Cost of goods sold.  Cost of sales consists of costs for raw materials, primarily paper, printing and binding costs, amortization of pre-publication costs and royalty charges. Our cost of sales increased by £69m, or 4%, to £1,910m in 2007, from £1,841m in 2006. The increase corresponds to the increase in sales with cost of sales at 45.9% of sales in 2007 compared to 46.1% in 2006.
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 £76m, or 5%, to £1,538m in 2007, from £1,462m in 2006. As a percentage of sales they remained at 37% in both 2007 and 2006.
Other operating income.  Other operating income mainly consists of freight recharges, sub-rights and licensing income and distribution commissions together with income from sale of assets. Other operating income increased marginally by 2% to £101m in 2007 from £99m in 2006.
Share of results of joint ventures and associates
The contribution from our joint ventures and associates decreased slightly from £24m in 2006 to £23m in 2007. Our share of profit from the Economist in 2006 included a one-off gain of £4m from the sale of its interest in Commonwealth Business Media Inc which was not repeated in 2007.
Operating profit
The total operating profit increased by £52m, or 10%, to £574m in 2007 from £522m in 2006. 2007 operating profit, translated at 2006 average exchange rates, would have been £34m higher.
Operating profit attributable to Pearson Education increased by £9m, or 3%, to £361m in 2007, from £352m in 2006. The increase was due to continued improvement in School and Professional margins, but was offset by an increase in intangible amortization from £18m in 2006 to £31m in 2007. Operating profit attributable to the FT Group increased by £28m, or 25%, to £140m in 2007, from £112m in 2006. The increase reflects the increase in revenues from both established businesses and an increased contribution from new acquisitions but also reflects improvements in margins particularly at FT Publishing. Operating profit attributable to the Penguin Group increased by £15m, or 26%, to £73m in 2007, from £58m in 2006 although the 2006 result included a one off goodwill charge of £7m relating to the recognition of pre-acquisition tax losses at Dorling Kindersley.
Net finance costs
Net finance costs increased from £74m in 2006 to £106m in 2007. Net interest payable in 2007 was £95m, up from £94m in 2006. Although we were partly protected by our fixed rate policy, the strong rise in average 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, euros and sterling at the year end) rose by 0.5% to 5.4%, reflecting a rise in interest rates and a change in the currency mix of year end debt. These two factors, partly offset by a decrease in the Group’s average net debt of £90m, increased the Group’s average net interest rate payable by 0.3% to 7.3%. In 2007 the net

24
finance income relating to post-retirement plans was an income of £10m compared to an income of £4m in the previous year.
Other net finance income relating to foreign exchange and short-term fluctuations in the market value of financial instruments included a net foreign exchange loss of £17m in 2007 compared to a gain of £19m in 2006. In 2007 the loss mainly related to losses on Euro denominated debt used to hedge the receipt of proceeds from the sale of Les Echos. In 2006 the exchange gains mainly relate to the unhedged exposure on Euro borrowings and swaps that could not be designated as a net investment under IAS 39. For a more detailed discussion of our borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowings” below and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
Taxation
The total tax charge in 2007 of £131m represents 28% of pre-tax profits compared to a charge of just £4m or less than 1% of pre-tax profits in 2006. The low tax rate in 2006 was mainly accounted for by two factors. First, in anticipation of the disposal of Government Solutions, we recognized 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 the light of our trading performance in 2006 and our strategic plans, together with the expected utilization of US net operating losses in the Government Solutions sale, we re-evaluated the likely utilization of operating losses both in the US and the UK; this enabled us to increase the amount of the deferred tax asset carried forward in respect of such losses. The combined effect of these two factors was to create a non-recurring credit of £127m in 2006 which was not repeated in 2007.
Minority interests
This comprises mainly the minority share in Interactive Data. Our share of Interactive Data remained at 62% throughout 2007, leaving the minority interest unchanged at 38%.
Discontinued operations
Discontinued operations relate to the disposal of Government Solutions (in February 2007), Les Echos (in December 2007), Datamark (in July 2007) and the Data Management (Scanners) business (in February 2008). The results of Government Solutions and Les Echos have been included in discontinued operations for 2007 and 2006 and have been consolidated up to the date of sale. Operating profit for Government Solutions in 2007 was £2m compared to £22m in 2006 and the loss on disposal after tax recorded in 2007 was £112m after a tax charge of £93m. Les Echos’ operating profit in 2007 amounted to £1m compared to £5m in 2006 and the profit on sale recorded in 2007 was £165m. There was no tax payable on the Les Echos sale. Datamark was bought with the eCollege acquisition and immediately sold. The only profit or loss recognized relating to Datamark was a £7m tax benefit arising from the loss on sale. The Data Management business was held throughout 2006 and 2007 and the operating profit before impairment charges in 2007 was £12m compared to £13m in 2006. The Data Management business was formerly part of the Group’s Other Assessment and Testing cash-generating unit (CGU) and was carved out of this CGU in preparation for disposal. As a result, the Group has recognized a goodwill impairment charge of £97m in 2007 in anticipation of the loss on disposal.
Profit for the year
The total profit for the financial year in 2007 was £310m compared to a profit in 2006 of £469m. The overall decrease of £159m was mainly due to the absence of the non-recurring tax credit of £127m recorded in 2006, the decrease in contribution from discontinued businesses of £52m and the increase in net finance costs of £32m, largely due to exchange losses. These items more than offset the increase in operating profit in 2007.
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 35.6p in 2007 compared to 55.9p in 2006 based on a weighted average number of shares in issue of 796.8m in 2007 and 798.4m in 2006. The decrease in earnings per share was

25
due to the decrease in profit for 2007 described above and was not significantly affected by the movement in the weighted average number of shares.
The diluted earnings per ordinary share of 35.6p in 2007 and 55.8p in 2006 was not significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant.
Exchange rate fluctuations
The weakening of the US dollar against sterling on an average basis had a negative impact on reported sales and profits in 2007 compared to 2006. 2007 sales, translated at 2006 average exchange rates, would have been higher by £223m and operating profit, translated at 2006 average exchange rates, would have been higher by £34m. 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 a non-statutory measure and is included as it is a key financial measure used by management to evaluate performance and allocate resources to business segments. See also note 2 of “Item 18. 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 adjustment 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, 2007
Higher
FT
Interactive

£m
School Education Professional Publishing Data Penguin Total

Sales 1,537 793 298 344 344 846 4,162
37% 19% 7% 8% 8% 21% 100%
Total operating profit 175 159 27 50 90 73 574
30% 28% 4% 9% 16% 13% 100%
Add back:
Amortization and adjustment of acquired intangibles 28 2 1 6 7 1 45

Adjusted operating profit: continuing operations 203 161 28 56 97 74 619
Adjusted operating profit: discontinued operations — — 14 1 — — 15

Total adjusted operating profit 203 161 42 57 97 74 634

32% 25% 7% 9% 15% 12% 100%

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Year Ended December 31, 2006
Higher
FT
Interactive

£m
School Education Professional Publishing Data Penguin Total

Sales 1,455 795 280 280 332 848 3,990
36% 20% 7% 7% 8% 22% 100%
Total operating profit 167 161 24 30 82 58 522
32% 31% 4% 6% 16% 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 25 27 89 66 552
Adjusted operating profit: discontinued operations — — 35 5 — — 40

Total adjusted operating profit 184 161 60 32 89 66 592

31% 27% 10% 6% 15% 11% 100%
School
School business sales increased by £82m, or 6%, to £1,537m in 2007, from £1,455m in 2006 and adjusted operating profit increased by £19m, or 10%, to £203m in 2007 from £184m in 2006. In addition to strong underlying growth in sales and profits, the School results in 2006 benefited from a full year contribution from the acquisitions of National Evaluation Systems (NES), Paravia Bruno Mondadori (PBM), Chancery and PowerSchool in 2006 together with a contribution in 2007 from the acquisition of Harcourt International. Offsetting these factors was the effect of the weakening of the US dollar, which we estimate reduced sales by £91m when compared to the equivalent figures at constant 2006 exchange rates.
In the US school market, Pearson’s school publishing revenues grew 3.5% against the Association of American Publishers’ estimate of an increase for the industry of 2.7%. New adoption market share was 31% 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 double digits after high single digit growth in 2006 and growth in excess of 20% in 2005. School testing benefited from further contract wins, market share gains and strength in online assessment.
The international School business, outside the US, continued to grow with strong performances from the publishing businesses in South Africa and Australia. In Italy, the integration of PBM was completed and produced integration savings, margin improvement and market share gains in 2007. In School publishing, the acquisition of Harcourt International increased scale in our international education businesses bringing leading content for school and vocational customers in many markets including the UK, South Africa, Australia and New Zealand. The international testing business was again able to benefit from technology leadership. In the UK, we marked 9.6 million GCSE, AS and A-Level scripts, 4.6 million of which were on screen. Successful global English Language Teaching franchises in all major market franchises (primary, secondary, adult, business and exam preparation) drove strong growth.English Adventure, developed with Disney, grew successfully and has sold more than six million units in less than three years since launch.
School margins improved again in 2007, increasing from 12.6% to 13.2% due to improved gross margins, savings from integration of acquired businesses and efficiency gains from the use of software platforms.
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Higher Education
Sales in Higher Education decreased slightly by £2m to £793m in 2007, from £795m in 2006. Adjusted operating profit remained flat at £161m. Both sales and adjusted operating profit were affected by the weakening of the US dollar which we estimate reduced sales by £57m and profits by £12m when compared to the equivalent figures at constant 2006 exchange rates.
In the US, the Higher Education sales were up by 6% (in US dollars) ahead of the Association of American Publishers’ estimate of industry growth for the ninth year in succession with rapid growth in online learning and custom publishing. In the US, investment in established and new author franchises, such as Campbell’sBiology, Kotler’sMarketing Management, Hubbard’sEconomics and Cicarrelli’sPsychology, continued to underpin the strong performance. The ’MyLab’ digital homework and assessment programs were launched in 22 new subject disciplines in 2007, increasing the total number of disciplines covered to 38. These programs support over 2,000 textbooks and were used globally by 2.9 million students in 2007 (up more than 30% on 2006). In corporate finance, one of the largest global markets in business education, Pearson published the successful first edition bestseller, Berk/DeMarzo’sCorporate Finance, together with MyFinanceLab and Pearson’s share of this market increases from 4% to 11% in the US and from 39% to 48% in the UK. It is the most successful launch of a first edition in this discipline in more than a decade and one of Pearson’s most successful global launches ever, winning university adoptions in 22 countries. In World History, the first edition of Fernandez-Armesto’sThe World: A Historywith MyHistoryLab increased Pearson’s market share from 25% to 35%. In July 2007, we acquired eCollege which builds on Pearson’s position as an education services provider. eCollege works with partner educational institutions to design, build and support online degree, certificate, diploma and professional development programs. Student enrollments increased by 44% in 2007 to 1.9 million. There was continued strong double digit growth in our custom solutions business which builds customized textbooks and online services and has become a leader in the creation of courseware and curricula fore-learning institutions.
International Higher Education publishing sales grew by 2%, benefiting from organic and acquisition investment. Particular areas of strength included local language editions of our major authors and custom publishing including the successful launch of “local language” science publishing in Germany. The “MyLab” and “Mastering” technology platforms are being successfully adapted for international markets and the MyLab programs are now being used in almost 50 countries with almost 160,000 student registrations for online courses in Europe, the Middle East and Africa.
Higher Education margins remained constant year on year at 20.3% with a slight reduction in US margins being compensated by improvement in international margins.
Professional
After excluding sales and adjusted operating profit from Government Solutions and the Data Management businesses (reported as discontinued), Professional sales increased by £18m, or 6%, to £298m in 2007 from £280m in 2006. Adjusted operating profit increased by £3m or 12% to £28m in 2007, from £25m in 2006. Sales were affected by the weakening US dollar, which reduced sales by £16m when compared to the equivalent figures at constant 2006 exchange rates.
Professional Testing sales were up by 10% in 2007. Approximately 5.8 million secure online tests were delivered in more than 5,000 test centers across the world in 2007. There was strong margin improvement as test volumes rose, driven by higher demand from existing customers such as GMAC (for business school applicants), NCLEX (for nurses) and the DSA/DVTA driving theory test. Additional contributions from new contracts included the American Board of Internal Medicine and the National Association Boards of Pharmacy. There were also strong renewals, including the Institute of Financial Services and the American Registry of Radiological Technologists.
Technology Publishing achieved good sales growth and significantly improved profitability, benefiting from a focused and refreshed front list, a favorable software release schedule and Safari Books Online, our electronic publishing platform (a joint venture with O’Reilly Media). Scott Kelby, a Peachpit author, is the top-selling US computer book author for the fourth consecutive year with titles includingThe iPod Book; The Digital Photography Book;andThe Adobe Photoshop Lightroom Book for Digital Photographers. Good growth in Europe

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was helped by publishing for the new Windows Vista launch, a new partnership with Microsoft Press in the Netherlands and a successful move into digital publishing and training in Germany. Our business imprints Wharton School Publishing and FTPress, aided by Pearson’s global distribution and strong retail relationships, had a successful year. Wharton School Publishing was recognized by the Amazon.com Best Business Books of 2007 withWe Are Smarter Than Me: How to Unleash the Power of Crowds in Your Business, by Barry Libert and Jon Spector, andFirms of Endearment: HowWorld-Class Companies Profit from Passion and Purpose, by Rajendra S. Sisodia, David B. Wolfe and Jaqdish N. Sheth.
Overall margins in the Professional business were higher at 9.4% in 2007 compared to 8.9% in 2006 as margins continued to improve in both the testing and professional publishing businesses.
FT Publishing
Sales at FT Publishing increased by £64m or 23%, from £280m in 2006 to £344m in 2007. Adjusted operating profit from continuing operations increased by £29m, from £27m in 2006 to £56m in 2007. The sales and profit increase benefits from a full year contribution from Mergermarket, acquired in the second half of 2006.
After excluding additional sales from a full year of ownership of Mergermarket, FT Publishing sales were up by 12% with advertising revenues up by 10%. FT newspaper circulation was up 2% to almost 440,000 (for the July-December 2007 Audit Bureau of Circulation, or ABC, measuring period), with a 19% increase in subscriptions. Digital subscribers to the FT were up 13% to 101,000 and monthly unique users were up 30% to 5.7 million. Monthly page views were up 33% to 48.2 million. FT.com attracted 150,000 new registered users since the launch of its innovative new access model in October 2007. There was a strong trading performance at FT Business as integration with the FT Newspaper helped to generate additional revenue and reduce costs. Mergermarket experienced rapid revenue growth with 90%+ subscription renewal rates and a series of new product launches around the world includingPharmawire,Debtwire in Asia Pacific anddealReporter in emerging markets in Europe, Middle East and Africa.
The Economist, in which Pearson owns a 50% stake, increased its circulation by 9% to 1.3 million (for the July-December 2007 ABC period). FTSE, in which Pearson also owns a 50% stake, achieved double digit sales growth, benefiting from a strong new business performance, a joint venture with Xinhua Finance in China and strong growth in Exchange Traded Fund (ETF) licenses.
Small acquisitions of complementary subscription-based and digital businesses made their first contribution to FT Publishing’s results including: Infinata, a provider of research and business information to life science and financial services companies; and Exec-Appointments, a well-established global job site that focuses on the high-earning executive sector with approximately 200,000 registered executive users.
Overall margins at FT Publishing continued to increase as the newspaper becomes more profitable and in 2007 were 16.3% compared to 9.6% in 2006.
Interactive Data
Interactive Data, grew its sales by 4% from £332m in 2006 to £344m in 2007. Adjusted operating profit grew by 9% from £89m in 2006 to £97m in 2007. Interactive Data margins increased from 26.8% in 2006 to 28.2% in 2007. Both sales and adjusted operating profit were affected by the weakening US dollar, which we estimate reduced sales by £20m and adjusted operating profit by £6m when compared to the equivalent figures at constant 2006 exchange rates.
Sales growth at Interactive Data was driven primarily by strong sales to both existing and new institutional customers and a renewal rate of approximately 95% within the Institutional Services business. The business continued to focus on high value services and the Pricing and Reference Data business continued to generate good growth in North America and Europe. The business continues to broaden its coverage of complex securities by expanding its universe of European asset-backed and mortgage-backed securities. The business also launched a new web-based offering, the Basket Calculation Service, designed to provide clients with the indicative optimized portfolio value for equity and fixed income exchange traded funds. The Real-Time Services business achieved strong growth with new institutional sales in its two core product areas of real-time data feeds and managed

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solutions. There was growing adoption of the PlusFeed data service for algorithmic trading applications, a successful introduction of DirectPlus, a new ultra low latency direct exchange data service and excellent sales momentum for managed solutions in North America with new customers including media companies, online brokerages, stock exchanges and financial institutions. Fixed Income Analytics completed 30 new BondEdge^® installations during the year and made good progress in the development of its next-generation BondEdge^® platform. In the Active Trader Services business, eSignal experienced modest expansion of its direct subscriber base, delivered numerous innovations across its suite of Active Trader Services, and added new content and capabilities on its financial websites.
The Penguin Group
Penguin Group sales decreased slightly to £846m in 2007 from £848m in 2006 and adjusted operating profit up 12% to £74m in 2007 from £66m in 2006. Both sales and adjusted operating profit were affected by the weakening US dollar which we estimate reduced sales by £37m and adjusted operating profit by £4m when compared to the equivalent figures at constant 2006 exchange rates.
Penguin maintained its competitive performance in major markets with a successful global publishing performance led by Alan Greenspan’sThe Age of Turbulence, with almost 1 million hard cover copies shipped worldwide, and Kim Edwards’ first novel,The Memory Keeper’s Daughter, a global #1 bestseller for Penguin in the US, UK, Australia and Canada. It was an outstanding year for bestsellers in the US with titles including Elizabeth Gilbert’sEat, Pray, Love (4.4 million copies shipped); Khaled Hosseini’sA Thousand Splendid Suns(2.2 million); and Ken Follett’sWorld Without End(almost 1 million). UK bestsellers included Marian Keyes’Anybody Out There?, Jamie Oliver’sJamie at Home, Jeremy Clarkson’sDon’t Stop Me Nowand Charlie Higson’sDouble or Die. Also in the UK, it was a strong year for the Brands & Licensing division driven byThe Dr Who Annual(the second bestselling children’s book of 2007) and bestsellingIn the Night Gardentitles. DK delivered a strong global performance in traditional, custom and digital publishing, benefiting from innovative formats includingThe Human Body Book, personalized travel guides via traveldk.com and the first DK textbooks for higher education markets.
In Australia, sales growth was generated from a publishing schedule including Bryce Courtenay withThe Persimmon Treeand Dr. Manny Noakes withCSIRO Total Wellbeing Diet Book 2. In India, Penguin India celebrated its 20th anniversary in 2007 with continued rapid growth. Penguin authors won all the major English language prizes in India’s national book awards: Vikram Chandra in fiction forSacred Games, Vikram Seth in non-fiction forTwo Livesand Kiran Desai in readers’ choice forThe Inheritance of Loss. In China, Jiang Rong and Howard Goldblatt won the inaugural Man Asian Literary prize forWolf Totem, to be published in English around the world by Penguin in 2008, and in South Africa, another strong year was led by John van de Ruit’sSpud:The Madness Continues.
Penguin continued to focus on efficiency and improvement in operating margins continues to benefit from the Pearson-wide renegotiation of major global paper, print and binding contracts and the integration of warehouse and back office operations in Australia and New Zealand. These efficiencies together with improved gross margins principally from innovation in formats such as the US premium paperback have helped to improve margins from 7.8% in 2006 to 8.7% in 2007.
Year ended December 31, 2006 compared to year ended December 31, 2005
Consolidated results of operations
Sales
Our total sales from continuing operations increased by £328m, or 9%, to £3,990m in 2006, from £3,662m in 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 impacted by movements in exchange rates, particularly in the US dollar. 2006 sales, translated at 2005 average exchange rates, would have been £4,033m.
Pearson Education had another strong year with an increase in sales of 9%. The School business was the biggest 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

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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 has grown faster than the industry for eight straight years. In the Professional business, Professional testing sales were up by more than 30% in 2006 following the successful start up of new contracts and a contribution from the newly acquired Promissor business. Professional publishing sales declined again in 2006 due to the continued industry-wide weakness in technology-related publishing.
The FT Group sales were 12% ahead of 2005. FT Publishing sales were up by 12% driven by higher advertising revenues at theFinancial Timesparticularly in the online, luxury goods and corporate finance categories. Interactive Data 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 record number of best sellers in the US 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 63% of our continuing business sales in 2006 and 2005. North America continued to be the most significant source of our sales and as a proportion of total continuing sales contributed 65% in both 2006 and 2005.
Cost of goods sold and operating expenses
The following table summarizes our cost of sales and net operating expenses:

Year Ended December 31
2006
2005

£m £m

Cost of goods sold 1,841 1,713

Distribution costs 288 281
Administration and other expenses 1,462 1,309
Other operating income (99) (84)

Total 1,651 1,506

Cost of goods sold.  Cost of sales consists of costs for raw materials, primarily paper, printing and binding costs, amortization of pre-publication costs and royalty charges. Our cost of sales increased by £128m, or 7%, to £1,841m in 2006, from £1,713m in 2005. The increase mainly reflected the increase in sales over the period although the overall gross margin also increased slightly from 53% in 2005 to 54% in 2006.
Distribution costs.  Distribution costs consisted 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 £153m, or 12%, to £1,462m in 2006, from £1,309m in 2005. As a percentage of sales they increased to 37% in 2006, from 36% in 2005. The increase in administration and other costs came principally from additional employee benefit expense, additional property costs and increased intangible amortization.
Other operating income.  Other operating income mainly consisted of freight recharges, sub-rights and licensing income and distribution commissions. Other operating income increased 18% to £99m in 2006 from £84m in 2005, with the increase mainly due to increased freight recharges.
Other net gains and losses
Profits or losses on the sale of businesses, associates and investments that are included in our continuing operations are reported as “other net gains and losses”. In 2005 the only item in this category was the £40m profit on the sale of our associate interest in MarketWatch. In 2006, there were no similar gains or losses.

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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.
Operating profit
The total operating profit increased by £25m, or 5%, to £522m in 2006 from £497m in 2005. This increase was due to increases across all the businesses, after taking account of the one-off gain from the sale of MarketWatch at FT Publishing of £40m in 2005 and a charge of £7m in 2006 at Penguin relating to an adjustment to goodwill following recognition of pre-acquisition tax losses. Operating profit in 2006, translated at 2005 average exchange rates, would have been £7m higher.
Operating profit attributable to Pearson Education increased by £44m, or 14%, to £352m in 2006, from £308m in 2005. The increase was due to continued improvement in School margins, the profit impact of strong sales and cost reductions in technology publishing in Professional testing. Operating profit attributable to the FT Group decreased by £17m, or 13%, to £112m in 2006, from £129m 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 £23m, £7m at Interactive Data and £16m at FT Publishing. The FT Publishing increase reflected thepick-up in advertising revenues. Operating profit attributable to the Penguin Group decreased by £2m, or 3%, to £58m in 2006, from £60m in 2005. The decrease was attributable to an adjustment to goodwill of £7m caused by the recognition of previously unrecognized tax losses relating to the acquisition of Dorling Kindersley in 2000.
Net finance costs
Net finance costs increased from £70m in 2005 to £74m in 2006. Net interest payable in 2006 was £94m, up from £77m in 2005. Although we were partly protected by our fixed rate policy, the strong rise in average 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, euros and sterling at the year end) rose by 1.5% to 4.9%. Combining the rate rise with an increase in the Group’s average net debt of £40m, the Group’s average net interest rate payable rose by 1.1% to 7.0%. In 2006 the net finance income relating to post-retirement plans was an income of £4m compared to a cost of £7m in the previous year. Other net finance income relating to foreign exchange and short-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.
Taxation
The total tax charge in 2006 of £4m represented just under 1% of pre-tax profits compared to a charge of £108m or 25% of pre-tax profits in 2005. The low tax rate in 2006 was mainly accounted for by two factors. First, in the light of the announcement of the disposal of Government Solutions, we were required 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 the light of our trading performance in 2006 and our strategic plans, together with the expected utilization of US net operating losses in the Government Solutions sale, we have re-evaluated the likely utilization of operating losses both in the US and the UK; this has enabled us to increase the amount of the deferred tax asset carried forward in respect of such losses. The combined effect of these two factors was to create a non-recurring credit of £127m.
Minority interests
Following the disposal of our 79% holding in Recoletos and the purchase of the remaining 25% minority stake in Edexcel in 2005, our minority interests comprised mainly the minority share in Interactive Data. In January 2006, we increased our stake in Interactive Data reducing the minority interest from 39% to 38%.

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Discontinued operations
On 22 February 2008 the Group completed the sale of its Data Management (Scanners) business and this business has been included in discontinued operations for the full year in 2006 and 2005. Operating profit for the Scanners business in 2006 was £13m compared to £15m in 2005.
In December 2007 the Group completed the sale of Groupe Les Echos and the results have been included in discontinued operations for 2006 and 2005. Operating profit for Les Echos in 2006 was £5m compared to £4m in 2005.
In December 2006 the Group announced the sale of its Government contracting business, Pearson Government 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 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. The pre-tax profit on disposal of Recoletos reported in 2005 was £306m.
Profit for the year
The total profit for the financial year in 2006 was £469m compared to a profit in 2005 of £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 in profit in 2006 due to improvement in operating profits and the sharp reduction in tax due to the recognition of losses in 2006.
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 55.9p in 2006 compared to 78.2p in 2005 based on a weighted average number of shares in issue of 798.4m in 2006 and 797.9m in 2005. 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.
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. Sales in 2006, translated at 2005 average exchange rates, would have been higher by £43m and 2006 operating profit, translated at 2005 average exchange rates, would have been higher by £7m.
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 a non-statutory measure and is included as it is a key financial measure used by management to evaluate performance and allocate resources to business segments. See also note 2 of “Item 18. 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 adjustment 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.

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Adjusted operating profit enables management to more easily track the underlying operational performance of the Group. A reconciliation of operating profit to adjusted operating profit for continuing operations is included in the tables below:

Year Ended December 31, 2006
Higher
FT
Interactive

£m
School Education Professional Publishing Data Penguin Total

Sales 1,455 795 280 280 332 848 3,990
36% 20% 7% 7% 8% 22% 100%
Total operating profit 167 161 24 30 82 58 522
32% 31% 4% 6% 16% 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 25 27 89 66 552
Adjusted operating profit: discontinued operations — — 35 5 — — 40

Total adjusted operating profit 184 161 60 32 89 66 592

31% 27% 10% 6% 15% 11% 100%

Year Ended December 31, 2005
Higher
FT
Interactive

£m
School Education Professional Publishing Data Penguin Total

Sales 1,295 779 238 249 297 804 3,662
36% 21% 6% 7% 8% 22% 100%
Total operating profit 142 156 10 54 75 60 497
29% 31% 2% 11% 15% 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 10 17 80 60 470
Adjusted operating profit: discontinued operations — — 35 1 — — 36

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 benefited from the inclusion of National Evaluation Systems (NES), Paravia Bruno Mondadori (PBM), Chancery and PowerSchool together with a number of smaller

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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 revenues 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, 4.6 million of which were marked 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.
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 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’sPsychology increased Pearson’s market share in the subject by 3% to 25% and was 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.

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Professional
After excluding sales and adjusted operating profit from Government Solutions and the Data Management businesses which were reported as discontinued, Professional sales increased by £42m, or 18%, to £280m in 2006 from £238m in 2005. Adjusted operating profit from continuing operations increased by £15m to £25m in 2006, from £10m in 2005. Sales were only slightly affected by the weakening US dollar, which we estimate reduced sales by £1m 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 successfulstart-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 FTPress imprints.
Overall margins in the Professional business were significantly higher at 8.9% in 2006 compared to 4.2% in 2005 as the testing business moved into profitability and the technology publishing business took specific cost actions.
FT Publishing
After excluding sales and adjusted operating profit from Les Echos which was reported as discontinued, sales at FT Publishing increased by £31m or 12%, from £249m in 2005 to £280m in 2006. Adjusted operating profit from continuing operations increased by £10m, from £17m in 2005 to £27m 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 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. 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 became more profitable and were 9.6% compared to 6.8% 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 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), Interactive Data’s largest business (approximately two-thirds of Interactive Data 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

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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.
Interactive Data 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 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).
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.
Liquidity and capital resources
Cash flows and financing
Net cash generated from operations increased by £38m (or 6%), to £659m in 2007 from £621m in 2006, even after a one-off special contribution of £100m to our UK pension fund (over and beyond the normal funding requirement). This increase reflected stronger cash contributions from all businesses, together with further improvements in working capital management. In 2007, the average working capital to sales ratio for our book publishing businesses improved to 25.6% from 26.3% in 2006. Average working capital is the average month end balance in the year of inventory (includingpre-publication), receivables and payables. In 2006, the net cash generated from operations decreased by £32m, or 5%, to £621m, from £653m in 2005. This reduction was entirely due to the weakening of the US dollar compared to sterling. The majority of the Group’s cash flows arise in US dollars, so any weakening of the US dollar reduces the Group’s cash flows in sterling terms. The closing rate for translation of dollar cash flows was $1.99 in 2007, $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 27.4% in 2005 to 26.3% in 2006.
Net interest paid was £90m in 2007 compared to £82m in 2006 and £72m in 2005. The 10% increase in 2007 over 2006 was primarily due to higher average interest rates in the UK and US. The 14% increase in 2006 over 2005

37
reflected the higher average debt resulting from the acquisitions made in the year and higher interest rates (particularly in the US).
Capital expenditure on property, plant and equipment was £86m in 2007 compared to £68m in 2006 and £76m in 2005. The increase in 2007 over 2006 reflects investment to update infrastructure, particularly at Penguin and FT Group. The reduction in 2006 compared to 2005 was due to the movement in US dollar exchange rates.
The acquisition of subsidiaries, joint ventures and associates accounted for a cash outflow of £476m in 2007 against £367m in 2006 and £253m in 2005. The principal acquisitions in 2007 were Harcourt Education International for £155m and eCollege for £266m. In 2006, the principal acquisition was of Mergermarket for £109m. The balance related 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 sale of subsidiaries and associates produced a cash inflow of £469m in 2007 against £10m in 2006 and £430m in 2005. The principal disposals in 2007 were of Government Solutions for £278m and Les Echos for £156m. The disposal in 2006 relates entirely to the proceeds from thetake-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 cash outflow from financing activities of £444m in 2007 represented the higher Group dividend (as the Group sought to match dividend growth more closely with earnings growth) and the repayment of one €591m bond, offset in part by drawings on the Group’s revolving credit facility. The cash outflow from financing of £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.
Capital resources
Our borrowings fluctuate by season due to the effect of the school year on the working capital requirements in the educational materials business. Assuming no acquisitions or disposals, our maximum level of net debt normally occurs in July, and our minimum level of net debt normally occurs in December. Based on a review of historical trends in working capital requirements and of forecast monthly balance sheets for the next 12 months, we believe that we have sufficient funds available for the Group’s present requirements, with an appropriate level of headroom given our portfolio of businesses and current plans. Our ability to expand and grow our business in accordance with current plans and to meet long-term capital requirements beyond this12-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, 2007, our net debt was £973m compared to net debt of £1,059m at December 31, 2006. Net debt is defined as all short-term, medium-term and long-term borrowing (including finance leases), less all cash, cash equivalents and liquid resources. Cash equivalents comprise short-term deposits with a maturity of up to 90 days, while liquid resources comprise short-term deposits with maturities of more than 90 days and other marketable instruments which are readily realizable and held on a short-term basis. Short-term, medium-term and long-term borrowing amounted to £1,608m at December 31, 2007, compared to £1,743m at December 31, 2006. At December 31, 2007, cash and liquid resources were £560m, compared to £592m at December 31, 2006.

38
Contractual obligations
The following table summarizes the maturity of our borrowings and our obligations under non-cancelable operating leases.

At December 31, 2007
Less than
One to
Two to
After five

Total one year two years five years years
£m £m £m £m £m

Gross borrowings:
Bank loans, overdrafts and commercial paper 444 444 — — —
Variable rate loan notes — — — — —
Bonds 1,150 105 176 264 605
Lease obligations 1,353 123 116 280 834

Total
2,947 672 292 544 1,439

At December 31, 2007 the Group had capital commitments for fixed assets, including finance leases already under contract, of £3m (2006: £nil). There are contingent liabilities in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries and associates. In addition there are contingent liabilities in respect of legal claims. None of these claims or guarantees is expected to result in a material gain or loss.
The Group is committed to a quarterly fee of 0.125% on the unused amount of the Group’s bank facility.
Off-Balance sheet arrangements
The Group does not have any off-balance sheet arrangements, as defined by the SEC Final Rule 67 (FR-67), “Disclosure in Management’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations”, that have or are reasonably likely to have a material current or future effect on the Group’s financial position or results of operations.
Borrowings
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.
We have in place two committed revolving credit facilities. The first is a $1.75bn revolving credit facility, of which $92m matures in May 2011 and the balance of $1.658bn matures in May 2012. The second facility is a $975m revolving credit facility, which has been amended since the balance sheet date and, assuming the company exercises its extension option, matures in December 2008. The company has a further option to extend $300m of the $975m facility to September 2009. At December 31, 2007, approximately $1.31bn and $695m were available under these facilities respectively. This included allocations to refinance short-term borrowings not directly drawn under the facility. Both credit facilities contain the same 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, tax and amortization 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.
“EBITDA” refers to earnings before interest, taxes, depreciation and amortization. We are currently in compliance with these covenants.

39
Treasury policy
Our treasury policy is described in note 15 of “Item 18. Financial Statements”. For a more detailed discussion of our borrowing and use of derivatives, see “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
Related parties
There were no significant or unusual related party transactions in 2007, 2006 or 2005. Refer to note 36 in “Item 18. Financial Statements”.
Accounting principles
For a description of our principal accounting policies used refer to note 1 in “Item 18. Financial Statements”.
~~Cost of Sales and Operating Expenses~~
      ~~The following table summarizes our cost of sales and net operating expenses:~~

Year Ended
December 31

2005 2004

£m £m
Cost of goods sold 2,022 1,789

Distribution costs 249 201
Administrative and other expenses 1,384 1,365
Other operating income (41 ) (46 )

Total operating expenses 1,592 1,520

~~Cost of Sales.~~Cost of sales consists of costs for raw materials, primarily paper, printing costs, amortization of pre-publication costs and royalty charges. Our cost of sales increased by £233 million, or 13%, to £2,022 million in 2005, from £1,789 million in 2004. The increase mainly reflected the increase in sales over the period although the overall gross margin declined slightly from 52% in 2004 to 51% in 2005.
~~Distribution Costs.~~~~Distribution costs consist primarily of shipping costs, postage and packing and are typically a fairly constant percentage of sales.~~
~~Administration and Other Expenses.~~Our administration and other expenses increased by £19 million, or 1%, to £1,384 million in 2005, from £1,365 million in 2004, although as a percentage of sales they decreased to 34% in 2005, from 37% in 2004. The increase in administration and other costs comes principally from additional employee benefit expense, but cost savings and more modest increases in other administration expenses has enabled overall operating margins to improve.
~~Other operating Income.~~Other operating income mainly consists of sub-rights and licensing income and distribution commissions. Other operating income decreased 11% to £41 million in 2005 from £46 million in 2004, with the decrease mainly representing the continued decline in commissions received for distribution of third party books.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
~~Other Net Gains and Losses~~
Directors and senior management
We are managed by a board of directors and a chief executive who reports to the board and manages through a management committee. We refer to the board of directors and the chairman of the board of directors as our “senior management”.
The following table sets forth information concerning senior management, as of April 2008.
      Profits or losses on the sale of businesses, associates and investments that are included in our continuing operations are reported as “other net gains and losses”. In 2005 the only item in this category was the £40 million profit on the sale of our associate interest in MarketWatch. In 2004, other gains and losses amounted to £9 million, with the principal items being profits on the sale of stakes in Capella and Business.com.Name
Age
~~Share of results of joint ventures and associates~~
Position
      The contribution from our joint ventures and associates increased from £8 million in 2004 to £14 million in 2005. The increase was due to profit improvement at The Economist Group and a reduction in losses at FT Deutschland.
~~Operating Profit~~
      The total operating profit increased by £132 million, or 32.7%, to £536 million in 2005 from £404��million in 2004. This £132 million or 33% increase was due to increases across all the businesses, the one-off gain from the sale of MarketWatch of £40 million and a beneficial impact of exchange. We estimate that had the 2004 average rates prevailed in 2005, operating profit would have been £12 million lower.
      Operating profit attributable to Pearson Education increased by £56 million, or 20%, to £343 million in 2005, from £287 million in 2004. The increase was due to strong sales and improved margins in both the School and Higher Education businesses. Operating profit attributable to the FT Group increased by £63 million, or 90%, to £133 million in 2005, from £70 million in 2004. £40 million of the increase was due to the profit from the sale of MarketWatch but there were also increases at IDC of £13 million and FT Publishing of £10 million. Operating profit attributable to the Penguin Group increased by £13 million, or 28%, to £60 million in 2005, from £47 million in 2004. The increase at Penguin was due in part to increased efficiencies and improved margins and also due to exchange gains and one-off items in 2004. Penguin’s
25
~~operating profit in 2004 was reduced by costs associated with disruption in UK distribution following the move to a new warehouse and closure costs associated with Penguin TV.~~
~~Net Finance Costs~~
Glen Moreno 64 Chairman
      Net finance costs reduced from £79 million in 2004 to £70 million in 2005. Net interest payable in 2005 was £77 million, up from £74 million in 2004. The group’s net interest rate payable rose by 0.9% to 5.9%. Although we were partly protected by our fixed rate policy, the strong rise in US dollar floating interest rates had an adverse effect. Year on year, average three month LIBOR (weighted for the Group’s borrowings in US dollars, euro and sterling) rose by 1.9% to 3.4%. This was largely offset by the £260m fall in average net debt, reflecting in particular the proceeds from the disposal of Recoletos and good cash generation. In addition, in 2005 we did not benefit from a one-off credit of £9m for interest on a repayment of tax that occurred in 2004. As at January 1, 2005 we adopted IAS 39~~‘Financial Instruments: Recognition and Measurement’~~ in our financial statements. This has had the effect of introducing increased volatility into the net finance cost and in 2005 the adoption of IAS 39 reduced net finance costs by £14 million. For a more detailed discussion of our borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowing” below and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
~~Taxation~~
      The total tax charge for the year was £124 million, representing a 27% rate on pre-tax profits of £466 million. This compares with a 2004 rate of 19% (or £63m on a pre-tax profit of £325m). In 2004, the tax charge reflected credits of £48m relating to previous years, a substantial element of which was non-recurring; adjustments relating to previous years in 2005 resulted in a credit of £18m. The 2005 rate benefited from the fact that the profit of £40m on the sale of Marketwatch.com was free of tax.
~~Minority Interests~~
      Following the disposal of our 79% holding in Recoletos in April 2005 and the purchase of the 25% minority stake in Edexcel in February 2005, our minority interests now mainly comprise the 39% minority share in IDC.
~~Discontinued Operations~~
      The results of Recoletos have been consolidated for the period up to February 28, 2005 and included in discontinued operations in 2005 and 2004. The results for 2005 include an operating loss for the two months to February 28, 2005 of £3 million compared to an operating profit in the full year to December 31, 2004 of £26 million. The profit on disposal of Recoletos reported in 2005 was £306 million.
~~Profit for the Financial Year~~
      The total profit for the financial year in 2005 was £644 million compared to a profit in 2004 of £284 million. The overall increase of £360 million was mainly due to the profit on disposal of Recoletos and MarketWatch together with significant improvement in operating profits reported across all the Pearson businesses. These increases were only partially offset by the increase in the tax charge in 2005.
~~Earnings per Ordinary Share~~
      The basic earnings per ordinary share, which is defined as the profit for the financial year divided by the weighted average number of shares in issue, was 78.2 pence in 2005 compared to 32.9 pence in 2004 based on a weighted average number of shares in issue of 797.9 million in 2005 and 795.6 million in 2004. This increase in earnings per share was due to the additional profit for the financial year described above and was not significantly affected by the movement in the weighted average number of shares.
      The diluted earnings per ordinary share of 78.1 pence in 2005 and 32.9 pence in 2004 was not significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant.
~~Exchange Rate Fluctuations~~
      The strengthening of the US dollar against sterling on an average basis had a positive impact on reported sales and profits in 2005 compared to 2004. We estimate that if the 2004 average rates had prevailed in 2005, sales would have been lower by £46 million and operating profit would have been lower by £12 million. See
26
~~“Item 11. Quantitative and Qualitative Disclosures About Market Risk” for a discussion regarding our management of exchange rate risks.~~
~~Sales and Operating Profit by Division~~
      The following table summarizes our operating profit and results from operations for each of Pearson’s divisions. Adjusted operating profit is included as it is a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under SFAS 131. Since 1998 we have reshaped the Pearson portfolio by divesting of non-core interests and investing in educational publishing and testing, consumer publishing and business information companies. During this period of transformation management has used adjusted operating profit to track underlying core business performance.
      In our adjusted operating profit we have excluded amortization of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization of acquired intangibles is not considered to be fully reflective of the underlying performance of the group. Other gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and investments that are included within continuing operations but which distort the performance for the year. Other net finance costs of associates are foreign exchange and other gains and losses that represent short-term fluctuations in market value and are subject to significant volatility. These gains and losses may not be realized in due course as it is normally the intention to hold these instruments to maturity. Increased volatility has been introduced as a result of adopting IAS 39 ’Financial Instruments: Recognition and Measurement’ as at January 1, 2005. Finance costs and income of joint ventures and associates are reported within the share of results of joint ventures and associates that is included within operating profit. Group finance costs and income are reported separately in the income statement below the operating profit line.
27
      Adjusted operating profit enables management to more easily track the underlying operational performance of the group. A reconciliation of operating profit to adjusted operating profit is included in the table below:

Year Ended December 31

2005 2004

£m % £m %

Total operating profit

Pearson Education:
School 142 27 112 27
Higher Education 156 29 133 33
Professional 45 8 42 10
FT Group:
FT Publishing 58 11 8 2
IDC 75 14 62 16
Penguin 60 11 47 12

Total 536 100 404 100

Add back:

Amortization of acquired intangibles

School 5 —
Higher Education — —
Professional — —
Penguin — —
FT Publishing 1 —
IDC 5 5

Total 11 5

Other net gains and losses

School — (4 )
Higher Education — (4 )
Professional — (2 )
Penguin — 5
FT Publishing (40 ) (4 )
IDC — —

Total (40 ) (9 )

Other net finance costs of associates

School — —
Higher Education — —
Professional — —
Penguin — —
FT Publishing 2 —
IDC — —

Total 2 —

Adjusted operating profit

Pearson Education:
School 147 29 108 27
Higher Education 156 31 129 32
Professional 45 9 40 10
FT Group:
FT Publishing 21 4 4 1
IDC 80 15 67 17
Penguin 60 12 52 13

Total 509 100 400 100

28
~~School~~
      School business sales increased by £208 million, or 19%, to £1,295 million in 2005, from £1,087 million in 2004 and adjusted operating profit increased by £39 million, or 36%, to £147 million in 2005 from £108 million in 2004. The School results in 2005 benefit from the inclusion of AGS Publishing, acquired in July 2005 and the strengthening of the US dollar, which we estimate added £34 million to sales and £2 million to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      In the US school market, Pearson’s school publishing business grew 12% ahead of the Association of American Publishers’ estimate of industry growth of 10.5%. New adoption market share was 33% in the adoptions where Pearson competed (and 24% of the total new adoption market). The School business now has leading positions in math, science, literature and foreign languages. School testing sales were up more than 20%, benefiting from significant market share gains and mandatory state testing under No Child Left Behind. School software also had a strong year with good sales and profit growth on curriculum and school administration services.
      Outside the US, the School publishing sales increased in high single digits. The worldwide English Language Teaching business benefited from strong demand for English language learning and investments in new products, including~~English Adventure~~ ~~(with Disney) for the primary school market,~~~~Sky~~ ~~for secondary schools,~~~~Total English~~ ~~for adult learners and~~~~Intelligent Business~~ ~~(with~~~~The Economist~~~~) for the business markets. There was also strong growth in the international school testing markets. Four million UK GCSE, AS andA-Level~~ ~~scripts were marked onscreen and 2005 saw the first year of running the UK National Curriculum tests and a new contract for a national school testing pilot in Australia.~~
      ~~School margins were up by 1.5% points to 11.4% with efficiency gains in central costs, production, distribution and software development.~~
~~Higher Education~~
      Sales in Higher Education increased by £50 million, or 7%, to £779 million in 2005, from £729 million in 2004. Adjusted operating profit increased by £27 million, or 21%, to £156 million in 2005 from £129 million in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £14 million to sales and £3 million to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      In the US, the Higher Education sales were up by 6% ahead of the Association of American Publishers’ estimate of industry growth of 5%. 2005 is the seventh consecutive year that Pearson’s US Higher Education business has grown faster than the industry. The US business benefited from continued growth from market-leading authors in key academic disciplines including biology (Campbell & Reece), chemistry (Brown & LeMay), sociology (Macionis), marketing (Kotler & Keller), math (Tobey & Slater), developmental math (Martin-Gay) and English composition (Faigley’s~~Penguin Handbook~~). There was also expansion in the career and workforce education sector, with major publishing initiatives gaining market share in allied health, criminal justice, paralegal, homeland security and hospitality. The online learning and custom publishing businesses saw rapid growth. Approximately 3.6 million US college students are studying through one of our online programs, an increase of 20% on 2004; and custom publishing, which builds customized textbooks and online services around the courses of individual faculties or professors, had double digit sales growth.
      International Higher Education publishing sales grew by 4%, benefiting from the local adaptation of global authors, including Campbell and Kotler, and the introduction of custom publishing and online learning capabilities into new markets in Asia and the Middle East.
      Higher Education margins were up by 2.3% points to 20%. Good margin improvement in the US and in international publishing was helped by shared services and savings in central costs, technology, production and manufacturing.
~~Professional~~
      Professional sales increased by £82 million, or 16%, to £589 million in 2005 from £507 million in 2004. Adjusted operating profit increased by £5 million, or 13%, to £45 million in 2005, from £40 million in 2004. Sales benefited from the strengthening US dollar, which we estimate added £8 million to sales when compared to the equivalent figures at constant 2004 exchange rates.
29
      Professional testing sales were up more than 40% in 2005 benefiting from the successful start-up of major new contracts including the Driving Standards Agency, National Association of Securities Dealers and the Graduate Management Admissions Council. Government Solutions grew sales by 38%, helped by new contracts with the US Department of Education and the Social Security Administration worth over $800 million, together with strong growth from add-ons to existing programs, including those with the US Department of Health and Human Services.
      Overall margins in the Professional business were a little lower in 2005 compared to 2004 mainly due to new contract start-up costs at Government Solutions. Margins in the Professional publishing businesses were maintained despite falling sales.
~~FT Publishing~~
      Sales at FT Publishing (excluding discontinued businesses) increased by £14 million or 4%, from £318 million in 2004 to £332 million in 2005. Adjusted operating profit increased by £17 million, from £4 million in 2004 to £21 million in 2005. Much of the sales and profit increase was at the FT newspaper; sales at the other business newspapers were broadly level with 2004 with a small increase in adjusted operating profit compared to 2004.
      FT newspaper sales were up 6% while adjusted operating profit increased £14 million to register a profit of £2 million in 2005 compared to a loss of £12 million in 2004. FT advertising revenues were up 9% for the year with sustained growth in luxury goods and worldwide display advertising. FT.com advertising sales were up 27% as some of the FT’s biggest advertisers shifted to integrated print and online advertising. The FT’s worldwide circulation was 2% lower for the year at 426,453 average copies per day although the second half of the year showed improvement to 430,635 average copies per day. FT.com’s paying subscribers increased by 12% to 84,000 and the average unique monthly users was up 7% to 3.2 million.
      Les Echos advertising and circulation revenues for 2005 were level with 2004 despite tough trading conditions. FT Business improved margins with growth in its international finance titles. Our share of the results of the FT’s joint ventures and associates improved as~~FT Deutschland~~ ~~reduced its losses and increased its average circulation despite a weak advertising market in Germany and~~~~The Economist~~ ~~increased profits helped by an increase in circulation (10% to an average weekly circulation of 1,038,519 for the January-June ABC period).~~
~~Interactive Data~~
      Interactive Data, grew its sales by 10% from £269 million in 2004 to £297 million in 2005. Adjusted operating profit grew by 19% from £67 million in 2004 to £80 million in 2005. Both sales and adjusted operating profit benefited from the strengthening US dollar, which we estimate added £2 million to sales and £1 million to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates.
      FT Interactive Data, IDC’s largest business (approximately two-thirds of IDC revenues) generated strong growth in North America and returned to growth in Europe. There was more modest growth at Comstock, IDC’s business providing real-time data for global financial institutions, and at CMS BondEdge, its fixed income analytics business. Renewal rates for IDC’s institutional businesses remain at around 95%. eSignal, IDC’s active trader services business, increased sales by 27% with continued growth in the subscriber base and a full year contribution from FutureSource, acquired in September 2004.
~~The Penguin Group~~
      The Penguin Group sales were up 2% to £804 million in 2005 from £786 million in 2004 and adjusted operating profit up 15% to £60 million in 2005 from £52 million in 2004. Both sales and adjusted operating profit benefited from the strengthening US dollar which we estimate added £9 million to sales and £6 million to adjusted operating profit when compared to the equivalent figures at constant 2004 exchange rates. 2005 adjusted operating profit also benefited from reduced operating costs at our UK distribution center.
      In the US, successful format innovation helped to address weakness in the mass market category that saw a further decline of 4% for the industry in 2005. The first seven Penguin Premium paperbacks were published in 2005, priced at $9.99, and all became bestsellers, with authors including Nora Roberts, Clive Cussler and Catherine Coulter.
30
      ~~Penguin authors received a number of awards during the year: A Pulitzer Prize (for Steve Coll’s~~~~Ghost Wars~~~~), a National Book Award (William T. Vollman’s~~~~Europe Central~~~~), the Whitbread Book of the Year (Hilary Spurling’s~~~~Matisse the Master~~~~), the Whitbread Novel of the Year (Ali Smith’s~~~~The Accidental~~~~) and the FT & Goldman Sachs Business Book of the Year Award (Thomas Friedman’s~~~~The World is Flat~~). In 2005, there were 129 New York Times bestsellers and 54 top 10 bestsellers in the UK. Major bestselling authors include Patricia Cornwell, John Berendt, Sue Grafton, Jared Diamond, Jamie Oliver, Gillian McKeith, Jeremy Clarkson and Gloria Hunniford.
      In 2005, there was also a strong contribution from new imprints and first-time authors. The new imprint strategy continued to gather pace and Penguin published more than 150 new authors in the US and approximately 250 worldwide — its largest ever investment in new talent. Sue Monk Kidd’s first novel,~~The Secret Life of Bees,~~ ~~has been a New York Times bestseller for almost two years; her second,~~~~The Mermaid Chair,~~ ~~reached number one in 2005.~~~~The Kite Runner,~~ Khaled Hosseini’s first book, stayed on the New York Times bestseller list for all of 2005, selling an additional two million copies (three million in total). In the UK, there was also strong performance from new fiction authors including Jilliane Hoffman, PJ Tracy, Karen Joy Fowler and Marina Lewycka.
~~Results of Operations~~
~~Year ended December 31, 2004 compared to year ended December 31, 2003~~
~~Consolidated Results of Operations~~
~~Sales~~
      Our total sales decreased by £154 million to £3,696 million in 2004, from £3,850 million in 2003. This decrease of 4% was attributable to the effect of foreign currency exchange. The strength of sterling compared to the US dollar had a significant negative effect on sales, and we estimate that had the 2003 average rates prevailed in 2004, sales would have been higher by £301 million. In constant exchange rate terms Pearson Education had a strong year with an increase in sales of 5%. The Higher Education and Professional businesses were the main contributors to this growth with the Higher Education business growing faster than its market for the sixth straight year and Professional benefiting from new contracts and add-ons to existing contracts at Pearson Government Solutions. The School business was helped by a full year contribution from Edexcel, the UK testing business, but otherwise sales were flat as new adoption spending in the US fell by approximately $200 million. The FT Group sales were ahead of last year after another good year at Interactive Data and a return to sales growth for the Financial Times newspaper in a more stable business advertising environment. Penguin’s results were disappointing with sales down 6% as reported, but flat on a constant currency basis after disruption to UK distribution and a weakness in the US consumer publishing market.
      Pearson Education, our largest business sector, accounted for 63% of our sales in 2004 and in 2003. North America continued to be the most significant source of our sales although sales in the region decreased, as a proportion of total sales, to 68% in 2004, compared to 71% in 2003. This decrease in 2004, however, reflects the comparative strength of sterling and the euro compared to the US dollar.
~~Cost of Sales and Net Operating Expenses~~
      ~~The following table summarizes our cost of sales and net operating expenses:~~

Year Ended
December 31

2004 2003

£m £m
Cost of goods sold 1,789 1,846

Distribution costs 201 206
Administrative and other expenses 1,365 1,439
Other income (46 ) (51 )

Total operating expenses 1,520 1,594

~~Cost of Sales.~~~~Cost of sales consists of costs for raw materials, primarily paper, printing costs, amortization of pre-publication costs and royalty charges. Our cost of sales decreased by £57 million, or 3%, to~~
31
~~£1,789 million in 2004, from £1,846 million in 2003. The decrease mainly reflected the decrease in sales over the period with overall gross margin remaining constant.~~
~~Distribution Costs.~~~~Distribution costs consist primarily of shipping costs, postage and packing.~~
~~Administration and Other Expenses.~~Our administration and other expenses decreased by £74 million, or 5%, to £1,365 million in 2004, from £1,439 million in 2003. Administration and other expenses as a percentage of sales remained constant at 37%. The decrease in administration and other expenses comes from both the effect of exchange and increased efficiencies, in particular from the cost actions taken at the Financial Times in recent years.
~~Other Operating Income.~~Other operating income mainly consists of sub-rights and licensing income and distribution commissions. Other operating income decreased 10% to £46 million in 2004 from £51 million in 2003 with the decrease mainly representing the continued decline in distribution commissions received for distribution of third party books.
~~Other Net Gains and Losses~~
      Profits or losses on the sale of businesses, associates and investments that are included in our continuing operations are reported as other net gains and losses. In 2004, other gains and losses amounted to £9 million with the principal items being profits on the sale of stakes in Capella and Business.com. In 2003 there were small losses on a number of items totaling £6 million.
~~Share of results of joint ventures and associates~~
      The contribution from our joint ventures and associates increased from £2 million in 2003 to £8 million in 2004. The increase was largely due to a reduction in losses at FT Deutschland together with some improvement in profit at the Economist.
~~Operating Profit/Loss~~
      The total operating profit in 2004 of £404 million compares to a profit of £406 million in 2003. This marginal decrease was due to the impact of exchange rates. We estimate that had the 2003 average rates prevailed in 2004, operating profit would have been £51 million greater. Operating profit attributable to Pearson Education remained constant at £287 million in both 2004 and 2003. There was an estimated reduction in profit of £29 million from exchange. After accounting for exchange rates, operating profit was ahead in each of the School, Higher Education and Professional businesses. Operating profit attributable to the FT Group increased by £33 million, or 89%, to £70 million in 2004, from £37 million in 2003. The increase was largely due to another strong performance from Interactive Data and significant cost savings at the Financial Times newspaper. Operating profit attributable to the Penguin Group decreased by £35 million, or 43%, to £47 million in 2004, from £82 million in 2003. The biggest single factor in the profit decline was exchange rates, which are estimated to have accounted for £14 million of the difference. There were also a number of other factors, including disruption in UK distribution following the move to a new warehouse and the weakness of the US consumer publishing market.
~~Net Finance Costs~~
      Net finance costs decreased by £14 million to £79 million in 2004 from £93 million in 2003. Net interest payable decreased by £10 million, or 12%, to £74 million in 2004, from £84 million in 2003. The reduction is due to lower average net debt levels in 2004, which more than offset the effect of a general increase in floating interest rates, and a one-off credit of £9 million for interest on a repayment of tax in France which reduced the net interest cost in 2004. Year end indebtedness decreased to £1,221 million in 2004 compared to £1,376 million in 2003 due to funds generated from operations and foreign exchange movements. The weighted average three month London Interbank Offered (“LIBOR”) rate, reflecting our borrowings in US dollars, euros and sterling, rose by 40 basis points, or 0.4%. The company is partially protected from these increases by our treasury policy, which put £736 million of the year end debt on a fixed rate basis. As a result the net interest rate payable (excluding the £9 million credit referred to above) rose by only 25 basis points or 0.25% to 5% in 2004. For a more detailed discussion of our borrowings and interest expenses see “— Liquidity and Capital Resources — Capital Resources” and “— Borrowing” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
32
~~Taxation~~
      The overall taxation charge for 2004 was £63 million, compared to a charge of £61 million in 2003. In 2004 the Group recorded a total pre-tax profit of £325 million giving a tax rate of 19% compared to a similar rate of 19% on total pre-tax profits of £313 million in 2003. These low rates of tax were mainly a result credits of £56 million and £48 million respectively relating to prior year items; these reflect a combination of settlements with the Inland Revenue authorities and changes to deferred tax balances.
~~Minority Interests~~
      ~~Minority interests principally consist of the public’s 39% interest in Interactive Data.~~
~~Discontinued Operations~~
      Following the disposal of Recoletos in 2005, the results of Recoletos have been included in discontinued operations in 2004 and 2003. The results for 2004 include an operating profit of £26 million compared to an operating profit in 2003 of £43 million. The profit in 2003 includes a profit of £12 million on the sale of the Recoletos interest in El Mundo.
~~Profit for the Financial Year~~
      The total profit for the financial year in 2004 was £284 million compared to a profit in 2003 of £275 million. The overall increase of £9 million was mainly due to the decrease in net finance costs in 2004 after adverse movements in exchange had eroded the underlying increase in operating profit.
~~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 32.9 pence in 2004 compared to 31.7 pence in 2003 based on a weighted average number of shares in issue of 795.6 million in 2004 and 794.4 million in 2003. This increase in earnings per share was due to the additional profit for the financial year described above and was not significantly affected by the movement in the weighted average number of shares.
      The diluted earnings per ordinary share of 32.9 pence in 2004 and 31.7 pence in 2003 was not significantly different from the basic earnings per share in those years as the effect of dilutive share options was again not significant.
~~Exchange Rate Fluctuations~~
      The weakening of the US dollar against sterling on an average basis had a negative impact on reported sales and profits in 2004 compared to 2003. We estimate that if the 2003 average rates had prevailed in 2004, sales would have been higher by £301 million and operating profit would have been higher by £51 million. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk” for a discussion regarding our management of exchange rate risks.
~~Sales and Operating Profit by Division~~
      The following table summarizes our operating profit and results from operations for each of Pearson’s divisions. Adjusted operating profit is included as it is a key financial measure used by management to evaluate performance and allocate resources to business segments, as reported under SFAS 131. Since 1998 we have reshaped the Pearson portfolio by divesting of non-core interests and investing in educational publishing and testing, consumer publishing and business information companies. During this period of transformation management has used adjusted operating profit to track underlying core business performance.
      In our adjusted operating profit we have excluded amortization of acquired intangibles, other gains and losses and other net finance costs of associates. The amortization of acquired intangibles is not considered to be fully reflective of the underlying performance of the group. Other gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and investments that are included within continuing operations but which distort the performance for the year.
33
      Adjusted operating profit enables management to more easily track the underlying operational performance of the group. A reconciliation of operating profit to adjusted operating profit is included in the table below:

Year Ended December 31

2004 2003

£m % £m %

Total operating profit

Pearson Education:
School 112 27 114 28
Higher Education 133 33 140 35
Professional 42 10 33 8
FT Group:
FT Publishing 8 2 (29 ) (7 )
IDC 62 16 66 16
Penguin 47 12 82 20

Total 404 100 406 100

Add back:

Amortization of acquired intangibles

School — —
Higher Education — —
Professional — —
Penguin — —
FT Publishing — —
IDC 5 4

Total 5 4

Other net gains and losses

School (4 ) 2
Higher Education (4 ) 2
Professional (2 ) 1
Penguin 5 1
FT Publishing (4 ) —
IDC — —

Total (9 ) 6

Other net finance costs of associates

School — —
Higher Education — —
Professional — —
Penguin — —
FT Publishing — —
IDC — —

Total — —

Adjusted operating profit

Pearson Education:
School 108 27 116 28
Higher Education 129 32 142 34
Professional 40 10 34 8
FT Group:
FT Publishing 4 1 (29 ) (7 )
IDC 67 17 70 17
Penguin 52 13 83 20

Total 400 100 416 100

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~~School~~
      The School business sales decreased by £62 million, or 5%, to £1,087 million in 2004, from £1,149 million in 2003 and adjusted operating profit decreased by £8 million, or 7%, to £108 million in 2004 from £116 million in 2003. Both sales and adjusted operating profit were adversely affected by the weakening US dollar and we estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £93 million higher than reported and results from operations £8 million higher. The School results include a full year contribution from Edexcel, 75% of which was acquired in 2003. The extra Edexcel contribution increased sales growth in 2004 but reduced profit growth as the business is loss making in the first half.
      In the US school market, adoption spending in 2004 fell by some $200 million to approximately $500 million. Our school businesses took the largest share (27%) of the new adoption opportunities. We benefited from strength across a wide range of subjects and grade levels, with a decline in elementary sales (after particularly strong market share growth in 2003) mitigated by a strong performance in the secondary market. We returned to growth in the open territories and in supplementary publishing, helped by restructuring actions taken in 2003 and by the sharp recovery in US state budgets. Our US school testing business benefited from growth in new and existing state contracts, including Texas, Ohio, Virginia and Washington. We continued to win new multi-year contracts including Tennessee, New Jersey and California ahead of implementation of the No Child Left Behind Act testing requirements, which become mandatory in the school year starting in September 2005. Our digital learning business showed a further profit improvement on slightly lower sales as we continued to integrate our content, testing and technology in a more focused way.
      Outside the US, the School business sales increased with continued growth in English Language Teaching (ELT) helped by a very significant investment in ELT and in school testing we won $200 million of multi-year contracts.
~~Higher Education~~
      Higher Education sales decreased by £41 million, to £729 million in 2004, from £770 million in 2003. Adjusted operating profit decreased by £13 million, or 9%, to £129 million in 2004 from £142 million in 2003. Both sales and adjusted operating profit were adversely affected by the weakening US dollar, and we estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £69 million higher than reported and results from operations £16 million higher than reported. In the US we grew faster than the market for the sixth consecutive year in US dollar terms, up 4% while the industry without Pearson was up 2% according to the Association of American Publishers.
      In the US, our Higher Education business benefited from strength in two-year career colleges, a fast growing segment, with vocational programs in allied health, technology and graphic arts, and elsewhere in math and modern languages. Margins reduced a little as we achieved good growth outside the US and continued to invest to make our technology central to the teaching and learning process. Our custom publishing business, which creates specific programs built around the curricula of individual faculties or professors, grew strongly. Pearson Custom has now increased its sales in dollar terms eight-fold over the past six years and we have introduced our first customized online resources for individual college courses.
~~Professional~~
      Sales and profit 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. Adjusted operating profit increased by £6 million, or 18%, to £40 million in 2004, from £34 million in 2003. We estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £60 million higher than reported and results from operations £5 million higher than reported.
      After taking out the effect of exchange rates, Pearson Government Solutions grew sales by 25%, with strong growth from add-ons to existing programs. We also won some important new contracts, including multi-year contracts worth $500 million from customers such as the US Department of Health and Human Services and the London Borough of Southwark. Our professional testing business grew sales (before exchange impacts) by 31% as we benefited from the start-up of major new contracts, although we continued to operate at a small loss as we invested in building up the infrastructure for our 150-strong UK test center
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~~network. Markets remained tough for our technology publishing titles, where although sales were lower, profits were broadly level as a result of further cost actions.~~
~~FT Publishing~~
      Sales at the FT Publishing (excluding discontinued businesses) increased by £3 million, from £315 million in 2003 to £318 million in 2004 and adjusted operating profit increased by £33 million from a loss of £29 million in 2003 to a profit of £4 million in 2004. Sales were boosted by a return to 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 3.0 million average unique monthly users. Adjusted operating profit at the FT improved by £24 million over 2003 as we continued to reduce the FT’s cost base, which is now £110 million lower than it was in 2000.
      Les Echos achieved euro sales growth of 4% and profits grew strongly despite a volatile advertising market. Average circulation grew 3% to 119,800, while competitors saw falling sales. FT Business posted significant sales growth of 8%, with progress in all its main markets. Profits improved 25% following a continued emphasis on cost management. Adjusted operating profit at the FT’s associates and joint ventures showed a profit of £6 million compared to £2 million in 2003. Losses narrowed at FT Deutschland as circulation and advertising revenue grew strongly. FT Deutschland reached the 100,000 copy sales mark in December and circulation averaged 96,600, up 6% on the previous year. The Economist Group again increased adjusted operating profit with The Economist’s circulation passing the 1 million mark with an average weekly circulation of 1,009,759~~(January-June~~ ~~Audit Bureau of Circulations period).~~
~~Interactive Data~~
      Interactive Data, our 61%-owned financial information business saw a decrease in sales of £4 million, from £273 million in 2003 to £269 million in 2004 and adjusted operating profit decreased by £3 million from £70 million in 2003 to £67 million in 2004. We estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £22 million higher than reported and results from operations £7 million higher than reported.
      FT Interactive Data and e-Signal (Interactive Data’s real-time financial market information and decision support tool business) performed well particularly in the US in 2004 where there were some signs of improvement in market conditions. Worldwide renewal rates among institutional clients remained at or above 95%. Demand for Interactive Data’s value-added services remained strong, with the signing of our 100th customer for our Fair Value Information Service product in December 2004. IDC had a first full year contribution from acquisitions made in 2003, ComStock and Hyperfeed Technologies, and acquired FutureSource in September 2004 to expand and compliment e-Signal.
~~The Penguin Group~~
      The Penguin Group had a difficult 2004 with sales down 6% to £786 million from £840 million in 2003 and adjusted operating profit down 37% to £52 million in 2004 from £83 million in 2003. Both sales and adjusted operating profit were adversely affected by the weakening US dollar, and we estimate that had 2003 average rates prevailed in 2004 then sales would have been approximately £57 million higher than reported and results from operations £14 million higher than reported. In addition to exchange, the decline in results from operations was caused by a number of factors including disruption at the new UK warehouse and a weakening in the US consumer publishing market.
      In the UK, our move to a new warehouse, to be shared with Pearson Education, disrupted supply of our books and had a particular impact on backlist titles. Although we traded well in the second half of 2004, and shipped more books to our UK customers than in the previous year, we incurred some £9 million of additional costs as we took special measures to deliver books, including the costs of running two warehouses, shipping
36
books direct and additional marketing support. By the end of the year we had eliminated the order backlog in the warehouse and the new management team has continued to make good progress in the early part of 2005.
      After a good start to the year, the US consumer publishing market deteriorated sharply in the second half and full year industry sales were 1% lower than in 2003, according to the Association of American Publishers. The adult mass market segment, which accounts for approximately one-third of Penguin’s US sales, was down 9% for the industry for the full year, and 13% in the second half.
      Despite the problems outlined above, Penguin had another great publishing year in 2004. We benefited from our new imprint strategy, with a further four imprints published for the first time. Non-fiction performed particularly well, with a 40% increase in our titles on the New York Times bestseller list, including Lynne Truss’s~~Eats, Shoots & Leaves~~ ~~(now with over one million copies in print), Ron Chernow’s~~~~Alexander Hamilton~~ ~~and Maureen Dowd’s~~~~Bushworld.~~ ~~Best selling UK titles included Jamie Oliver’s~~~~Jamie’s Dinners,~~ ~~Sue Townsend’s~~~~Adrian Mole and the Weapons of Mass Destruction~~ ~~and Gillian McKeith’s~~~~You Are What You Eat~~.
~~Liquidity and Capital Resources~~
~~Cash Flows and Financing~~
      Net cash inflow from operating activities increased by £170 million, or 24%, to £875 million in 2005, from £705 million in 2004, even though the 2004 cash inflow included collection of the $151 million receivable in respect of the TSA contract. Cash flows within the education businesses and IDC in particular continued to grow strongly and cash flows at Penguin recovered significantly from their lower levels in 2004 and 2003. Underlying working capital efficiency improved considerably. On an average basis (excluding the impact of the TSA receivable), the working capital to sales ratio for our book publishing businesses improved from 29.4% to 27.4%. Compared to 2003, the net cash inflow from operating activities in 2004 increased by £174 million, or 33%, to £705 million from £531 million. Although the 2004 performance was helped by the receipt of the $151 million receivable in respect of the TSA contract, growth within the education businesses and IDC underpinned the underlying improvement.
      Net interest paid was £72 million in 2005 compared to £85 million in 2004 and £76 million in 2003. The 7% decrease in 2005 over 2004 reflected the reduction in debt following receipt of the proceeds from the disposals of Recoletos and MarketWatch (offset in part by the impact of the year on year increases in interest rates), while the 2004 increase compared to 2003 was entirely due to the year on year increases in interest rates.
      Capital expenditure on property, plant and equipment was £76 million in 2005 compared to £101 million in 2004 and £79 million in 2003. The higher spending in 2004, compared to both 2005 and 2003, reflected up-front expenditure on our Professional testing contracts.
      The acquisition of subsidiaries, joint ventures and associates accounted for a cash outflow of £253 million in 2005 against £51 million in 2004 and £65 million in 2003. The principal acquisitions in 2005 were of AGS for £161 million within the School business and IS. Teledata for £29 million by Interactive Data. The principal acquisitions in 2004 were of KAT and Dominie Press for £10 million within our education businesses and FutureSource by Interactive Data for £9 million. The principal acquisition in 2003 was of ComStock by Interactive Data for net cash of £68 million. The sale of subsidiaries and associates produced a cash inflow of £430 million in 2005 against £31 million in 2004 and £56 million in 2002. The principal disposals in 2005 were of Recoletos for net cash proceeds of £371 million and MarketWatch for net cash proceeds of £54 million. The proceeds in 2004 relate primarily to the sale of Argentaria Cartera by Recoletos. The principal disposal in 2003 was the sale of Unedisa by Recoletos.
      The cash outflow from financing of £321 million in 2005 reflects the improved group dividend and the repayment of bank borrowings following the sale of Recoletos. The cash outflow from financing of £261 million in 2004 reflects the payment of the group dividend and the repayment of one€550 million bond offset by the proceeds from the issue of new $350 million and $400 million bonds. The cash outflow from financing of £142 million in 2003 again reflects the group dividend and the issue in the year of a $300 million bond as we took advantage of favorable market conditions, offset by the repayment of a€~~250 million bond. Bonds are issued as part of our overall financing program to support general corporate expenditure.~~
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~~Capital Resources~~
      Our borrowings fluctuate by season due to the effect of the school year on the working capital requirements in the educational materials business. Assuming no acquisitions or disposals, our maximum level of net debt normally occurs in July, and our minimum level of net debt normally occurs in December. Based on a review of historical trends in working capital requirements and of forecast monthly balance sheets for the next 12 months, we believe that we have sufficient funds available for the group’s present requirements, with an appropriate level of headroom given our portfolio of businesses and current plans. Our ability to expand and grow our business in accordance with current plans and to meet long-term capital requirements beyond this 12-month period will depend on many factors, including the rate, if any, at which our cash flow increases and the availability of public and private debt and equity financing, including our ability to secure bank lines of credit. We cannot be certain that additional financing, if required, will be available on terms favorable to us, if at all.
      At December 31, 2005, our net debt was £996 million compared to net debt of £1,221 million at December 31, 2004. Net debt is defined as all short-term, medium-term and long-term borrowing (including finance leases), less all cash and liquid resources. Liquid resources comprise short-term deposits of 90 days and investments that are readily realizable and held on a short-term basis. Short-term, medium-term and long-term borrowing amounted to £1,959 million at December 31, 2005, compared to £1,823 million at December 31, 2004. At December 31, 2005, cash and liquid resources were £902 million, compared to £461 million at December 31, 2004.
~~Contractual Obligations~~
      ~~The following table summarizes the maturity of our borrowings and our obligations under non-cancelable operating leases.~~

At December 31, 2005

Less Than One to Two to After Five
Total One Year Two Years Five Years Years

£m £m £m £m £m
Gross borrowings:
Bank loans, overdrafts and commercial paper 102 102 — — —
Variable rate loan notes — — — — —
Bonds 1,854 152 436 310 956
Lease obligations 1,395 129 115 288 863

Total
3,351 383 551 598 1,819

      The group had capital commitments for fixed assets, including finance leases already under contract, of £1 million. There are contingent liabilities in respect of indemnities, warranties and guarantees in relation to former subsidiaries and in respect of guarantees in relation to subsidiaries and associates. In addition there are contingent liabilities in respect of legal claims. None of these claims or guarantees is expected to result in a material gain or loss.
      ~~The group is committed to a quarterly fee of 0.125% on the unused amount of the group’s bank facility.~~
~~Off-Balance Sheet arrangements~~
      ~~The Group does not have any off-balance sheet arrangements, as defined by the SEC Final Rule 67(FR-67),~~~~“Disclosure in Management’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations”,~~ ~~that have or are reasonably likely to have a material current or future effect on the Group’s financial position or results of operations.~~
~~Borrowings~~
      We have in place a $1.35 billion term revolving credit facility, which matures in July 2009. At December 31, 2005, approximately $1.35 billion was available under this facility. This included allocations to
38
~~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.~~
      ~~“EBITDA” refers to earnings before interest, taxes, depreciation and amortization. We are currently in compliance with these covenants.~~
~~Treasury Policy~~
      ~~We hold financial instruments for two principal purposes: to finance our operations and to manage the interest rate and currency risks arising from our operations and from our sources of financing.~~
      We finance our operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer term loans from banks and capital markets. We borrow principally in US dollars, sterling and euro at both floating and fixed rates of interest, using derivatives, where appropriate, to generate the desired effective currency profile and interest rate basis. The derivatives used for this purpose are principally interest rate swaps, interest rate caps and collars, currency swaps and forward foreign exchange contracts. For a more detailed discussion of our borrowing and use of derivatives, see “Item 11. Quantitative and Qualitative Disclosures About Market Risk”.
~~Related Parties~~
      ~~There were no significant or unusual related party transactions in 2005, 2004 or 2003. Refer to note 32 in “Item 17. Financial Statements”.~~
~~Accounting Principles~~
      ~~The following summarizes the principal differences between IFRS and US GAAP in respect of our financial statements. For further details refer to note 35 in “Item 17. Financial Statements”.~~
      Before the adoption of IFRS 3 on 1 January 2003 and before the adoption of FAS 142 on 1 January 2002, goodwill was recognized as an asset and amortization expense was recorded over useful lives ranging between 3 and 20 years. Under IFRS 3 and FAS 142 goodwill is no longer amortized but tested annually for impairment. Before the adoption of IFRS, the Group’s intangible assets were not recognized as they did not meet the requirements under UK GAAP. Under IFRS and US GAAP, intangible assets are 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. Therefore, intangible assets such as publishing rights, non-compete agreements, software, databases, patents and non-contractual customer relationships such as advertising relationships have been recognized and are being amortized over a range of useful lives between 2 and 25 years. A difference between US GAAP and IFRS arises in goodwill and intangible assets due to the different adoption dates of IFRS 3 and FAS 142 as well as the impact of foreign exchange on the translation of those underlying assets that are denominated in a foreign currency. This difference also creates a difference in the gain or loss recognized on the disposal of a business.
      Under IFRS, the Group reviews the recoverability of goodwill annually. These reviews are based on comparing the fair value of the Group’s cash-generating units determined by discounting future cash flows to their carrying value. Under US GAAP, a two stage impairment test is required at least annually under FAS 142. The Group performed the transitional impairment test under FAS 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 FAS 142 in 2005, 2004 and 2003. The Group has determined that its reporting units under FAS 142 are consistent with its cash-generating units under IAS.
      ~~IAS 12~~~~“Income Taxes”~~ requires a full provision to be made for deferred taxes. Deferred taxes are to be accounted for on all temporary differences, with deferred tax assets recognized to the extent that they are more likely than not recoverable against future taxable profits. Under US GAAP, deferred tax assets not considered recoverable are adjusted through a separate valuation allowance in the balance sheet. There are no separate valuation allowances under IFRS. Under US GAAP, deferred taxes are accounted for in accordance with FAS 109,~~“Accounting for Income Taxes,”~~ ~~with a full provision also made for deferred taxes on all temporary~~
39
~~differences and a valuation allowance is established when it is more likely than not that they will not be realised. This is similar to the treatment required under IAS 12.~~
      Using the transitional exceptions of IAS 39, derivatives were accounted for in accordance with UK GAAP for the years ended 31 December 2003 and 2004. Under UK GAAP, there are no specific criteria, which must be fulfilled in order to record derivative contracts such as interest rate swaps, currency swaps and forward currency contracts as a hedging instrument. Accordingly, based upon our intention and stated policy with respect to entering into derivative transactions, they have been recorded as hedging instruments for UK GAAP. This means that unrealized gains and losses on these instruments are typically deferred and recognized when realized. From 1 January 2005, the Group has adopted IAS 39~~“Financial Instruments: Recognition and Measurement”~~ ~~and IAS 32~~~~“Financial Instruments: Disclosure and Presentation”.~~ ~~Under US GAAP, we have adopted FAS 133,~~~~“Accounting for Derivative Instruments and Hedging Activities”~~ and its related guidance. In 2003, our derivative contracts did not meet the prescribed criteria for hedge accounting, and have been recorded at market value at each period end, with changes in their fair value being recorded in the profit and loss account. In 2004 the Group met the prescribed designation requirements and hedge effectiveness tests under US GAAP for certain of its derivative contracts. As a result, the movements in the fair value of the effective portion of fair value hedges and net investment hedges have been offset in earnings and other comprehensive income respectively by the corresponding movement in the fair value of the underlying bond or asset.
      Finance lease rentals are capitalized 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 IFRS and US GAAP, the annual pension is determined in accordance with IAS 19 “Employee Benefits” and FAS 87 “Employers Accounting for Pensions”. Actuarial assumptions are adjusted annually to reflect current market and economic conditions. Under IFRS the difference between the fair value of the assets and the defined benefit obligation is recognized as a prepayment/ liability. Actuarial gains and losses are recognized in the statement of recognized income and expenses. Under US GAAP, if the fair value of a pension plan’s assets is below the plan’s accumulated benefit obligation, a minimum pension liability is required to be recognized in the balance sheet. Unrecognized gains or losses outside the 10% corridor are spread over the employees’ remaining service lifetimes.
      Under IFRS and US GAAP, we account for options and restricted shares granted to employees using their fair value. Compensation expense is determined based upon the fair value at the grant date, and has been estimated using the Black Scholes, Binomial or Monte Carlo model as appropriate. Compensation cost is recognized over the service life of the awards, which is normally equal to the vesting period. Differences between the US GAAP and IFRS charges are mainly due to the different treatment of options with graded vesting features. Under IFRS, the charge is recognized as the options gradually vest. Under US GAAP, the charge is recognized on a straight line basis over the vesting period. Other noteable differences include the treatment of forfeitures.
      ~~For a further explanation of the differences between IFRS and US GAAP see note 35 to the consolidated financial statements.~~
~~Recent U.S. Accounting Pronouncements~~
      ~~In November 2004, the FASB issued FASB Statement No. 151~~~~“Inventory Costs — An Amendment of ARB No. 43, Chapter 4~~” (“FAS 151”). FAS 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, FAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. FAS 151 is effective for fiscal years beginning after June 15, 2005.
40
~~The Group will adopt FAS 151 in 2006 but does not expect the adoption of the new standard to have a material impact.~~
      ~~In December 2004, the FASB issued FASB Statement No. 153~~~~“Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”~~ (“FAS 153”). FAS 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 Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. FAS 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. FAS 153 is effective for the fiscal periods beginning after June 15, 2005. The Group will adopt FAS 153 in 2006 but does not expect the adoption of the new standard to have a material impact.
      ~~In December 2004, the FASB issued FASB Statement No. 123 (revised 2004)~~~~“Share-Based Payment”~~ ~~(“FAS 123(R)”), which replaces FAS No. 123~~~~“Accounting for Stock-Based Compensation”~~ ~~(“FAS 123”) and supersedes APB Opinion No. 25~~~~“Accounting for Stock Issued to Employees.”~~ FAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under FAS 123 no longer will be an alternative to financial statement recognition. The Group will adopt FAS 123(R) in 2006 but does not expect the adoption of the new standard to have a material impact as it already recognizes share-based payment cost in its income statement in accordance with FAS 123.
      ~~In March 2005, the FASB issued FASB Interpretation No. 47~~~~“Accounting for Conditional Asset Retirement Obligations — an interpretation of FASB Statement No. 143”~~ (“FIN 47”). FIN 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or settlement are conditional on a future event. FIN 47 is effective for the fiscal periods ending after December 15, 2005. The adoption of FIN 47 did not have a material impact on the Group.
      ~~In May 2005, the FASB issued Statement No. 154,~~~~“Accounting Changes and Error Corrections — A replacement of APB Opinion No. 20 and FASB Statement No. 3”~~ (“FAS 154”). This statement requires retrospective application to prior periods’ financial statements of changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement applies to all voluntary changes in accounting principles and changes required by an accounting pronouncement that does not include specific transition provisions. FAS 154 is required to be adopted in fiscal years beginning after December 15, 2005. FAS 154 would not have had a material effect on the financial position, results of operations or cash flows of the Group under US GAAP as at December 31, 2005.
      ~~In October 2005, the FASB issued FASB Staff Position (FSP) 13-1~~~~“Accounting for Rental Costs Incurred during a Construction Period”~~ ~~(“FSP~~ ~~13-1”).~~ ~~FSP~~ ~~13-1~~ requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense and included in income from continuing operations. FSP ~~13-1~~ ~~is effective for the fiscal periods beginning after December 15, 2005. The Group will adopt FSP~~ ~~13-1~~ ~~in 2006 but does not expect the adoption of the new standard to have a material impact.~~
      ~~In January 2006 the FASB issued FASB Statement No. 155~~~~“Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140”~~ (“FAS 155”). FAS 155 provides entities with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract. FAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Group is currently evaluating the impact the adoption of FAS 155 will have, but does not expect it to have a material impact.
~~Recent International Accounting Pronouncements~~
~~IFRS 7 “Financial Instruments: Disclosures”.~~ IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk. IFRS 7 is effective for accounting
41
~~periods beginning on or after 1 January 2007. The Group is currently assessing the impact of IFRS 7 on the Group’s financial statements, but does not expect it to be significant.~~
      ~~A complementary amendment of IAS 1~~~~“Presentation of Financial Statements — Capital Disclosures”~~. The amendment to IAS 1 introduces disclosures about the level of an entity’s capital and how it manages capital. The amendment to IAS 1 is effective for accounting periods beginning on or after 1 January 2007. The Group is currently assessing the impact of the amendment to IAS 1, but does not expect it to be significant.
      ~~IFRIC 4~~~~“Determining whether an Arrangement contains a Lease”~~. IFRIC 4 requires the determination if whether an arrangement is or contains a lease to be based on the substance of the arrangement. IFRIC 4 is effective for accounting periods beginning on or after 1 January 2006. The Group will implement IFRIC 4 from 1 January 2006 but does not expect it to have a significant impact on the Group’s operations.
      ~~IAS 21 (Amendment)~~~~“Net investment in a foreign operation”~~. This amendment deals with the requirement for a monetary item that forms part of a reporting entity’s net investment in a foreign operation to be denominated in the functional currency of either the reporting entity or the foreign operation. The amendment also clarifies the accounting treatment of exchange differences arising on a loan made between two “sister companies” within a group. The exchange differences would be taken to equity in the parent’s consolidated financial statements, irrespective of the currency in which the loan is made, provided that the nature of the loan is similar to an equity investment, that is, settlement of the loan is neither planned nor expected to occur in the foreseeable future.
      ~~IFRIC 8~~~~“Scope of IFRS 2”~~~~. IFRIC 8 clarifies that transactions within the scope of IFRS 2“Share-based~~ payment”, include those in which the entity cannot specifically identify some or all of the goods or services received. If the identifiable consideration given appears to be less than the fair value of the equity instruments granted or liability incurred, this situation generally indicates that other consideration has been or will be received.
~~ITEM 6.~~      ~~DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES~~
~~Directors and Senior Management~~
      We are managed by a board of directors and a chief executive who reports to the board and manages through a management committee. We refer to the board of directors and the chairman of the board of directors as our “senior management”.
      ~~The following table sets forth information concerning senior management, as of April 2006.~~
~~Name~~ ~~Age~~ ~~Position~~
~~Glen Moreno~~ 62 ~~Chairman~~
~~Marjorie Scardino~~ 59
Marjorie Scardino 61 Chief Executive
~~David Bell~~ 59 ~~Director for People and Chairman of the FT Group~~
~~Terry Burns~~ 62 ~~Non-executive Director~~
~~Patrick Cescau~~ 57 ~~Non-executive Director~~
~~Rona Fairhead~~ 44 ~~Chief Financial Officer~~
~~Susan Fuhrman~~ 62 ~~Non-executive Director~~
~~John Makinson~~ 51 ~~Chairman and Chief Executive Officer, Penguin Group~~
~~Reuben Mark~~ 67 ~~Non-executive Director~~
~~Vernon Sankey~~ 56 ~~Non-executive Director~~
~~Rana Talwar~~ 58 ~~Non-executive Director~~
David Arculus 59 ~~Non-executive Director~~
~~Ken Hydon~~ 61 Non-executive Director
~~Glen Moreno~~ ~~was appointed chairman on 1 October 2005. He is the senior independent non-executive director of Man Group plc~~
David Bell 61 Director for People
Terry Burns 64 Non-executive Director
Patrick Cescau 59 Non-executive Director
Rona Fairhead 46 Chairman and ~~also a director of Fidelity International Limited~~Chief Executive, The FT Group
Robin Freestone 49 Chief Financial Officer
Susan Fuhrman 64 Non-executive Director
Ken Hydon 63 Non-executive Director
John Makinson 53 Chairman and ~~a trustee of The Prince of Liechtenstein Foundation and of The Liechtenstein Global Trust.~~Chief Executive, Penguin Group
Glen Morenowas appointed chairman of Pearson on October 1, 2005. He is the senior independent director of Man Group plc and a director of Fidelity International Limited.
Marjorie Scardinojoined the board and became chief executive in January 1997. She is a member of Pearson’s nomination committee. She trained and practiced as a lawyer and was chief executive of The Economist Group from 1993 until joining Pearson. She is also a non-executive director of Nokia Corporation and a director of several charitable organizations.
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 at the beginning of 2006. His previous roles include chairman of Severn Trent plc and IPC Group, chief operating officer of United Business Media plc and group managing director of EMAP plc.
~~Marjorie Scardino~~ joined the board and became chief executive in January 1997. She is a member of Pearson’s nomination committee. She was chief executive of The Economist Group from 1993 until joining Pearson. She is also a non-executive director of Nokia Corporation.
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David Bellbecame a director in March 1996. He ~~is chairman of the FT Group, having been chief executive of the~~~~Financial Times~~ ~~from 1993 to 1998. In July 1998, he~~ was appointed Pearson’s director for people with responsibility for ~~the recruitment, motivation, development~~finding, keeping, rewarding and ~~reward of~~inspiring our employees across the Pearson Group. He is ~~also a non-executive director of VITEC Group plc and~~ chairman of the ~~International Youth Foundation.~~Financial Timesand Sadler’s Wells Theatre. He is also chairman of Crisis, a charity for the homeless and The Institute for War and Peace Reporting.

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Terry Burnsbecame a non-executive director in May 1999 and the senior independent director in February 2004. He currently serves on the 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 Hispano. ~~On 1 October 2005, he was appointed deputy~~He has been chairman of Marks and Spencer Group ~~plc.~~plc since July 2006, having previously been deputy chairman from October 1, 2005.

Patrick Cescaubecame a non-executive director in April 2002. He joined the audit committee in January 2005, and is also a member of the nomination committee. He ~~joined Unilever in 1973, latterly serving as Finance Director until January 2001, at which time he was appointed Director of Unilever’s Foods Division. He~~ is currently group chief executive of Unilever.

Rona Fairheadbecame a director and was appointed chief financial officer of Pearson in June ~~2002. She had~~2002, having previously served as deputy finance director from October 2001. She was appointed chief executive of the FT Group on June 12, 2006 and chairman of Interactive Data in September 2007. From 1996 until 2001, she worked at ICI plc, where she served as executive vice president, group control and strategy, and as a member of the executive committee from 1998. Prior to that, she worked for Bombardier Inc. in finance, strategy and operational roles. She is ~~also~~ a non-executive director of HSBC Holdings ~~plc.~~plc and chairs the HSBC audit committee.

Robin Freestonebecame a director of Pearson and was appointed chief financial officer on June 12, 2006, 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. He is also a non-executive director and founder shareholder of eChem Limited.
Susan Fuhrmanbecame a non-executive director in July 2004. She is a member of the audit and nomination committees. She is ~~dean~~president of Teachers College at Columbia University, America’s oldest and largest graduate school of education having previously been Dean of the Graduate school of Education at the University of Pennsylvania. She is a member of the Board of Trustees of the Carnegie Foundation for the Advancement of Teaching and ~~a member~~an officer of the ~~Council for Corporate and School Partnerships~~National Academy of ~~the~~ ~~Coca-Cola~~ ~~Foundation.~~Education.
~~John Makinson~~ became chairman of the Penguin Group in May 2001 and its chief executive officer in June 2002. He was appointed chairman of Interactive Data in December 2002. He served as Pearson Finance Director from March 1996 until June 2002. From 1994 to 1996 he was managing director of the~~Financial Times,~~ ~~and prior to that he founded and managed the investor relations firm Makinson Cowell. He is also a non-executive director of George Weston Limited in Canada.~~
~~Reuben Mark~~ became a non-executive director in 1988 and served on the audit and nomination committees and as chairman of the personnel committee. He became chief executive of the Colgate Palmolive Company in 1984, and chairman in 1986. He has held these positions since then. He is also a director of Time Warner Inc. He retired from the board at the 2006 AGM.
~~Vernon Sankey~~ became a non-executive director in 1993 and served as chairman of the audit committee and as a member of the treasury and nomination committees. He was previously chief executive of Reckitt & Colman plc and is chairman of Photo-Me International plc. He is also a non-executive director of Taylor Woodrow plc and Zurich Financial Services AG. He retired from the board at the 2006 AGM.
~~Rana Talwar~~ became a non-executive director in March 2000 and currently serves on the personnel, nomination and treasury committees. He is currently chairman of Sabre Capital Worldwide and Centurion Bank and a non-executive director of Schlumberger Limited and Fortis Bank. He served as group chief executive of Standard Chartered plc from 1998 until 2001, and was at Citicorp from 1969 to 1997, where he held a number of senior international management roles.
~~David Arculus~~ became a non-executive director in February 2006 and currently serves on the audit and nomination committees and as chairman of the personnel committee. He is a non-executive director of Telefonica SA, and was chairman of O2 plc from 2004 until it was acquired by Telefonica in early 2006. His previous roles include chairman of Severn Trent plc, chairman of IPC Group, chief operating officer of United Business Media plc, group managing director of EMAP plc and~~non-executive~~ ~~director of Barclays Bank plc.~~
Ken Hydonbecame a non-executive director in February 2006 and currently serves on the nomination committee and as chairman of the audit committee. He is a non-executive director of Tesco plc, ~~and~~ Reckitt Benckiser ~~plc.~~plc and Royal Berks NHS Foundation Trust. He was previously finance director of Vodafone Group plc and of subsidiaries of Racal Electronics.
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John Makinsonbecame chairman of the Penguin Group in May 2001 and its chief executive officer in June 2002. He served as Pearson’s finance director from March 1996 until June 2002. He is also chairman of the Institute of Public Policy Research and a director of The International Rescue Committee (UK).
New Appointments
Effective May 1, 2008, Pearson is making the following appointments to the board:
Coimbatore Krishnarao Prahaladis the Paul and Ruth McCracken distinguished University Professor of Corporate Strategy at the University of Michigan Ross School of business. He will serve as anon-executive director.
Will Ethridgeis the chief executive of Pearson’s North American education business, spanning School, Higher Education and Professional publishing, assessment, technology and services. He will serve as an executive director.
Compensation of ~~Senior Management~~senior management

It is the role of the personnel committee (the 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~~Committee also takes note of the remuneration for those executives with base pay over a certain level, representing approximately the top 50 executives of the company.

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Remuneration policy
~~Remuneration Policy~~

Pearson seeks to generate a performance culture by operating incentive ~~programmes~~programs that support its business goals and reward their achievement. It is the company’s policy that total remuneration (base compensation plus ~~short-~~short and long-term incentives) should reward both ~~short-~~short 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~~ Performance conditions for the ~~job, taking into account relevant recruitment markets~~company’s various performance-related annual or long-term incentive plans are linked to the company’s strategic objectives and ~~business sectors and geographic regions. Benefit programmes should ensure that Pearson retains a competitive recruiting advantage.~~
aligned with the interests of shareholders. Share ownership is encouraged throughout the company. ~~Equity-based reward programmes align the interests of directors, and employees in general, with those of shareholders by linking rewards directly to Pearson’s financial performance.~~

Total remuneration is made up of fixed and performance-linked elements, with each element supporting different objectives. Base salary ~~and other fixed remuneration (such as benefits and pension) reflect~~reflects competitive market level, role and individual contribution. Annual incentives motivate the achievement of annual strategic goals. Bonus share matching encourages executive directors and ~~operational goals.~~other senior executives to acquire and hold Pearson shares and aligns executives’ and shareholders’ interests. Long-term incentives ~~focus on~~drive long-term earnings and share price growth ~~improvement in returns~~ and value creation and align ~~with~~executives’ and shareholders’ ~~interests through ownership and retention of shares.~~interests.

Consistent with its policy, the ~~committee~~Committee places considerable emphasis on the performance-linked elements i.e. annual ~~incentive,~~incentives, 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.
Our policy is that the remuneration 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 ~~and US~~ companies in different sectors including the media sector. Some are of a similar size to Pearson, ~~some smaller,~~while others are larger, but the method which the ~~committee’s~~Committee’s independent advisers use to make comparisons on remuneration takes this into account. ~~In addition, all~~All have very substantial overseas operations. We also use selected media companies in North ~~America as well as the UK~~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 remuneration was not competitive.
~~Base Salary~~
Base salary

Our normal policy is to review salaries annually, ~~considering~~taking into account the remuneration of directors and executives in similar positions in comparable companies, individual performance and levels of pay and pay increases throughout the company.
~~Other Emoluments~~
Allowances and benefits
      ~~Other emoluments may include benefits such as company car, healthcare, and, where relevant, amounts paid in respect of housing or other costs.~~

It is the company’s policy that its benefit ~~programmes~~programs should be competitive in the context of the local ~~labour~~labor market, but as an international company we require executives to operate worldwide and recognize that recruitment also operates worldwide.
~~Annual Bonus~~
Annual incentives

The ~~committee~~Committee establishes the annual incentive plans for the executive directors and the chief executives of the company’s principal operating companies, including performance measures and targets.
The committee also establishes the target and maximum levels of individual incentive opportunity based on an assessment by the committee’s independent advisers of market practice for comparable companies and jobs. The perform-
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~~ance~~financial performance measures 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, target and maximum levels of different levels of payout.
With the exception of the ~~CEO,~~chief executive, 10% of the total annual incentive opportunity for the executive directors and other members of the Pearson Management Committee is based on performance against personal ~~objectives. For~~objectives as agreed with the ~~CEO, all measures are financial.~~chief executive.

For ~~2006,~~2008, the financial performance measures for Pearson plc are sales, growth in underlying adjusted earnings per share for continuing operations at constant exchange rates, average working capital as a ratio to sales and operating cash flow. For subsequent years, the measures will be set at the time.

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For 2008, the Committee has reviewed the structure for annual incentives for executive directors other than the chief executive. Previously, this has expressed individual annual incentive opportunities by reference to base salary. In future, starting in 2008, these incentive opportunities will be expressed as absolute cash amounts. The Committee with the advice of the chief executive will determine the aggregate level of annual incentives and individual incentive opportunities taking into account all relevant factors. These factors may include the profitability of the company, individual roles and responsibilities, market annual incentive levels, and the performance required to achieve the maximum payout. In aggregate, the target individual incentive opportunities for the chief executive will be up to 0.4% of operating profit in the company’s operating plan each year.
~~There have been~~
For 2008, there is no ~~changes~~change to the ~~executive directors’ individual incentive opportunities. For the CEO, the target annual~~ incentive opportunity isfor the chief executive which remains at 100% of base salary and ~~the maximum is~~ 150%~~. For~~ of salary at maximum. The average target individual incentive opportunity for the other executive directors ~~and other members of the Pearson Management Committee, the target~~ is up£381,000 (compared to ~~a maximum of 75% of salary~~£345,000 in 2007) and the maximum is twice ~~target.~~target (as in 2007).

The ~~committee may award individual~~annual incentive plans are discretionary ~~payments~~and the Committee reserves the right to make adjustments to payouts up or ~~exercise discretion~~down taking into account exceptional factors in line with the ~~payment of bonuses under the plan.~~Committee’s existing policy.

The ~~committee~~Committee will continue to review the annual incentive plans each year and to revise the performance measures, targets and individual incentive opportunities in light of current conditions.

Annual incentive payments do not form part of pensionable earnings.
~~Bonus Share Matching~~
For 2007, annual incentives for Marjorie Scardino, David Bell and Robin Freestone were based on the financial performance of Pearson plc. In the case of John Makinson, 60% of his annual incentive was based on the performance of Penguin Group and 30% on the financial performance of Pearson plc. In the case of Rona Fairhead, 60% of her annual incentive was based on the financial performance of FT Group and 30% 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.
~~The company encourages~~
For Pearson plc, the performance measures were adjusted sales, earnings per share growth, average working capital to sales ratio and operating cash flow. Adjusted sales at £4,218m were above target but below maximum. Average working capital as a ratio to sales, operating cash flow of £684m and underlying growth in adjusted earnings per share at constant exchange rates consistent with reported adjusted earnings per share of 46.7p were all above maximum.
For FT Group, the performance measures were sales, operating profit and operating cash flow. Sales were above target but below maximum. Operating profit and operating cash flow were above maximum.
For Penguin Group, the performance measures were sales, operating margin, average working capital as a ratio to sales and operating cash flow. Performance across all measures was above maximum.
None of the executive directors ~~and other senior executives~~was directly covered by the plans for the education businesses where the same performance measures applied.
Bonus share matching
We are asking shareholders by separate resolution to ~~acquire and hold Pearson shares.~~
      ~~The~~approve the renewal of the annual bonus share matching plan ~~permits~~first approved by shareholders in 1998. The Committee has reviewed the operation of this plan since its introduction. Taking into account how plans of this type have evolved, we are seeking to renew the plan on broadly similar terms. We are proposing certain changes that we think are consistent with market practice, will simplify the plan and enhancetake-up, particularly in our key market.
Subject to shareholders’ approval, the renewed annual bonus share matching plan will operate in 2008 in respect of annual incentives for 2007. The plan will continue to permit executive directors and senior executives around the company to invest up to 50% of any after-tax annual bonus in Pearson shares. ~~For awards to be made in 2006 and thereafter, if these~~
If the participant’s invested shares are held, ~~and~~they will be matched subject to earnings per share growth over the three-year performance period on a gross basis up to a maximum of one matching share for every one held i.e. the number of matching shares will be equal to the number of shares that could have been acquired with the amount of the pre-tax annual bonus taken in invested shares.

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One matching share for every two invested shares held i.e. 50% of the maximum matching award, will be released if the company’s adjusted earnings per share increase in real terms by ~~at least~~ 3% per annum compound over the ~~company will match them on a gross basis of one~~three-year performance period. One matching share for every ~~two~~one invested share held ~~after three years,~~i.e. 100% of the maximum matching award, will be released if the company’s adjusted earnings per share increase in real terms by 5% per annum compound over the same period.
For real growth in adjusted earnings per share of between 3% and ~~another one for two held (i.e.~~5% per annum compound, the rate at which the participant’s invested shares will be matched will be calculated according to a ~~total of one-for-one) after five years.~~straight-line sliding scale.

Real growth is ~~measured against~~calculated by reference to the UK Government’s Index of Retail Prices (All Items). We choose to test our earnings per share growth against UK inflation over three ~~and five~~ years to measure the company’s financial progress over the period to which the entitlement to matching shares relates.
~~The Long-Term Incentive Plan~~
Where matching shares vest in accordance with the plan, a participant will also receive ‘dividend’ shares representing the gross value of dividends that would have been paid on the matching shares during the holding period and re-invested.
~~Shareholders at~~
The long-term incentive plan
At the ~~AGM~~annual general meeting in April 2006, shareholders approved the renewal of the long-term incentive plan first introduced in 2001. The committee has reviewed the operation of this plan in the light of the company’s strategic goals and concluded that it is operating satisfactorily and achieving its objectives. We have therefore sought and received approval of its renewal on broadly its original terms.

Executive directors, senior executives and other managers ~~will be~~are eligible to participate in the plan which can deliver restricted stockand/or stock options. The aim ~~as before~~ is to give the ~~committee~~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 2008.

Restricted stock granted to executive directors ~~will vest~~vests only when stretching corporate performance targets over a specified period have been met. Awards ~~will~~ vest on a sliding scale based on performance over the period. There ~~will be~~is no retesting. The ~~committee will determine~~Committee determines the performance measures and targets governing an award of restricted stock prior to grant.
~~It is~~
The performance measures that have applied since 2006 and that will apply for 2008 and subsequent awards 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 that are subject to performance conditions over a three-year period, 75% of the award vests at the end of the three-year period. The remaining 25% of the award only vests if the participant retains the after-tax number of shares that vest at year three for a further two years.
Restricted stock may be granted without performance conditions to satisfy recruitment and retention objectives. Restricted stock awards that are not ~~the committee’s intention~~subject to ~~grant stock options in 2006. Should the committee decide to grant them in future, options~~performance conditions will not be granted to any of the current executive ~~directors~~directors.
Where shares vest, participants receive additional shares representing the gross value of dividends that would ~~come with a minimum three-year vesting~~have been paid on these shares during the performance period and ~~would vest~~reinvested. The expected value of awards made on ~~a sliding scale based on stretching performance over the three-year period with no retesting.~~this basis take this into account.

The ~~committee’s independent advisers calculate~~Committee establishes each year the expected value of ~~both restricted stock and stock options i.e. their net present value after~~individual awards taking into account ~~all~~assessments by the ~~conditions and, in particular, the probability that any performance conditions will be met. Taking into account the~~Committee’s independent ~~advisors’ values and assessments~~advisers of market practice for comparable companies, directors’ total remuneration relative to the ~~committee establishes guidelines each year for~~market. In establishing the ~~maximum~~ expected value of individual ~~awards.~~awards, the Committee also has regard to the face value of the awards and their potential value should the performance targets be met in full.

In any rolling10-year period, no more than 10% of Pearson equity will be issued, or ~~available for issue,~~be capable of being issued, under all Pearson’s share plans, and no more than 5% of Pearson equity will be issued, or ~~available for issue,~~be capable of being issued, under executive or discretionary plans.

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Shareholding policy
~~Shareholding Policy~~

As previously noted, in line with the policy of encouraging widespread employee ownership, the company encourages executive directors to build up a substantial shareholding in the company.
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 ~~necessary~~appropriate to specify a particular relationship of shareholding to salary.
~~Service Agreements~~
Service agreements

In accordance with long established policy, all continuing executive directors have rolling service agreements under which, other than by termination in accordance with the terms of these agreements, employment continues until retirement.
These service agreements provide that the company may terminate these agreements by giving 12 months’ notice, and in some instances they specify the compensation payable by way of liquidated damages in circumstances where the company terminates the agreements without notice or cause. We feel that these notice periods and provisions for liquidated damages are adequate compensation for loss of office and in line with the market. The compensation payable in these circumstances is typically 100% of annual salary, 100% of other benefits and a proportion of potential bonus.
Peter Jovanovich stood down as a director of the company for health reasons on 31 January 2005, but remained entitled to contractual short- and long-term disability and other benefits. These arrangements are set out in an agreement dated 28 January 2005. Dennis Stevenson retired as chairman and director on 1 October 2005. Glen Moreno was appointed chairman and director on 1 October 2005.
~~Retirement Benefits~~Retirement benefits
      ~~Following are the retirement benefits for each of the executive directors.~~

Executive directors participate in the ~~approved~~ pension arrangements set up for Pearson employees. Marjorie Scardino, John Makinson, Rona Fairhead and ~~Peter Jovanovich~~Robin Freestone will also ~~receive benefits under unapproved~~have other retirement 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 spouseand/or dependants 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, ~~December~~ 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~~pension plan is the Pearson Group Pension Plan and ~~some~~ 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 currently possible after age 50. The accrued pension is reduced on retirement prior to age 60. Pensions in payment are guaranteed to increase each year at 5% or the increase in the Index of Retail Prices, if lower. Pensions for a member’s spouse, ~~dependent~~dependant childrenand/or nominated financial dependant are payable in the event of death.

Members of the Pearson Group Pension Plan who joined after May 1989 are subject to an upper limit of earnings that can be used for pension purposes, known as the earnings cap. This limit, £108,600 as at April 6, 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). The cap was £112,800 as at April 6, 2007.
In response to the UK Government’s plans for pensions simplification and so-called ~~’A-Day’~~‘A-Day’ effective from April 2006, UK executive directors and other members of the Pearson Group Pension Plan who are, or become, affected by the lifetime allowance ~~will be~~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. ~~Further details will be set out in the report on directors’ remuneration for 2006.~~

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Marjorie Scardino
~~Marjorie Scardino~~
Marjorie Scardino participates in the Pearson Inc. Pension Plan and the approved 401(k) plan.
Additional pension benefits will be provided through an unfunded unapproved defined contribution plan and a
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funded defined contribution plan approved by HM Revenue and Customs as a corresponding plan to replace part of the unfunded plan. The account balance of the unfunded unapproved defined contribution plan is determined by reference to the value of a notional cash account that increases annually by a specified notional interest rate. This plan provides the opportunity to convert a proportion of this notional cash account into a notional share account reflecting the value of a number of Pearson ordinary shares. The number of shares in the notional share account is determined by reference to the market value of Pearson shares at the date of conversion.
~~David Bell~~
David Bell

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. Early~~service but early retirement ~~with a reduced pension~~ before that date is possible, subject to company consent.
~~Rona Fairhead~~
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 by~~cap. Until April 2006, the ~~Finance Act 1989. The~~ company also ~~contributes~~contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on her behalf. ~~In the event of death before retirement, the proceeds~~Since April 2006, she has received a taxable and non-pensionable cash supplement in replacement of the ~~FURBS account will be used to provide benefits for her dependants.~~FURBS.
~~Peter Jovanovich~~
Robin Freestone
~~Peter Jovanovich~~
Robin 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 accrual~~Money Purchase 2003 section of ~~2% of final average earnings, less benefits accrued in~~ the Pearson ~~Inc.~~Group Pension ~~Plan~~Plan. Company contributions are 16% of pensionable salary per annum, restricted to the plan earnings cap.
Until April 2006, the company also contributed to a Funded Unapproved Retirement Benefits Scheme (FURBS) on his behalf. Since April 2006, he has received a taxable and ~~US Social Security. He ceased to build up further benefits~~non-pensionable cash supplement in replacement of the SERP at 31 December 2002. Additional defined contribution benefits are provided through a funded, unapproved 401(k) excess plan and an unfunded, unapproved arrangement. In the event of death while in receipt of disability benefits, the account balances in the defined contribution arrangements will be used to provide benefits for dependants. The SERP arrangement provides a spouse’s pension on death while in receipt of disability benefits and the option of a death in retirement pension by reducing the member’s pension.FURBS.
~~John Makinson~~
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 ~~pensions~~pension payable from the Pearson Group Pension Plan and the closed FURBS to target a pension of two-thirds of a revalued base salary on retirement at age 62. The revalued base salary is defined as £450,000 effective at June 1, ~~June~~ 2002, increased at January 1 ~~January~~ 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.
~~Chairman’s Remuneration~~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 remuneration
Our policy is that the chairman’s pay should be set at a level that is competitive with those of chairmen in similar positions in comparable companies. He is not entitled to any annual or long-term incentive, retirement or other benefits.
~~The committee’s view is~~
In accordance with the terms of his appointment, the Committee reviewed the chairman’s remuneration in 2007. In the light of this review, including a market assessment by Towers Perrin, the board approved the Committee’s recommendation that ~~taking into account~~ the chairman’s remuneration ~~of chairmen in comparable positions, the appropriate total pay level is £425,000~~be increased to £450,000 per ~~year.~~year with effect from January 1, 2007.
~~Non-executive Directors~~Non-Executive directors

Fees for non-executive directors are determined by the full board having regard to market practice and within the restrictions contained in ~~the company’s~~Pearson’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)~~Pearson) and do not participate in the ~~company’s~~Pearson’s equity-based incentive plans.
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~~For 2005, the chairman and the executive directors of~~
In 2007, the board reviewed the level and structure of non-executive directors’ fees which had ~~not~~last been ~~changed since~~reviewed with effect from January ~~2000. After reviewing external benchmarks, they~~1, 2005. In the light of this review, which included a market assessment by Towers Perrin, the board agreed an increase in the basic fee, ~~to £45,000,~~ an increase in the ~~fee~~fees for ~~the~~Committee chairmanship, audit ~~and personnel committee chairmen to £10,000, the introduction of separate fees of £5,000 for audit and personnel~~ committee membership, and ~~of £10,000 for~~ the senior independent director and the ~~replacement~~removal of the previous separate fee ~~for non-UK based directors with a fee of £2,500~~ for overseas meetings.
~~One-third~~
The level and structure of non-executive directors’ fee effective from July 1, 2007 is as follows:
Fees payable from
July 1, 2007 (£)
Non-executive director fee 60,000
Chairmanship of audit committee 20,000
Chairmanship of personnel committee 15,000
Membership of audit committee 10,000
Membership of personnel committee 5,000
Senior independent director 15,000
A minimum of 25% of the basic fee ~~or the entire fee in the case of Rana Talwar,~~ is paid in Pearson shares that the non-executive directors have committed to retain for the period of their directorships.
~~In the case of Patrick Cescau, his fee was paid over to his employer.~~
Non-executive directors serve Pearson under letters of appointment and do not have service contracts. There is no entitlement to compensation on the termination of their directorships.

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Remuneration of ~~Senior Management~~senior management

Excluding contributions to pension funds and related benefits, senior management remuneration for ~~2005~~2007 was as follows:

Salaries/Fees Bonus(1) Other(2) Total

£’000 £’000 £’000 £’000
Chairman

Dennis Stevenson (retired 1 October 2005) 281 — — 281
Glen Moreno (appointed 1 October 2005) 106 — — 106
Executive directors

Marjorie Scardino 710 1,038 62 1,810
David Bell 395 560 17 972
Rona Fairhead 420 608 16 1,044
Peter Jovanovich 41 — 373 414
John Makinson 475 564 211 1,250

Senior management as a group
2,428 2,770 679 5,877

Salaries/
Annual

Fees incentive Allowances(1) Benefits(2) Total(3)
£000 £000 £000 £000 £000

Chairman

Glen Moreno 450 — — — 450
Executive directors

Marjorie Scardino 900 1,341 52 39 2,332
David Bell 442 650 — 19 1,111
Rona Fairhead 487 693 — 27 1,207
Robin Freestone 405 597 — 15 1,017
John Makinson 507 743 169 29 1,448

Senior management as a group
3,191 4,024 221 129 7,565

Notes:
(1) ~~For~~ Allowances for Marjorie Scardino David Bell and Rona Fairhead, annual incentives were based on the financial performance of Pearson plc. In the case of John Makinson, 70% of his annual incentive was based on the performance of Penguin Group and 20% on the financial performance of Pearson plc. In the case of David Bell, Rona Fairhead and John Makinson, 10% of their annual incentives was based on performance against personal objectives.
      For Pearson plc, the performance measures were earnings per share growth, operating cash flow, sales and average working capital as a ratio to sales. Actual underlying growth in adjusted earnings per share at constant exchange rates consistent with the reported adjusted earnings per share (pre-intangibles) of 34.1p, operating cash flow of £570m and average working capital as a ratio to sales were each better than the level of performance required for maximum payout. Actual sales at £4,096m were above target but below maximum.
      For Penguin Group, the performance measures were operating profit, operating cash flow and average working capital as a ratio to sales. For operating cash flow and working capital as a ratio to sales actual performance was better than that required for maximum payout and for operating profit was above target but below maximum.
~~(2)~~ ~~Other emoluments~~ include ~~company car and healthcare benefits. In the case of Marjorie Scardino, these include £39,245~~£41,760 in respect of housing costs and a ~~cash~~ US payroll supplement of ~~£8,372.~~£10,446. John Makinson is entitled to a location and market premium in relation to the management of the business of the Penguin Group in the ~~US. He~~US and received ~~£186,279 in cash~~£168,545 for ~~2005.~~2007.
(2) Benefits include company car, car allowance, health care and, for Marjorie Scardino, pension planning and financial advice. Marjorie Scardino, Rona Fairhead, David Bell and John Makinson have the use of a chauffeur. ~~In accordance with~~
(3) No amounts as compensation for loss of office and no expense allowances chargeable to UK income tax were paid during the ~~agreement dated 28 January 2005 referred to on page 26 of this report, Peter Jovanovich received short-and long-term disability payments in cash for the period 1 February 2005 to 31 December 2005.~~year.
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Share ~~Options~~options of ~~Senior Management~~senior management

This table sets forth for each director the number of share options held as of December 31, ~~2005~~2007 as well as the exercise price, rounded to the nearest whole ~~penny/~~pence/cent, and the range of expiration dates of these options.

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Number of
~~Exercise~~ ~~Earliest~~Exercise
Earliest

Director
Options (1) Price Exercise Date Expiry Date
Marjorie Scardino(2) 176,556 a * 973.3p 09/14/01 09/14/08

~~Dennis Stevenson~~ ~~3,556~~5,660 ba * 1090.0p ~~494.8p~~09/14/01 ~~01/08/11~~09/14/08
37,583 ~~01/02/12~~c * 1372.4p 06/08/02 06/08/09
37,583 c * 1647.5p 06/08/02 06/08/09
41,550 d * 1421.0p 05/09/02 05/09/11
41,550 d * 1421.0p 05/09/03 05/09/11
41,550 d * 1421.0p 05/09/04 05/09/11
41,550 d * 1421.0p 05/09/05 05/09/11

Total
~~3,556~~423,582 —

~~Marjorie Scardino~~ ~~176,556~~
David Bell 20,496 a * 973.3p 09/14/~~09/~~01 09/14/~~09/~~08
~~5,660~~ a * ~~1090.0p~~ ~~14/09/01~~ ~~14/09/08~~
~~2,224~~373 b ~~424.8p~~507.6p 08/01/~~08/06~~08 02/01/~~02/07~~09
~~37,583~~297 b 629.6p 08/01/09 02/01/10
821 b 690.4p 08/01/10 02/01/11
18,705 c * 1372.4p 06/08/~~06/~~02 06/08/~~06/~~09
~~37,583~~18,705 c * 1647.5p 06/08/~~06/~~02 06/08/~~06/~~09
~~37,583~~ c ~~1921.6p~~ ~~08/06/02~~ ~~08/06/09~~
~~36,983~~ c ~~3224.3p~~ ~~03/05/03~~ ~~03/05/10~~
~~41,550~~16,350 d * 1421.0p 05/09/~~05/~~02 05/09/~~05/~~11
~~41,550~~16,350 d * 1421.0p 05/09/~~05/~~03 05/09/~~05/~~11
~~41,550~~16,350 d * 1421.0p 05/09/~~05/~~04 05/09/~~05/~~11
~~41,550~~16,350 d * 1421.0p 05/09/~~05/~~05 05/09/~~05/~~11

Total
~~500,372~~124,797 —

~~David Bell~~ ~~20,496~~ a
Rona Fairhead 1,904 b * ~~973.3p~~494.8p ~~14/09/01~~08/01/07 ~~14/09/~~02/01/08
~~272~~2,371 b ~~696.0p~~690.4p 08/01/~~08/05~~12 02/01/~~02/06~~13
~~444~~ b ~~424.8p~~ ~~01/08/06~~ ~~01/02/07~~
~~1,142~~ b ~~494.8p~~ ~~01/08/07~~ ~~01/02/08~~
~~373~~ b ~~507.6p~~ ~~01/08/08~~ ~~01/02/09~~
~~18,705~~ c * ~~1372.4p~~ ~~08/06/02~~ ~~08/06/09~~
~~18,705~~ c * ~~1647.5p~~ ~~08/06/02~~ ~~08/06/09~~
~~18,705~~ c ~~1921.6p~~ ~~08/06/02~~ ~~08/06/09~~
~~18,686~~ c ~~3224.3p~~ ~~03/05/03~~ ~~03/05/10~~
~~16,350~~20,000 d * ~~1421.0p~~822.0p ~~09/05/~~11/01/02 ~~09/05/~~11/01/11
~~16,350~~20,000 d * ~~1421.0p~~822.0p ~~09/05/~~11/01/03 ~~09/05/~~11/01/11
~~16,350~~20,000 d * ~~1421.0p~~822.0p ~~09/05/~~11/01/04 ~~09/05/~~11/01/11
~~16,350~~ d * ~~1421.0p~~ ~~09/05/05~~ ~~09/05/11~~

Total
~~162,928~~64,275 —

~~Rona Fairhead~~ ~~1,904~~
Robin Freestone 1,866 b ~~494.8p~~507.6p 08/01/~~08/07~~08 02/01/~~02/08~~09
~~20,000~~ d * ~~822.0p~~ ~~01/11/02~~ ~~01/11/11~~
~~20,000~~ d * ~~822.0p~~ ~~01/11/03~~ ~~01/11/11~~
~~20,000~~ d * ~~822.0p~~ ~~01/11/04~~ ~~01/11/11~~

Total
~~61,904~~1,866 —

John Makinson 30,576 a * 973.3p 09/14/01 09/14/08
4,178 b 424.8p 08/01/10 02/01/11
21,477 c * 1372.4p 06/08/02 06/08/09
21,477 c * 1647.5p 06/08/02 06/08/09
19,785 d * 1421.0p 05/09/02 05/09/11
19,785 d * 1421.0p 05/09/03 05/09/11
19,785 d * 1421.0p 05/09/04 05/09/11
19,785 d * 1421.0p 05/09/05 05/09/11
Total
156,848 —
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Number of Exercise Earliest
Director Options (1) Price Exercise Date Expiry Date

Peter Jovanovich 8,250 a * 757.5p 12/09/00 12/09/07
102,520 a * 676.4p 12/09/00 12/09/07
32,406 c * 1372.4p 08/06/02 08/06/09
32,406 c * 1647.5p 08/06/02 08/06/09
32,406 c 1921.6p 08/06/02 08/06/09
33,528 c 3224.3p 03/05/03 03/05/10
31,170 d * $ 21.00 09/05/02 09/05/11
31,170 d * $ 21.00 09/05/03 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
20,000 d * $ 11.97 01/11/02 01/11/11
20,000 d * $ 11.97 01/11/03 01/11/11
20,000 d * $ 11.97 01/11/04 01/11/11

Total
426,196 —

John Makinson 36,736 a * 584.0p 08/08/99 08/08/06
73,920 a * 676.4p 12/09/00 12/09/07
30,576 a * 973.3p 14/09/01 14/09/08
4,178 b 424.8p 01/08/10 01/02/11
21,477 c * 1372.4p 08/06/02 08/06/09
21,477 c * 1647.5p 08/06/02 08/06/09
21,477 c 1921.6p 08/06/02 08/06/09
21,356 c 3224.3p 03/05/03 03/05/10
19,785 d * 1421.0p 09/05/02 09/05/11
19,785 d * 1421.0p 09/05/03 09/05/11
19,785 d * 1421.0p 09/05/04 09/05/11
19,785 d * 1421.0p 09/05/05 09/05/11

Total
310,337 —

Notes:
(1)   Shares under option are designated as:aexecutive;bworldwide save for shares;cpremium priced; anddlong-term incentive; and*where options are exercisable.
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a Executive
~~Subject to any performance condition being met, executive options become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth.~~
~~Options granted prior to 1996 are not subject to performance conditions representing market best practice at that time.~~
~~The exercise of options granted since 1996 is subject to a real increase in the company’s adjusted earnings per share over any three-year period prior to exercise.~~
The plans under which these options were granted were replaced with the introduction of the long-term incentive plan in 2001. No executive options have been granted to the directors since 1998. All options that remain outstanding are exercisable (all performance conditions having already been met prior to 2007) and lapse if they remain unexercised at the tenth anniversary of the date of grant.
b Worldwide save for shares
~~The acquisition of shares under the worldwide save for shares plan is not subject to the satisfaction of a performance target.~~
The acquisition of shares under the worldwide save for shares plan is not subject to the satisfaction of a performance target.
c Premium priced
~~Subject to the performance conditions being met, Premium Priced Options (PPOs) become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth.~~
PPOs were granted in three tranches. For these to become exercisable, the Pearson share price has to stay above the option price for 20 consecutive days within three, five and seven years respectively. In addition, for options to be exercisable, the company’s adjusted earnings per share have to increase in real terms by at least 3% per annum over the three-year period prior to exercise.
The plan under which these options were granted was replaced with the introduction of the long-term incentive plan in 2001. No Premium Priced Options (PPOs) have been granted to the directors since 1999. The share price targets for the three-year and five-year tranches of PPOs granted in 1999 have already been met prior to 2007. The share price target for the seven-year tranche of PPOs granted in 2000 was not met in 2007 and the options lapsed. The secondary real growth in earnings per share target for any PPOs to become exercisable has already been met prior to 2007. All PPOs that remain outstanding lapse if they remain unexercised at the tenth anniversary of the date of grant.
d Long-term incentive
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Options granted in 2001 were based on pre-grant earnings per share growth of 75% against a target of 16.6% over the period 1997 to 2000 and are not subject to further performance conditions on exercise.
Long-term incentive options granted on May 9, 2001 become exercisable in tranches on the first, second, third and fourth anniversary of the date of grant and lapse if they remain unexercised at the tenth. The fourth tranche lapses if any of the options in the first, second or third tranche are exercised prior to the fourth anniversary of the date of grant.
Long-term incentive options granted on November 1, 2001 become exercisable in tranches on the first, second and third anniversary of the date of grant and lapse if they remain unexercised at the tenth.
All options that remain outstanding are exercisable and lapse if they remain unexercised at the tenth anniversary of the date of grant.
(2)   In addition, Marjorie Scardino contributes US$1,000 per month (the maximum allowed) to the ~~above listed options~~US employee stock purchase plan. The terms of this plan allow participants to make monthly contributions for one year and to acquire shares at the end of that period at a price that is the lower of the market price at the beginning or the end of the period, both ~~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 ~~Ownership~~ownership of ~~Senior Management~~senior management

The table below sets forth the number of ordinary shares and restricted shares held by each of our directors as at March 31, ~~2006.~~2008. Additional information with respect to share options held by, and bonus awards for, these persons is set out above in “Remuneration of Senior Management” and “Share Options for Senior Management”. The total number of ordinary shares held by senior management as of March 31, ~~2006~~2008 was ~~626,152~~1,246,083 representing less than 1% of the issued share capital on March 31, ~~2006.~~2008.

As at March 31, 2006 Ordinary Shares(1) Restricted Shares(2)

Glen Moreno 100,000 —
Marjorie Scardino 184,889 1,336,015
David Bell 103,158 587,829
Terry Burns 5,717 —
Patrick Cescau — —
Rona Fairhead 43,209 637,936
Susan Fuhrman 2,681 —
John Makinson 149,466 642,756
Reuben Mark 16,908 —
Vernon Sankey 5,563 —
Rana Talwar 14,561 —

Ordinary
Restricted

As at March 31, 2008
shares(1) shares(2)

Glen Moreno 180,000 —
Marjorie Scardino 400,886 1,825,384
David Arculus 10,545 —
David Bell 172,896 631,408
Terry Burns 8,792 —
Patrick Cescau 3,079 —
Rona Fairhead 123,460 742,896
Robin Freestone 7,930 278,143
Susan Fuhrman 5,726 —
Ken Hydon 7,494 —
John Makinson 306,592 696,012
Rana Talwar (resigned April 27, 2007) 18,683 —
Notes:
(1) Amounts include shares acquired by individuals under the annual bonus share matching plan and amounts purchased in the market by individuals.

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

Employee ~~Share Ownership Plans~~share ownership plans
~~Worldwide Save for Shares & US Employee Share Purchase Plans~~
Worldwide save for shares and US employee share purchase plans

In 1998, we introduced a worldwide save for shares plan. Under this plan, our employees around the world have the option to save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the commencement of the employee’s participation in the plan.

In the United States, this plan operates as a stock purchase plan under Section 423 of the US Internal Revenue Code of 1986. This plan was introduced in 2000 following Pearson’s listing on the New York Stock Exchange. Under it, participants save a portion of their monthly salary over six month periods, at the end of which they have the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.
Board Practices

Our board currently comprises the chairman, who is a part-timenon-executive ~~four~~ director, five executive directors and ~~six~~five non-executive directors. Our articles of association provide that at every annual general meeting, one-third of the board of directors, or the number nearest to one-third, shall retire from office. The directors to
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retire each year are the directors who have been longest in office since their last election or appointment. A retiring director is eligible for re-election. If at any annual general meeting, the place of a retiring director is not filled, the retiring director, if willing, is deemed to have been re-elected, unless at or prior to such meeting it is expressly resolved not to fill the vacated office, or unless a resolution for the re-election of that director has been put to the meeting and lost. Our articles of association also provide that every director be subject to re-appointment by shareholders at the next annual general meeting following their appointment.

Details of our approach to corporate governance and an account of how we comply with NYSE requirements can be found on our website (www.pearson.com/investor/corpgov.htm).

The board of directors has established the following committees, all of which have written terms of reference setting out their authority and duties:
~~Audit Committee~~
Audit committee

This committee provides the board with a vehicle to appraise our financial management and reporting and to assess the integrity of our accounting procedures and financial controls. ~~Until April 21, 2006, Vernon Sankey chaired~~Ken Hydon chairs this committee and ~~Terry Burns,~~its other members are David Arculus, Patrick Cescau and ~~Reuben Mark were members. Vernon Sankey was~~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. Vernon Sankey and Reuben Mark retired from the committee on April 21, 2006 and Terry Burns stepped down from the committee on April 27, 2006. Ken Hydon, David Arculus and Susan Fuhrman have now joined the committee, with Ken Hydon as both the chairman and designated audit committee financial expert. Our internal and external auditors have direct access to the committee to raise any matter of concern and to report the results of work directed by the committee. The committee reports to the full board of directors.
~~Personnel Committee~~
Personnel committee

This committee meets regularly to decide the remuneration and benefits of the executive directors and the chief executives of our three operating divisions. The committee also recommends the chairman’s remuneration to the board of directors for its decision and reviews management development and succession plans. ~~Until April 21, 2006, Reuben Mark chaired~~David Arculus chairs this committee and its other members are Terry Burns and ~~Rana Talwar were members. Reuben Mark retired from the~~Glen Moreno.

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Nomination committee ~~on April 21, 2006. David Arculus has now joined the committee as chairman. All the three members are non-executive directors.~~
~~Nomination Committee~~
This committee meets from time to time as necessary to consider the appointment of new directors. The committee is chaired by Glen Moreno and comprises Marjorie Scardino and all of the non-executive directors.
~~Treasury Committee~~
This committee sets the policies for our treasury department and reviews its procedures on a regular basis. Dennis Stevenson was chairman of the committee until his retirement on October 1, 2005 and Rona Fairhead, Vernon Sankey and Rana Talwar were members. Vernon Sankey retired from the committee on April 21, 2006. The constitution of the committee will be reviewed later in the year.
Employees

The average ~~numbers~~number of persons employed by us during each of the three fiscal years ended ~~2005~~2007 were as follows:
• ~~32,203~~32,692 in fiscal ~~2005~~2007,

• ~~33,086~~34,341 in fiscal ~~2004,~~2006, and

• ~~30,584~~32,203 in fiscal ~~2003.~~2005.

We, through our subsidiaries, have entered into collective bargaining agreements with employees in various locations. Our management has no reason to believe that we would not be able to renegotiate any such agreements on satisfactory terms. We encourage employees to contribute actively to the business in the context of their particular job roles and believe that the relations with our employees are generally good.
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The table set forth below shows for ~~2005, 2004~~2007, 2006 and ~~2003~~2005 the average number of persons employed in each of our operating divisions.

Average number employed 2005 2004 2003

School 10,133 10,403 9,348
Higher Education 4,196 4,087 3,912
Professional 8,342 7,491 6,434
Penguin 4,051 4,085 4,318
FT Publishing 1,952 1,989 2,283
IDC 1,956 1,826 1,628
Other 1,573 1,365 928
Continuing operations 32,203 31,246 28,851

Discontinued operations — 1,840 1,733

Total 32,203 33,086 30,584

Average number employed
2007 2006 2005

School 12,906 11,064 10,133
Higher Education 5,098 4,368 4,196
Professional 3,458 3,204 3,259
Penguin 4,163 3,943 4,051
FT Publishing 2,083 1,766 1,434
Interactive Data 2,300 2,200 1,956
Other 1,614 1,669 1,573

Continuing operations 31,622 28,214 26,602

Discontinued operations 1,070 6,127 5,601

Total 32,692 34,341 32,203

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

To our knowledge, as of ~~February 26, 2006,~~March 31, 2008, the only beneficial owners of 3% or more of our issued and outstanding ordinary share capital were ~~Franklin Resources Inc.~~Templeton Global Advisors Ltd which owned ~~104,485,808~~56,508,060 ordinary shares representing ~~13.0%~~6.99% of our outstanding ordinary shares, Aviva plc which owned 41,301,715 ordinary shares representing 5.11% of our outstanding ordinary shares and ~~The Capital~~Legal & General Group ~~Companies Inc.~~plc which owned ~~55,653,209~~33,336,528 ordinary shares representing ~~6.9%~~4.12% of our outstanding ordinary shares. On ~~February 26, 2006,~~March 31, 2008, record holders with registered addresses in the United States held ~~34,992,603~~30,237,762 ADRs, which represented ~~4.4%~~3.74% of our outstanding ordinary shares. ~~Because some~~Some of these ADRs are held by nominees and so 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, ~~2005~~2007 are shown in note 13 in “Item ~~17.~~18. Financial Statements.” Amounts due from joint ventures and associates are set out in note 1720 and dividends receivable from joint ventures and associates are set out in note 13 in “Item ~~17.~~18. Financial Statements”. There were no other related party transactions in ~~2005.~~2007.
ITEM 8. FINANCIAL INFORMATION

The financial statements filed as part of this Annual Report are included on pages F-1 through~~F-80~~ F-70 hereof.

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Other than those events described in note 3337 in “Item ~~17.~~18. Financial Statements” of thisForm 20-F and seasonal fluctuations in borrowings, there has been no significant change to our financial condition or results of operations since December 31, ~~2005.~~2007. Our borrowings fluctuate by season due to the effect of the school year on the working capital requirements of the educational book business. Assuming no acquisitions or disposals, our maximum level of net debt normally occurs in July, and our minimum level of net debt normally occurs in December.

Our policy with respect to dividend distributions is described in response to “Item 3. Key Information” above.
Legal Proceedings

We and our subsidiaries are defendants in a number of legal proceedings including, from time to time, government and arbitration proceedings, which are incidental to our and their operations. We do not expect that the outcome of pending proceedings, either individually or in the aggregate, will have a significant effect on our financial position or profitability nor have any such proceedings had any such effect in the recent past. To our knowledge, there are no material proceedings in which any member of senior management or any of our affiliates is a party adverse to us or any of our subsidiaries or in respect of which any of those persons has a material interest adverse to us or any of our subsidiaries.
ITEM 9. THE OFFER AND LISTING

The principal trading market for our ordinary shares is the London Stock Exchange. Our ordinary shares also trade in the United States in the form of ADSs evidenced by ADRs under a sponsored ADR facility with The Bank of New York as depositary. We established this facility in March 1995 and amended it in August 2000 in connection with our New York Stock Exchange listing. Each ADS represents one ordinary share.
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The ADSs trade on the New York Stock Exchange under the symbol “PSO”.

The following table sets forth the highest and lowest middle market quotations, which represent the average of closing bid and asked prices, for the ordinary shares, as derived from the Daily Official List of the London Stock Exchange and the average daily trading volume on the London Stock Exchange:
• on an annual basis for our five most recent fiscal years,

• on a quarterly basis for our most recent quarter and two most recent fiscal years, and

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

Ordinary Shares
Average Daily
Reference Period High Low Trading Volume

(Ordinary
(In pence) shares)
Five Most Recent Fiscal Years

2005 695 608 5,296,700
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
Most Recent Quarter and Two Most Recent Fiscal Years

2006 First quarter 811 671 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
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
Most Recent Six Months

April 2006 798 756 7,614,100
March 2006 811 720 7,055,300
February 2006 737 706 4,336,400
January 2006 734 671 7,577,400
December 2005 692 674 3,912,900
November 2005 673 636 6,524,000

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Ordinary shares Average daily

Reference period
High Low trading volume
(In pence) (Ordinary shares)

Five most recent fiscal years

2007 915 695 6,405,600
2006 811 671 5,004,500
2005 695 608 5,296,700
2004 682 579 6,219,200
2003 680 430 6,631,800
Most recent quarter and two most recent fiscal years

2008 First quarter 733 682 5,083,300
2007 Fourth quarter 798 695 5,156,300
Third quarter 843 729 6,481,400
Second quarter 915 825 7,390,600
First quarter 872 762 6,632,100
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
Most recent six months

March 2008 700 648 5,124,400
February 2008 696 636 3,831,400
January 2008 733 621 6,110,700
December 2007 755 695 3,917,200
November 2007 792 712 3,714,700
October 2007 798 742 7,540,100
ITEM 10. ADDITIONAL INFORMATION
Memorandum and ~~Articles~~articles of ~~Association~~association

We summarize below the material provisions of our memorandum and articles of association, as amended, which have been filed as an exhibit to our annual report onForm 20-F for the year ended December 31, ~~2003.~~2007. 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 fit to further our interests or incidental or conducive to the attainment of our objectives and purposes.
Directors’ ~~Powers~~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~~directors

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

Notwithstanding the foregoing, a director will be entitled to vote, and be counted in the quorum, on any resolution concerning any of the following matters:
• the giving of any guarantee, security or indemnity in respect of money lent or obligations incurred by him or her or by any other person at the request of or for the benefit of us or any of our subsidiaries;

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

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

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

• any proposal concerning insurance that we propose to maintain or purchase for the benefit of directors or for the benefit of persons, including directors.

Where proposals are under consideration concerning the appointment of two or more directors to offices or employment with us or any company in which we are interested, these proposals may be divided and considered separately and each of these directors, if not prohibited from voting under the proviso of the fourth clause above, will be entitled to vote and be counted in the quorum with respect to each resolution except that concerning his or her own appointment.
Borrowing ~~Powers~~powers

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

Under the articles of association, directors are paid out of our funds for their services as we may from time to time determine by ordinary resolution and, in the case of non-executive directors, up to an aggregate of ~~£500,000~~£750,000 or such other amounts as resolved by the shareholders at a general meeting. Directors currently are not required to be qualified by owning our shares. ~~While~~Changes to the Companies Act, ~~1985 states that no~~which 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~~general meetings

Shareholders’ meetings ~~may~~could previously be either annual general meetings or extraordinary general meetings. However the concept of an extraordinary meeting has not been retained by the Companies Act 2006 and shareholder meetings can now only be annual general meetings.
The following matters are ~~ordinarily~~usually transacted at an annual general meeting:
• ~~sanctioning or declaring~~approving dividends;

• consideration of the accounts and balance sheet;

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

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

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

• the renewal, limitation, extension, variation or grant of any authority of or to the board, pursuant to the Companies Act 1985, to allot securities.
~~Business transacted at an extraordinary general meeting may also be transacted at an annual general meeting.~~
We hold ~~a general meeting as~~ our annual general meeting within fifteen months after the date of the preceding annual general meeting, at a place and time determined by the board.
The board may call ~~an extraordinary~~a general meeting whenever it thinks fit. If at any time ~~and for~~there are not within the United Kingdom sufficient directors capable of acting to form a quorum, any ~~reason. The board must~~director or any two members may convene ~~an extraordinary~~a general meeting ~~if requested~~in the same manner as nearly as possible as that in which meetings may be convened by the board.
No business shall be dealt with at any general meeting unless a quorum is present when the meeting proceeds to ~~do so by shareholders holding not less than one-tenth of our issued share capital.~~
business. Three ~~shareholders~~members present in person and entitled to vote ~~will constitute~~shall be a quorum for ~~any general meeting.~~ all purposes. A corporation being a member shall be deemed to be personally present if represented by its duly authorized representative.
If a quorum for a meeting convened at the request of shareholders is not present within fifteen minutes of the appointed time, the meeting will be dissolved. In any other case, the general meeting will be adjourned to the same day in the next week, at the same time and place, or to a time and place that the chairman fixes. If at that rescheduled meeting a quorum is not present within fifteen minutes from the time appointed for holding the meeting, the shareholders present in person or by proxy will be a quorum. The chairman or, in his absence, the deputy chairman or any other director nominated by the board, will preside as chairman at every general meeting. If no director is present at the general meeting or no director consents to act as chairman, the shareholders present shall elect one of their number to be chairman of the meeting.
Ordinary ~~Shares~~shares

Certificates representing ordinary shares are issued in registered form and, subject to the terms of issue of those shares, are issued following allotment or receipt of the form of transfer bearing the appropriate stamp duty by our ~~registrar, Lloyds Bank Registrars, the Causeway, Worthing,~~registrars, Equiniti, Aspect House, Spencer Road, Lancing, West Sussex, BN99 ~~6DA,~~6TH, United Kingdom, telephone number ~~+44-1903-502-541.~~+44-845-607-6838.
Share ~~Capital~~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,~~2006, 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 determine by special resolution of the ~~shareholders, determine.~~shareholders.

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.

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Subject to the terms of the shares which have been issued, the directors may from time to time make calls upon the shareholders in respect of any moneys unpaid on their shares, provided that (subject to the terms of the shares so issued) no call on any share shall be payable at less than fourteen clear days from the last call. The directors may, if they see fit, receive from any shareholder willing to advance the same, all and any part of the moneys uncalled and unpaid upon any shares held by him.
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Changes in ~~Capital~~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;~~2006; 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~~rights

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

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

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

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

Holders of ordinary shares are entitled to receive dividends out of our profits that are available by law for distribution, as we may declare by ordinary resolution, subject to the terms of issue thereof. However, no dividends may be declared in excess of an amount recommended by the board of directors. The board may pay interim dividends to the shareholders as it deems fit. We may invest or otherwise use all dividends left unclaimed for six months after having been declared for our benefit, until claimed. All dividends unclaimed for a period of twelve years after having been declared will be forfeited and revert to us.

The directors may, with the sanction of a resolution of the shareholders, offer any holders of ordinary shares the right to elect to receive ordinary shares credited as fully paid, in whole or in part, instead of cash in respect of such dividend.

The directors may deduct from any dividend payable to any shareholder all sums of money (if any) presently payable by that shareholder to us on account of calls or otherwise in relation to our shares.
Liquidation ~~Rights~~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~~provisions of the ~~Articles~~articles of ~~Association~~association

Whenever our capital is divided into different classes of shares, the special rights attached to any class may, unless otherwise provided by the terms of the issue of the shares of that class, be varied or abrogated, either with the written consent of the holders of three-fourths of the issued shares of the class or with the sanction of an extraordinary resolution passed at a separate meeting of these holders.

In the event that a shareholder or other person appearing to the board of directors to be interested in ordinary shares fails to comply with a notice requiring him or her to provide information with respect to their interest in voting shares pursuant to section ~~212~~820 of the Companies Act ~~1985,~~2006, we may serve that shareholder with a notice of default. After service of a default notice, that shareholder shall not be entitled to attend or vote
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at any general meeting or at a separate meeting of holders of a class of shares or on a poll until he or she has complied in full with our information request.

If the shares described in the default notice represent at least one-fourth of 1% in nominal value of the issued ordinary shares, then the default notice may additionally direct that in respect of those shares:
• we will not pay dividends (or issue shares in lieu of dividends); and

• we will not register transfers of shares unless the shareholder is not himself in default as regards supplying the information requested and the transfer, when presented for registration, is in such form as the board of directors may require to the effect that after due and careful inquiry, the shareholder is satisfied that no person in default is interested in any of the ordinary shares which are being transferred or the transfer is an approved transfer, as defined in our articles of association.

No provision of our articles of association expressly governs the ordinary share ownership threshold above which shareholder ownership must be disclosed. Under the Companies Act ~~1985,~~2006, any person who acquires, either alone or, in specified circumstances, with others:
• a material interest in our voting share capital equal to or in excess of 3%; or

• a non-material interest equal to or in excess of 10%,
comes under an obligation to disclose prescribed particulars to us in respect of those ordinary shares. A disclosure obligation also arises where a person’s notifiable interests fall below the notifiable percentage, or where, above that level, the percentage of our voting share capital in which a person has a notifiable interest increases or decreases.
Limitations ~~Affecting Holders~~affecting holders of ~~Ordinary Shares~~ordinary shares or ADSs

Under English law and our memorandum and articles of association, persons who are neither UK residents nor UK nationals may freely hold, vote and transfer ordinary shares in the same manner as UK residents or nationals.

With respect to the items discussed above, applicable UK law is not materially different from applicable US law.
Material ~~Contracts~~contracts
~~The following summaries are~~
Pearson has 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~~any contracts outside the ordinary course of business during the two year period immediately preceding the date of this annual ~~report:~~report.
~~Issuance of $350,000,000 4.70% Guaranteed Senior Notes due 2009 and $400,000,000 5.70% Guaranteed Senior Notes due 2014~~Executive employment contracts
Our wholly-owned subsidiary, Pearson Dollar Finance plc, issued $350 million principal amount of 4.70% senior notes due 2009 and $400 million principal amount of 5.70% senior notes due 2014, in each case fully and unconditionally guaranteed by Pearson plc, under an indenture dated May 25, 2004 between Pearson Dollar Finance plc, Pearson plc and The Bank of New York, as trustee. The first semi-annual interest payment was made on December 1, 2004. Pearson Dollar Finance may redeem the notes at any time, in whole or in part, at its option.
      The indenture describes the circumstances that would be considered events of default. If an event of default occurs, other than an insolvency or bankruptcy of Pearson Dollar Finance plc, Pearson plc or a principal subsidiary of Pearson plc (as defined in the indenture), the holders of at least 25% of the principal amount of the then outstanding notes may declare the notes, along with accrued but unpaid interest and other amounts described in the indenture, as immediately due and payable. In the event of an insolvency or bankruptcy of Pearson Dollar Finance plc, Pearson plc or a principal subsidiary of Pearson plc (as defined in the indenture), the principal of all outstanding notes shall become due and payable immediately.
      ~~The indenture limits our ability to create liens to secure certain types of debt intended to be listed or traded on an exchange.~~
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~~Issuance of $300,000,000 4.625% Senior Notes due 2018~~
      We issued $300 million principal amount of 4.625% senior notes due 2018 under an indenture dated June 23, 2003 between us and The Bank of New York, as trustee. The first semi-annual interest payment was made on December 15, 2003. We may redeem the notes at any time, in whole or in part, at our option.
      The indenture describes the circumstances that would be considered events of default. If an event of default occurs, other than the insolvency or bankruptcy of us or a principal subsidiary (as defined in the indenture), the holders of at least 25% of the principal amount of the then outstanding notes may declare the notes, along with accrued, but unpaid, interest and other amounts described in the indenture, as immediately due and payable.
      ~~The indenture limits our ability to create liens to secure certain types of debt intended to be listed or traded on an exchange.~~
~~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 &and 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~~months’ base salary and benefits together with a proportion of potential bonus.

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~~Agreement with Peter Jovanovich~~Exchange controls
On January 28, 2005, we entered into a letter agreement with Peter Jovanovich with respect to his employment with Pearson Education and its affiliates. Due to poor health, Mr. Jovanovich terminated his employment with us. The letter agreement sets forth the terms of his disability leave and confirms his existing disability benefits, including benefits under our short term disability plan, long-term disability plan, and supplemental long-term disability plan. Under the terms of the agreement, Mr. Jovanovich will receive standard benefits (except awards under Pearson plc stock plans), and thereafter, will receive coverage under our medical, dental and vision plans and our life insurance plan, plus a payment for unused vacation days. We have agreed to continue to credit Mr. Jovanovich’s individual defined contribution arrangement. We also agreed to pay him his 2004 annual bonus. The value of Mr. Jovanovich’s disability package, and his total remuneration for our 2004 financial year, is included in “Item 6. Directors and Senior Management”.
~~Exchange Controls~~
There are no UK government laws, decrees, regulations or other legislation which restrict or which may affect the import or export of capital, including the availability of cash and cash equivalents for use by us or the remittance of dividends, interest or other payments to nonresident holders of our securities, except as otherwise described under “— Tax Considerations” below.
Tax ~~Considerations~~considerations

The following is a discussion of the material US federal income tax considerations and UK tax considerations arising from the acquisition, ownership and disposition of ordinary shares and ADSs by a US holder. A US holder is:
• an individual citizen or resident of the US, or

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

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

This discussion deals only with ordinary shares and ADSs that are held as capital assets by a US holder, and does not address tax considerations applicable to US holders that may be subject to special tax rules, such as:
• dealers or traders in securities or currencies,

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

• tax-exempt entities,

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

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

• US holders that have a principal place of business or “tax home” outside the United States, or

• US holders whose “functional currency” is not the US dollar.

For US federal income tax purposes, holders of ADSs will be treated as the owners of the ordinary shares represented by those ADSs.
The discussion below is based upon current UK law and the provisions of the US Internal Revenue Code of 1986, or the Code, and regulations, rulings and judicial decisions as of the date of this Annual Report; any 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 “ Income Tax Treaty”). The discussions below regarding US residents are based on the articles of the New Income Tax Treaty.
In addition, the following discussion assumes that The Bank of New York will perform its obligations as depositary in accordance with the terms of the depositary agreement and any related agreements.

Because US and UK tax consequences may differ from one holder to the next, the discussion set out below does not purport to describe all of the tax considerations that may be relevant to you and your particular situation. Accordingly, you are advised to consult your own tax advisor as to the US federal, state and local, UK and other, including foreign, tax consequences of investing in the ordinary shares or ADSs. The statements of US and UK tax law set out below are based on the laws and interpretations in force as of the date of this Annual Report, and are subject to any changes occurring after that date.
UK ~~Income Taxation~~income taxation of ~~Distributions~~distributions

The ~~United Kingdom~~UK does not impose dividend withholding tax on dividends paid to US holders.
US ~~Income Taxation~~income taxation of ~~Distributions~~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.

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The amount of any distribution will equal the amount of the cash distribution. Distributions, if any, in excess of our current and accumulated earnings and profits will constitute a non-taxable return of capital to a US holder and will be applied against and reduce the US holder’s tax basis in its ordinary shares or ADSs. To the extent that these distributions exceed the tax basis of the US holder in its ordinary shares or ADSs, the excess generally will be treated as capital gain.

Dividends that we pay will not be eligible for the dividends received deduction generally allowed to US corporations under Section 243 of the Code.

In the case of distributions in pounds, the amount of the distributions generally will equal the US dollar value of the pounds distributed, determined by reference to the spot currency exchange rate on the date of receipt of the distribution by the US holder in the case of shares or by The Bank of New York in the case of ADSs, regardless of whether the US holder reports income on a cash basis or an accrual basis. The US holder will realize separate foreign currency gain or loss only to the extent that this gain or loss arises on the actual disposition of pounds received. For US holders claiming tax credits on a cash basis, taxes withheld from the distribution are translated into US dollars at the spot rate on the date of the distribution; for US holders claiming tax credits on an accrual basis, taxes withheld from the distribution are translated into US dollars at the average rate for the taxable year.

A distribution by the Company to noncorporate shareholders before ~~2009~~2011 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.~~US federal income tax principles.
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UK ~~Income Taxation~~income taxation of ~~Capital Gains~~capital gains

Under the 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~~UK for UK tax purposes and who (in the case of an individual) does not carry on a trade, profession or vocation in the ~~United Kingdom~~UK through a branch or agency, or (in the case of a company) does not carry on a trade in the UK through a UK permanent establishment, to which ordinary shares or ADSs are attributable will not be liable for UK taxation on capital gains or eligible for relief for allowable losses, realized on the sale or other disposal (including redemption) of these ordinary shares or ADSs.
US ~~Income Taxation~~income taxation of ~~Capital Gains~~capital gains

Upon a sale or exchange of ordinary shares or ADSs to a person other than Pearson, a US holder will recognize gain or loss in an amount equal to the difference between the amount realized on the sale or exchange and the US holder’s adjusted tax basis in the ordinary shares or ADSs. Any gain or loss recognized will be capital gain or loss and will be long-term capital gain or loss if the US holder has held the ordinary shares or ADSs for more than one year. Long-term capital gain of a noncorporate US holder is generally taxed at a maximum rate of 15%. This long-term capital gain rate is scheduled to expire in ~~2009.~~2011.

Gain or loss realized by a US holder on the sale or exchange of ordinary shares or ADSs generally will be treated asUS-source gain or loss for US foreign tax credit purposes.
Estate and ~~Gift Tax~~gift tax

The current Estate and Gift Tax Convention, or the Convention, between the ~~United States~~US and the ~~United Kingdom~~UK 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,~~US, 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~~UK or pertain to the fixed base in the ~~United Kingdom~~UK 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~~UK to be

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credited against tax payable in the US or for tax paid in the US 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~~UK based on priority rules set forth in the Convention.
Stamp ~~Duty~~duty

No stamp duty or stamp duty reserve tax (SDRT) will be payable in the ~~United Kingdom~~UK 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~~UK and that the instrument or written agreement of transfer is not executed in the ~~United Kingdom.~~UK. 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 isshould not, from March 13, 2008, be subject to stamp duty ator SDRT under legislation announced and to be enacted in the ~~fixed rate of £5.00 per instrument of transfer.~~Finance Act 2008.
Close ~~Company Status~~company status

We believe that the close company provisions of the UK Income and Corporation Taxes Act 1988 do not apply to us.
Documents on ~~Display~~display

Copies of our Memorandum and Articles of Association ~~the material contracts described above~~ and filed as exhibits to this Annual Report and certain other documents referred to in this Annual Report are available for inspection at our registered office at 80 Strand, London WC2R 0RL ~~(c/~~(c/o the Company Secretary), or, in
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the ~~United States,~~US, at the registered office of Pearson Inc. at 1330 Avenue of the Americas, 7th Floor, New York, New York, during usual business hours upon reasonable prior request.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
~~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,~~chief financial officer, who acts pursuant to policies approved by ~~a Treasury Committee of our~~the board of directors. ~~This~~The Audit Committee receives regular reports on our treasury activities, ~~which outside~~and we periodically meet with external advisers ~~also~~to review ~~periodically.~~our activities.

We have a policy of not undertaking any speculative transactions, and we do not hold ~~the~~our 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~~IFRS requirements on hedge accounting, during ~~2005~~2007 and ~~2004 (but not 2003)~~2006 we qualified for hedge accounting under ~~US GAAP~~IFRS 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.
~~Adoption of International Financial Reporting Standards~~Interest rates
From 1 January 2005 the Group adopted IAS 39 “Financial Instruments: Recognition and Measurement” and IAS 32 “Financial Instruments: Disclosure and Presentation”. The market values of the Group’s derivatives were recognized in the balance sheet at the date of adoption. Subsequent changes in their market value will change the carrying values on the balance sheet and create movements in the finance cost section of the income statement, unless they have been designated (and passed the prescribed tests) for hedge accounting treatment. In addition, IAS 39 requires to value the Group’s derivatives at 1 January 2005 as if the standard had been in place at the start date of each individual contract. This has given rise to transition adjustments, which in some cases are being amortised over the remaining life of the relevant transaction. Also, where the Group qualifies for hedge accounting on a derivative, the carrying value of the relevant bond is adjusted to reflect this (in addition to the requirement under IFRS that accrued interest should be included in the carrying value of the bond or derivative).
      As the Group elected to adopt IAS 39 from 1 January 2005 as permitted by the transitional provisions in IFRS 1, the effects described above are not reflected in the 2004 and 2003 comparatives. A detailed description on the effects of the adoption of IAS 39 is included in note 1 and note 34 in “Item 17. Financial Statements”.
~~Interest Rates~~
The Group’s financial exposure to interest rates arises primarily from its ~~borrowings, particularly those in US dollars.~~borrowings. The Group manages its exposure by borrowing at fixed and variable rates of interest, and by entering into derivative ~~instruments.~~transactions. Objectives

61
approved by ~~the Treasury Committee of~~ the board concerning the proportion of debt outstanding at fixed rates govern the use of these financial instruments.

The Group’s objectives are applied to core net debt, which is measured at the year-end and comprises borrowings net of ~~year-end~~ cash and other liquid funds. ~~Since September 2005 the~~Our objective ~~has been~~is to maintain a proportion of forecast core net debt in fixed or capped form for the next four years, subject to a maximum of 65% and a minimum that starts at 40% and falls by 10% each year. ~~Within this target range the proportion that is hedged is triggered by a formula based on historical interest rate frequencies. Previously the minimum was 40%.~~

The principal method ~~to hedge~~of hedging interest rate risk is to enter into an agreement with a bank counterparty to pay a ~~fixed-rate~~fixed rate and receive a variable rate, known as a swap. Under interest rate swaps, the Group agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and variable-rate amounts calculated by reference to an agreed notional principal amount. The majority of ~~these~~the Group’s swap contracts are US dollar denominated,
62
and some of them have deferred start dates, in order to maintain the desired risk profile as other contracts mature. The variable rates received are normally based on three-month ~~and~~or six-month LIBOR, and the dates on which these rates are set do not necessarily exactly match those of the hedged borrowings. Management 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, the 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 typical practice is ~~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 ~~several~~some cases, the bond issue ~~was~~is denominated in a different currency ~~than~~to the ~~debt being refinanced~~Group’s desired borrowing risk profile and the Group ~~has entered~~enters into a related cross currency interest rate ~~and currency~~ swap in order to maintain ~~an unchanged borrowing~~this 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 ~~sharply~~significantly the income statement impact of changes in the market value of a derivative). The Group then divides the total portfolio between hedge-accounted and pooled segments, so that the expected movement on the pooled segment is ~~minimal.~~minimized.
Currency ~~Exchange Rates~~exchange rates

Although the Group is based in the ~~United Kingdom,~~UK, it has significant investments in overseas operations. The most significant currency in which the Group trades is the US dollar.

The Group’s policy is to align approximately the currency composition of its core net borrowings with its forecast operating ~~profit.~~profit before depreciation and amortization. This policy aims to dampen the impact of changes in foreign exchange rates on consolidated interest cover and earnings. ~~In September 2005 this~~This policy ~~was modified to apply~~applies only to currencies that ~~accounted~~account for more than 15% of group operating profit, which is currently ~~only~~are the US ~~dollar. Previously, the policy applied specifically to US dollars, Euro~~dollar and ~~Sterling.~~sterling. However, the Group still borrows 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~~Group operating profit. At December 31, ~~2005~~2007 the Group’s net ~~borrowings/ (cash)~~borrowings in ~~the three~~our main currencies ~~above~~ (taking into account the effect of cross currency rate swaps) were: US dollar ~~£1114 million, euro £78 million~~£1,119m, and sterling ~~£(93) million~~£45m.

The Group uses both currency denominated debt and derivative instruments to implement the above policy. Its intention is that gains/losses on the derivatives and debt offset the losses/gains on the foreign currency assets and income. Each quarter the value of hedging instruments is monitored against the assets in the relevant currency and, where practical, a decision is made whether to treat the debt or derivative as a net investment hedge (permitting foreign exchange movements on it to be taken to reserves) for the purposes of reporting under ~~IFRS and US GAAP.~~IFRS.

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.~~sterling. Fluctuations in currency exchange rates affect the currency values recorded in our accounts, although they do not give rise to any realized gain or loss, nor to any currency cash flows.

62
The Group is also exposed to currency exchange rates in its cash transactions and its investments in overseas operations. Cash transactions — typically for purchases, sales, interest or dividends — require cash conversions between currencies. Fluctuations in currency exchange rates affect the cash amounts that the Group pays or receives.
Forward ~~Foreign Exchange Contracts~~foreign exchange contracts

The Group sometimes uses forward foreign exchange contracts where a specific major project or forecasted cash flow, including acquisitions and disposals, arises from a business decision that has used a specific foreign
63
exchange rate. The Group’s policy is to effect routine transactional conversions between currencies, for example to collect receivables or settle payables, at the relevant spot exchange rate.

The Group seeks to offset purchases and sales in the same currency, even if they do not occur simultaneously. In addition, its debt and cash portfolios management gives rise to temporary currency shortfalls and surpluses. Both of these activities require using short-dated foreign exchange swaps between currencies.

Although the Group prepares its consolidated financial statements in ~~Sterling,~~sterling, significant sums have been invested in overseas assets, particularly in the ~~United States.~~US. Therefore, fluctuations in currency exchange rates, particularly between the US dollar and ~~Sterling,~~sterling, and ~~also~~to a lesser extent between the ~~Euro~~euro and ~~Sterling,~~sterling, are likely to affect shareholders’ funds and other accounting values.
Derivatives

Under ~~both~~ IFRS, ~~and 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 either recorded in ~~either~~ other comprehensive income or ~~earnings.~~are offset in earnings by the corresponding movement in the fair value of the underlying hedged item. Any ineffective portion of derivatives that are classified as hedges is immediately recognized in earnings.
~~Using the transitional exceptions of IAS 39, derivatives were accounted for in accordance with UK GAAP for the years ended December 31, 2003~~
In 2007 and 2004. Under UK GAAP, there are no specific criteria, which must be fulfilled in order to record derivative contracts such as interest rate swaps, currency swaps and forward currency contracts as a hedging instrument. Accordingly, based upon our intention and stated policy with respect to entering into derivative transactions, they have been recorded as hedging instruments for UK GAAP. This means that unrealized gains and losses on these instruments are typically deferred and recognized when realized. From January 1, 2005, the Group has adopted IAS 39~~“Financial Instruments: Recognition and Measurement”~~ ~~and IAS 32~~~~“Financial Instruments: Disclosure and Presentation”,~~ ~~which resulted in a transitional adjustment in reserves of £12 million.~~
      Under US GAAP, in 2003 our derivative contracts did not meet the prescribed criteria for hedge accounting, and have been recorded at market value at each period end, with changes in their fair value being recorded in the profit and loss account. In 2005 and 20042006 the Group met the prescribed designation requirements and hedge effectiveness tests under ~~US GAAP~~IFRS for ~~certain~~some 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.~~hedged item.

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.
~~ITEM 12.~~     ~~DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES~~Quantitative information about market risk
~~Not applicable.~~
The sensitivity of the Group’s derivative portfolio to changes in interest rates is found in note 15 of “Item 18. Financial Statements”.
~~PART II~~
ITEM ~~13.~~12. ~~DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES~~DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
~~None.~~
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
~~Not applicable.~~
None.

63
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, ~~2005~~2007 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, as amended, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and
64
Exchange Commission’s rules and ~~forms.~~forms and that such information is accumulated and communicated to management, including the principal executive officer and principal financial officer, 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.~~ detected, and that such information is accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate, to allow such timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
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, 2007, and has concluded that such internal control over financial reporting was effective.
PricewaterhouseCoopers LLP, which has audited the consolidated financial statements of the Company for the year ended December 31, 2007, has also audited the effectiveness of the Company’s internal control over financial reporting under Auditing Standard No. 5 of the Public Company Accounting Oversight Board (United States). Their audit report may be found onpage F-2.
Change in Internal Control Over Financial Reporting
During the period covered by this Annual Report onForm 20-F, Pearson has made no significant changes to its internal control over financial reporting that have materially affected or are reasonably likely to materially affect Pearson’s internal control over financial reporting.
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
~~ITEM 16A.~~     ~~AUDIT COMMITTEE FINANCIAL EXPERT~~
      The members of the Board of Directors of Pearson plc have determined that Vernon Sankey was an audit committee financial expert within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission for the period until April 21, 2006. The members of the Board of Directors of Pearson plc have determined that Ken Hydon is an audit committee financial expert ~~for subsequent periods.~~
~~ITEM 16B.~~     ~~CODE OF ETHICS~~within the meaning of the applicable rules and regulations of the US Securities and Exchange Commission.

ITEM 16B. CODE OF ETHICS
Pearson has adopted a code of ethics (the Pearson code of business conduct) which applies to all employees including the Chief Executive Officer and Chief Financial Officer and other senior financial management. This code of ethics is available on our website (www.pearson.com/investor/corpgov.htm). The information on our website is not incorporated by reference into this report.

64
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
~~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 2005 2004 2003

£m £m £m
Statutory audit 4 3 3
Audit-related regulatory reporting services 1 1 —
Non-audit services 2 2 2
Non-audit services are analysed as follows:
Tax compliance services 1 1 1
Tax advisory services — 1 1
Other non-audit services 1 — —

Auditors’ Remuneration
2007 2006
£m £m

Audit fees 3 5
Audit-related fees 1 4
Tax fees 2 1
All other fees 1 1
Audit fees include £35,000 (2006: £35,000) of audit fees relating to the audit of the parent company.
Audit-related fees represent 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 attestation under section 404 of the Sarbanes-Oxley Act.
Tax services include services related to tax planning and various other tax advisory services.
All other fees include fees for services relating to the disposal of the Data Management business, due diligence on acquisitions and advisory services in relation to information technology and section 404.
~~Note~~ Included in statutory audit fees are amounts relating to the parent company of £30,000 (2004: £20,000; 2003: £20,000). Audit-related regulatory reporting fees are £225,000 (2004: £225,000; 2003: £200,000). Non-audit fees in the UK in 2005 are £1,000,000 (2004: £1,000,000; 2003: £341,000) and are in respect of tax advisory and tax compliance services and other advisory services. The remainder of the non-audit fees relate to overseas subsidiaries.
65
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~~ Maximum
~~Total number of~~ ~~of shares that~~ number
~~units purchased~~ ~~may yet be~~Total number of
of shares that
~~as part of publicly~~ units purchased ~~under~~
~~Total number of~~ may yet be
~~Average price~~ ~~announced plans~~ ~~the plans or~~
~~Period~~ ~~shares purchased~~ ~~paid per share~~ ~~or programs~~ ~~programs~~
as part of publicly
purchased under
Total number of

~~September 1, 2005 - September 30, 2005~~Average price
~~625,000~~announced plans
the plans or
Period
shares purchased paid per share or programs programs
February 1, 2007 - February 28, 2007 1,000,000 £~~6.63~~8.19 N/A N/A
June 1, 2007 - June 30, 2007 2,500,000 £8.39 N/A N/A
December 1, 2007 - December 31, 2007 1,400,000 £7.31 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.

65
PART III
~~ITEM 17.~~     ~~FINANCIAL STATEMENTS~~

ITEM 17. FINANCIAL STATEMENTS
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
The financial statements filed as part of this Annual Report are included on pages F-1 through~~F-79~~ F-70 hereof.
~~ITEM 18.~~     ~~FINANCIAL STATEMENTS~~
ITEM 19. EXHIBITS
~~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.#~~
~~4.1~~ ~~Letter Agreement dated January 28, 2005 between Pearson plc and Peter Jovanovich.#~~
~~4.2~~ ~~Irrevocable undertakings in respect of an offer by Retos Cartera, for the shares of Recoletos Grupo de Communicación, dated December 14, 2004 between Pearson plc and Retos Cartera.#~~
8.1 List of Significant Subsidiaries.
12.1 Certification of Chief Executive Officer.
12.2 Certification of Chief Financial Officer.
13.1 Certification of Chief Executive Officer.
13.2 Certification of Chief Financial Officer.
15 Consent 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.~~

66
# ~~Incorporated by reference from the Form 20-F of Pearson plc for the year ended December 31, 2004 and filed June 27, 2005.~~
66
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
Report of Independent Registered Public Accounting Firm
F-2
Consolidated Income Statement for the year ended December 31, 2007, 2006 and 2005
~~F-3~~ F-4
Statement of Recognized Income and Expense for the ~~Year Ended~~year ended December 31, 2007, 2006 and 2005
~~F-4~~ F-5
Consolidated Balance Sheet as at December 31, ~~2005~~2007 and 2006
F-5
Consolidated Cash Flow Statement for the ~~Year Ended~~year ended December 31, 2007, 2006 and 2005
F-7
Notes to the ~~Accounts~~Consolidated Financial Statements
F-8

F-1
~~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, 2007 and December 31, 2006 consolidated financial statements and of its internal control over financial reporting as of December 31, 2007 and an audit of its December 31, 2005 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.
In our opinion, the accompanying consolidated balance sheets and the related consolidated ~~income statements, consolidated~~ statements of ~~recognised~~income, of cash flows and of recognized income and expense ~~and consolidated cash flow statements~~ present fairly, in all material respects, the financial position of Pearson plc and its subsidiaries (the “Group”) at December 31, 2007 and December ~~2005, 2004 and 2003,~~31, 2006 and the results of their operations and ~~their~~ cash flows for each of the three years in the period ended December 31, ~~December 2005,~~2007, in conformity with~~EU-adopted~~ International Financial Reporting ~~Standards. These~~Standards (IFRSs) as issued by the International Accounting Standards Board. Also, in our opinion the Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007 based on criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Group’s management are responsible for these financial statements, ~~are the responsibility~~for maintaining effective internal control over financial reporting and for its assessment of the ~~Company’s management; our~~effectiveness of internal control over financial reporting, included in “Management’s Annual Report on Internal Control Over Financial Reporting” appearing under Item 15 of thisForm 20-F. Our responsibility is to express ~~an opinion~~opinions on these financial statements and on the Group’s internal control over financial reporting based on our ~~audits.~~ audits which were integrated in 2007 and 2006.
We conducted our audits ~~of these statements~~ in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the ~~audit~~audits to obtain reasonable assurance about whether the financial statements are free of material ~~misstatement. An audit includes~~misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our ~~opinion.~~opinions.
~~As discussed in Note 1,~~
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the ~~Company adopted International Accounting Standards (IAS) 32 “Financial Instruments: Disclosure~~reliability of financial reporting and ~~Presentation” and IAS 39 “Financial Instruments: Recognition and Measurement”~~the preparation of financial statements for external purposes in accordance with ~~International Financial Reporting Standards~~generally accepted accounting 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 ~~adopted by the European Union. The change has been accounted for prospectively from 1 January 2005.~~
~~EU-adopted~~ ~~International Financial Reporting Standards vary~~necessary to permit preparation of financial statements in ~~certain significant respects from~~accordance with generally accepted accounting principles, ~~generally accepted~~and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the ~~United States~~company; and (iii) provide reasonable assurance regarding prevention or timely detection of ~~America. Information relating~~unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

F-2
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 ~~nature and effect~~risk that controls may become inadequate because of ~~such differences is presented~~changes in ~~Note 35 to~~conditions, or that the ~~consolidated financial statements.~~degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
~~London, England~~
~~May 5, 2006~~
London
United Kingdom
April 25, 2008

F-3
~~F-2~~
~~CONSOLIDATED INCOME STATEMENT~~
~~YEAR ENDED~~Consolidated Income Statement
Year ended 31 ~~DECEMBER 2005~~
(December 2007
All figures in £ ~~millions)~~millions

Notes 2005 2004 2003

Continuing operations

Sales
2 4,096 3,696 3,850
Cost of goods sold (2,022 ) (1,789 ) (1,846 )

Gross profit 2,074 1,907 2,004
Operating expenses 5 (1,592 ) (1,520 ) (1,594 )
Other net gains and losses 4 40 9 (6 )
Share of results of joint ventures and associates 14 8 2

Operating profit
2 536 404 406
Finance costs 7 (132 ) (96 ) (100 )
Finance income 7 62 17 7

Profit before tax
466 325 313
Income tax 8 (124 ) (63 ) (61 )

Profit for the year from continuing operations
342 262 252
Profit for the year from discontinued operations 3 302 22 23

Profit for the year
644 284 275

Attributable to:

Equity holders of the Company 624 262 252
Minority interest 20 22 23

Earnings per share for profit from continuing and discontinued operations attributable to the equity holders of the Company during the year (expressed in pence per share)

— basic 9 78.2 p 32.9 p 31.7 p
— diluted 9 78.1 p 32.9 p 31.7 p
Earnings per share for profit from continuing operations attributable to the equity holders of the Company during the year (expressed in pence per share)

— basic 9 40.4 p 30.8 p 29.4 p
— diluted 9 40.3 p 30.8 p 29.4 p

Notes 2007 2006 2005

Continuing operations

Sales 2 4,162 3,990 3,662
Cost of goods sold 4 (1,910 ) (1,841 ) (1,713 )

Gross profit
2,252 2,149 1,949
Operating expenses 4 (1,701 ) (1,651 ) (1,506 )
Other net gains and losses 5 — — 40
Share of results of joint ventures and associates 13 23 24 14

Operating profit
2 574 522 497
Finance costs 7 (150 ) (133 ) (132 )
Finance income 7 44 59 62

Profit before tax
468 448 427
Income tax 8 (131 ) (4 ) (108 )

Profit for the year from continuing operations
337 444 319
(Loss)/profit for the year from discontinued operations 3 (27 ) 25 325

Profit for the year
310 469 644

Attributable to:

Equity holders of the Company 284 446 624
Minority interest 26 23 20

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 35.6p 55.9p 78.2p
— diluted 9 35.6p 55.8p 78.1p

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 39.0p 52.7p 37.5p
— diluted 9 39.0p 52.6p 37.4p

F-4
~~F-3~~
~~CONSOLIDATED STATEMENT OF RECOGNISED INCOME AND EXPENSE~~
~~YEAR ENDED 3 DECEMBER 2005~~
(Consolidated Statement of Recognised Income and Expense
Year ended 31 December 2007
All figures in £ ~~millions)~~millions

Notes 2005 2004 2003

Net exchange differences on translation of foreign operations 26 327 (203 ) (288 )
Actuarial gains/(losses)on defined benefit pension and post-retirement medical schemes 24 26 (61 ) (28 )
Taxation on items taken directly to equity 8 12 9 —

Net income/(expense) recognised directly in equity
365 (255 ) (316 )
Profit for the year 644 284 275

Total recognised income and expense for the year
1,009 29 (41 )

Attributable to:

Equity holders of the Company 989 7 (64 )
Minority interest 20 22 23

Effect of transition adjustment on adoption of IAS 39

Attributable to:

Equity holders of the Company 34 (12 )

~~F-4~~

Notes 2007 2006 2005

Net exchange differences on translation of foreign operations 29 25 (417 ) 327
Actuarial gains on retirement benefit obligations 25 80 107 26
Taxation on items charged to equity 8 29 12 12

Net income/(expense) recognised directly in equity
134 (298 ) 365
Profit for the year 310 469 644

Total recognised income and expense for the year
444 171 1,009

Attributable to:

Equity holders of the Company 418 148 989
Minority interest 26 23 20

Effect of transition adjustment on adoption of IAS 39

Attributable to:

Equity holders of the Company — — (12 )
~~CONSOLIDATED BALANCE SHEET~~
~~AS AT~~Consolidated Balance Sheet
As at 31 ~~DECEMBER 2005~~
(December 2007
All figures in £ ~~millions)~~millions

Notes 2005 2004 2003

Assets

Non-current assets

Property, plant and equipment 11 384 355 402
Intangible assets 12 3,854 3,278 3,550
Investments in joint ventures and associates 13 36 47 64
Deferred income tax assets 14 385 359 342
Financial assets — Derivative financial instruments 16 79 — —
Other financial assets 15 18 15 21
Other receivables 19 108 102 100

4,864 4,156 4,479
Current assets

Intangible assets — pre-publication 17 426 356 362
Inventories 18 373 314 319
Trade and other receivables 19 1,031 933 1,025
Financial assets — Derivative financial instruments 16 4 — —
Cash and cash equivalents (excluding overdrafts) 20 902 461 551

2,736 2,064 2,257
Non-current assets classified as held for sale — 358 —

2,736 2,422 2,257

Total assets
7,600 6,578 6,736

Notes 2007 2006

Assets

Non-current assets

Property, plant and equipment 11 355 348
Intangible assets 12 3,814 3,581
Investments in joint ventures and associates 13 20 20
Deferred income tax assets 14 328 417
Financial assets — Derivative financial instruments 17 23 36
Retirement benefit assets 25 62 —
Other financial assets 16 52 17
Other receivables 20 129 124

4,783 4,543
Current assets

Intangible assets — Pre-publication 18 450 402
Inventories 19 368 354
Trade and other receivables 20 946 953
Financial assets — Derivative financial instruments 17 28 50
Financial assets — Marketable securities 40 25
Cash and cash equivalents (excluding overdrafts) 21 560 592

2,392 2,376
Non-current assets classified as held for sale 31 117 294

2,509 2,670

Total assets
7,292 7,213

F-5
~~F-5~~
~~CONSOLIDATED BALANCE SHEET (CONTINUED)~~
~~AS AT~~Consolidated Balance Sheet (Continued)
As at 31 ~~DECEMBER 2005~~
(December 2007
All figures in £ ~~millions)~~millions

Notes 2005 2004 2003

Liabilities

Non-current liabilities

Financial liabilities—Borrowings 21 (1,703 ) (1,714 ) (1,349 )
Financial liabilities—Derivative financial instruments 16 (22 ) — —
Deferred income tax liabilities 14 (204 ) (139 ) (140 )
Retirement benefit obligations 24 (389 ) (408 ) (364 )
Provisions for other liabilities and charges 22 (31 ) (43 ) (59 )
Other liabilities 23 (151 ) (99 ) (70 )

(2,500 ) (2,403 ) (1,982 )
Current liabilities

Trade and other liabilities 23 (974 ) (868 ) (943 )
Financial liabilities — Borrowings 21 (256 ) (109 ) (578 )
Current income tax liabilities (104 ) (89 ) (54 )
Provisions for other liabilities and charges 22 (33 ) (14 ) (18 )

(1,367 ) (1,080 ) (1,593 )
Liabilities directly associated with non-current assets classified as held for sale — (81 ) —

Total liabilities
(3,867 ) (3,564 ) (3,575 )

Net assets
3,733 3,014 3,161

Equity

Share capital 25 201 201 201
Share premium 25 2,477 2,473 2,469
Other reserves 26 (328 ) (623 ) (410 )
Retained earnings 26 1,214 749 709

Total equity attributable to equity holders of the Company
3,564 2,800 2,969
Minority interest 169 214 192

Total equity
3,733 3,014 3,161

Notes 2007 2006

Liabilities

Non-current liabilities

Financial liabilities — Borrowings 22 (1,049 ) (1,148 )
Financial liabilities — Derivative financial instruments 17 (16 ) (19 )
Deferred income tax liabilities 14 (287 ) (245 )
Retirement benefit obligations 25 (95 ) (250 )
Provisions for other liabilities and charges 23 (44 ) (29 )
Other liabilities 24 (190 ) (162 )

(1,681 ) (1,853 )
Current liabilities

Trade and other liabilities 24 (1,050 ) (998 )
Financial liabilities — Borrowings 22 (559 ) (595 )
Current income tax liabilities (96 ) (74 )
Provisions for other liabilities and charges 23 (23 ) (23 )

(1,728 ) (1,690 )
Liabilities directly associated with non-current assets classified as held for sale 31 (9 ) (26 )

Total liabilities
(3,418 ) (3,569 )

Net assets
3,874 3,644

Equity

Share capital 27 202 202
Share premium 27 2,499 2,487
Treasury shares 28 (216 ) (189 )
Other reserves 29 (514 ) (592 )
Retained earnings 29 1,724 1,568

Total equity attributable to equity holders of the Company
3,695 3,476
Minority interest 179 168

Total equity
3,874 3,644

These financial statements have been approved for issue by the board of directors on ~~26 February 2006~~13 March 2008 and signed on its behalf by
Robin Freestone,~~Rona Fairhead,~~ Chief financial officer
F-6
~~CONSOLIDATED CASH FLOW STATEMENT~~
~~YEAR ENDED~~Consolidated Cash Flow Statement
Year ended 31 ~~DECEMBER 2005~~
(December 2007
All figures in £ ~~millions)~~millions

Notes 2005 2004 2003

Cash flows from operating activities

Cash generated from operations 29 875 705 531
Interest paid (101 ) (98 ) (87 )
Tax paid (65 ) (45 ) (44 )

Net cash generated from operating activities
709 562 400

Cash flows from investing activities

Acquisition of subsidiaries, net of cash acquired 27 (246 ) (41 ) (60 )
Acquisition of joint ventures and associates (7 ) (10 ) (5 )
Purchase of property, plant and equipment (PPE) (76 ) (101 ) (79 )
Proceeds from sale of PPE 29 3 4 8
Purchase of intangible assets (24 ) (24 ) (26 )
Investment in pre-publication (222 ) (181 ) (173 )
Purchase of other financial assets (2 ) (1 ) (3 )
Disposal of subsidiaries, net of cash disposed 28 376 7 (3 )
Disposal of joint ventures and associates 54 24 57
Disposal of other financial assets — 17 —
Interest received 29 13 11
Dividends received from joint ventures and associates 14 12 10

Net cash used in investing activities
(101 ) (281 ) (263 )

Cash flows from financing activities

Proceeds from issue of ordinary shares 25 4 4 5
Purchase of treasury shares (21 ) (10 ) (1 )
Proceeds from borrowings — 414 235
Short-term investments (acquired)/repaid — (5 ) 1
Other borrowings — 59 (13 )
Repayments of borrowings (79 ) (524 ) (159 )
Finance lease principal payments (3 ) (2 ) (3 )
Dividends paid to Company’s shareholders 10 (205 ) (195 ) (188 )
Dividends paid to minority interests (17 ) (2 ) (19 )

Net cash used in financing activities
(321 ) (261 ) (142 )
Effects of exchange rate changes on cash and cash equivalents 13 (4 ) 45

Net increase in cash and cash equivalents
300 16 40

Cash and cash equivalents at beginning of year 544 528 488

Cash and cash equivalents at end of year
20 844 544 528

Notes 2007 2006 2005

Cash flows from operating activities

Net cash generated from operations 33 659 621 653
Interest paid (109 ) (106 ) (101 )
Tax paid (87 ) (59 ) (65 )

Net cash generated from operating activities
463 456 487

Cash flows from investing activities

Acquisition of subsidiaries, net of cash acquired 30 (472 ) (363 ) (246 )
Acquisition of joint ventures and associates (4 ) (4 ) (7 )
Purchase of property, plant and equipment (PPE) (86 ) (68 ) (76 )
Proceeds from sale of PPE 33 14 8 3
Purchase of intangible assets (33 ) (29 ) (24 )
Purchase of other financial assets — — (2 )
Disposal of subsidiaries, net of cash disposed 32 469 10 376
Disposal of joint ventures and associates — — 54
Interest received 19 24 29
Dividends received from joint ventures and associates 32 45 14

Net cash used in investing activities
(61 ) (377 ) 121

Cash flows from financing activities

Proceeds from issue of ordinary shares 27 12 11 4
Purchase of treasury shares (72 ) (36 ) (21 )
Proceeds from borrowings 272 84 —
Liquid resources acquired (15 ) (24 ) —
Repayment of borrowings (391 ) (145 ) (79 )
Finance lease principal payments (2 ) (3 ) (3 )
Dividends paid to Company’s shareholders 10 (238 ) (220 ) (205 )
Dividends paid to minority interests (10 ) (15 ) (17 )

Net cash used in financing activities
(444 ) (348 ) (321 )
Effects of exchange rate changes on cash and cash equivalents 3 (44 ) 13

Net decrease in cash and cash equivalents
(39 ) (313 ) 300

Cash and cash equivalents at beginning of year 531 844 544

Cash and cash equivalents at end of year
21 492 531 844

F-7
~~F-7~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~
~~General information~~Notes to the Consolidated Financial Statements

General information
Pearson plc (the Company) and its subsidiaries (together the Group) are involved in the provision of information for the educational sector, consumer publishing and business information.

The Company is a limited liability company incorporated and domiciled in England. The address of its registered office is 80 Strand, London WC2R 0RL.

The Company has its primary listing on the London Stock Exchange but is also listed on the New York Stock Exchange.

These consolidated financial statements were approved for issue by the ~~Board~~board of ~~Directors~~directors on ~~26 February 2006.~~13 March 2008.
11.   Accounting policies

The principal accounting policies applied in the preparation of these consolidated financial statements are set out below.
a. Basis of preparation

These consolidated financial statements have been prepared in accordance with ~~EU-adopted~~ International Financial Reporting Standards (IFRS) and International Financial Reporting Interpretations Committee (IFRIC) interpretations as adopted by the European Union (EU) and with those parts of the Companies Act 1985and/or the Companies Act 2006 (as applicable) applicable to companies reporting under IFRS.
      ~~IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ has been applied in preparing these financial statements.~~ These consolidated financial statements are ~~the Group’s first financial statements to be~~also prepared in accordance with IFRS as ~~adopted~~issued by the ~~EU.~~
International Accounting Standards Board (IASB). In respect of the accounting standards applicable to the Group there is no difference between EU-adopted and IASB-adopted IFRS. The ~~policies set out below have been consistently applied~~Group transitioned from UK GAAP to all the years presented, with the exception of IAS 32 ‘Financial Instruments: Disclosure and Presentation’ and IAS 39 ‘Financial Instruments: Recognition and Measurement’ which have been applied with effect fromIFRS on 1 January ~~2005.~~2003.
~~Consolidated financial statements of Pearson plc until 31 December 2004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS.~~
      When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments.
      Note 34 describes how, in preparing these consolidated financial statements, the Directors have applied accounting standards as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1.
These consolidated financial statements have been prepared under the historical cost ~~convention.~~convention as modified by the revaluation of financial assets and liabilities (including derivative financial instruments) at fair value.

(1) Interpretations and amendments to published standards effective in 2007— The Group has adopted IFRS 7 ‘Financial Instruments: Disclosures’ from 1 January 2007. The impact of the standard has been to expand the disclosures provided in these financial statements regarding the Group’s financial instruments (see notes 15, 17, 20 and 22). The Group has also adopted Amendments to IAS 1 ‘Presentation of Financial Statements — Capital Disclosures’ which resulted in the presentation of its objectives, policies and processes for managing capital as set out in note 27.
In addition, IFRIC 10 ‘Interim Financial Reporting and Impairment’ is mandatory for the Group’s accounting periods beginning on or after 1 January 2007. Management assessed the relevance of this interpretation with respect to the Group’s operations and concluded that it is not relevant to the Group.
(2) Standards, interpretations and amendments to published standards that are not yet effective— The Group has decided to adopt IFRIC 14 ‘IAS 19 — The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’ before its effective date (1 January 2008). IFRIC 14 resulted in no change to the full recognition of the pension asset as disclosed in note 25.
The Group has not early adopted the following new pronouncements that are not yet effective:
• IFRS 8 ‘Operating Segments’ (effective for annual reporting periods beginning on or after 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;
• Amendment to IAS 23 ‘Borrowing Costs’ (effective for annual reporting periods beginning on or after 1 January 2009). The amendment to IAS 23 requires capitalisation of borrowing costs that relate to assets

F-8
Notes to the Consolidated Financial Statements (Continued)
that take a substantial period of time to get ready for use or sale, with the exception of assets measured at fair value or inventories manufactured or produced in large quantities on a repetitive basis;
• IFRIC 11 ‘Group and Treasury Share Transactions’ (effective for annual reporting periods beginning on or after 1 March 2007). IFRIC 11 addresses how to apply IFRS 2 Share-based Payment to share-based payment arrangements involving an entity’s own equity instruments or equity instruments of another entity in the same group.
Management is currently assessing the impact of these new standards and interpretations 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 13 ‘Customer Loyalty Programmes’ (effective for annual reporting periods beginning on or after 1 July 2008). IFRIC 13 explains how entities that grant loyalty award credits to customers should account for their obligations to provide free or discounted goods or services to customers who redeem award credits. As none of the Group entities operate a customer loyalty programme, IFRIC 13 is not relevant to the Group’s operations;
• IFRIC 12 ‘Service Concession Arrangements’ (effective for annual reporting periods beginning on or after 1 January 2008). IFRIC 12 addresses the accounting by private-sector entities that, by contract with a government, participate in developing, financing, operating, and maintaining infrastructure assets relating to public services traditionally provided by governments. As none of the Group entities participate in these activities, IFRIC 12 is not relevant to the Group.
(3) Critical accounting assumptions and judgements— The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting ~~estimates.~~assumptions. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas ~~involving~~requiring a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements, are ~~disclosed below~~discussed in ~~‘Critical~~the relevant accounting ~~assumptions and judgements’.~~
~~F-8~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Interpretations and amendments to published standards effective in 2005~~policies under the following headings:
~~The following amendments and interpretations to standards are mandatory for the Group’s accounting periods beginning on or after 1 January 2005:~~
• ~~IFRIC 2 ‘Members’ Shares in Co-operative Entities and Similar Instruments’;~~

•   Intangible assets:
Goodwill
•   Intangible assets: ~~SIC 12 (Amendment) ‘Consolidation — Special Purpose Entities’; and~~ Pre-publication assets
•   Royalty advances
•   Taxation ~~IAS 39 (Amendment) ‘Transition and Recognition of Financial Assets and Financial Liabilities’.~~
      ~~Management assessed the relevance of these amendments and interpretations with respect to the Group’s operations and concluded that they are not relevant to the Group.~~
~~Standards, interpretations and amendments to published standards that are not yet effective~~
      Certain new standards, amendments and interpretations to existing standards have been published that are mandatory for the Group’s accounting periods beginning on or after 1 January 2006 or later periods but which the Group has not early adopted. These are as follows:
• IFRS 7 ‘Financial Instruments: Disclosures’ (effective from 1 January 2007). IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk.

•   Employee benefits: • A complementary amendment to IAS 1 ‘Presentation of Financial Statements — Capital Disclosures’(effective from 1 January 2007). The amendment to IAS 1 introduces disclosures about the level of an entity’s capital and how it manages capital. Management is currently assessing the impact of IFRS 7 and the complementary amendment to IAS 1 on the Group’s financial statements; andPension obligations
•   Revenue recognition
• IFRIC 4 ‘Determining whether an Arrangement contains a Lease’ (effective from 1 January 2006). IFRIC 4 requires the determination whether an arrangement is or contains a lease to be based on the substance of the arrangement. Management is currently assessing the impact of IFRIC 4 on the Group’s operations, but does not expect it to be significant.
      ~~In addition, management assessed the relevance of the following amendments and interpretations with respect to the Group’s operations and concluded that they are not relevant to the Group:~~
• ~~IAS 39 (Amendment) ‘Cash Flow Hedge Accounting of Forecast Intragroup Transactions’ (effective from 1 January 2006);~~
• ~~IAS 39 (Amendment) ‘The Fair Value Option’ (effective from 1 January 2006);~~
• ~~IAS 39 (Amendment) and IFRS 4 (Amendment) ‘Financial Guarantee Contracts’ (effective from 1 January 2006);~~
• ~~IFRS 1 (Amendment) ‘First-time Adoption of International Financial Reporting Standards’ (effective from 1 January 2006);~~
• ~~IFRS 6 ‘Exploration for and Evaluation of Mineral Resources’ (effective from 1 January 2006);~~
• ~~IFRIC 5 ‘Rights of Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds’ (effective from 1 January 2006); and~~
• ~~IFRIC 6 ‘Liabilities arising from Participating in a Specific Market — Waste Electrical and Electronic Equipment’ (effective from 1 December 2005).~~
b. Consolidation

(1) ~~Subsidiaries~~Business combinations— ~~Subsidiaries are entities over which the Group has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights.~~
~~F-9~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Subsidiaries are fully consolidated from the date on which control is transferred to the Group and are de-consolidated from the date that control ceases.~~
The purchase method of accounting is used to account for the acquisition of subsidiaries by the Group. ~~Acquisitions made prior to the date of transition to IFRS were accounted for in accordance with UK GAAP (see note 34).~~ The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition.
Where the settlement of consideration payable is deferred, or contingent on future events, the fair value of the deferred component is determined by discounting the amount payable or probable to be paid to its present value using an appropriate discount rate.
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.

F-9
Notes to the Consolidated Financial Statements (Continued)
For material acquisitions, the fair value of the acquired intangible assets is determined by an external, independent valuer. The excess of the cost of acquisition over the fair value of the Group’s share of the identifiable net assets acquired ~~after the identification of purchased intangible assets,~~ is recorded as goodwill. See note 1e~~(1)~~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 ~~ventures,~~venturers, under a contractual arrangement. Associates are entities over which the Group has significant influence but not the power to control the financial and operating policies, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in joint ventures and associates are accounted for by the equity method ~~of accounting~~ and are initially recognised at cost. ~~The Group’s investment in associates includes related goodwill.~~

The Group’s share of its joint ventures’ and associates’ post-acquisition profits or losses is recognised in the income statement, and its share of post-acquisition movements in reserves is recognised in reserves. The Group’s share of its joint ventures’ and associates’ results is recognised as a component of operating profit as these operations form part of the core publishing business of the Group and an integral part of existing wholly owned businesses. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in a joint venture or associate equals or exceeds its interest in the joint venture or associate, the Group does not recognise further losses, unless the Group has incurred obligations or made payments on behalf of the joint venture or associate.
c. Foreign currency translation

(1) Functional and presentation currency— Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The consolidated financial statements are presented in ~~Sterling,~~sterling, which is the Company’s functional and presentation currency.

(2) Transactions and balances— Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of 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 as from 1 January 2005.~~equity.

(3) Group companies— The results and financial position of all Group ~~entities~~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.~~
~~F-10~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

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 ~~intercompany~~inter-company loan balances, which are not intended to be repaid ~~for~~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.

F-10

Notes to the Consolidated Financial Statements (Continued)
At the date of transition to IFRS the cumulative translation differences ~~for~~in respect of foreign operations have been deemed to be zero.
Any gains and losses on disposals of foreign operations will exclude translation differences ~~arising~~that arose prior to the transition date.

The principal overseas currency for the Group is the US ~~Dollar.~~dollar. The average rate for the year against ~~Sterling~~sterling was ~~$1.81 (2004: $1.83; 2003: $1.63)~~$2.00 (2006: $1.84; 2005: $1.81) and the year end rate was ~~$1.72 (2004: $1.92; 2003: $1.79)~~$1.99 (2006: $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 assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
The carrying value of an asset is written down to its recoverable amount if the carrying value of the asset is greater than its estimated recoverable amount.
e.         ~~Buildings (freehold) 20–50 years~~
      ~~Buildings (leasehold) 50 years (or over the period of the lease if shorter)~~
      ~~Plant and equipment 3–20 years~~
      ~~The asset’s residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.~~
e. Intangible assets

(1) Goodwill— 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 and joint ventures is included in investments in ~~associates.~~ associates and joint ventures.
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-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 ~~costs~~ ~~— Costs directly associated with~~stage are capitalised if the ~~production of identifiable and unique software products, where it is probable that they will generate~~Group expects economic benefits ~~exceeding costs, are recognised as intangible assets~~from the development. Capitalisation in the application development stage begins once the Group can reliably measure the expenditure attributable to the software development and ~~are~~has demonstrated its intention to complete and use the software. Internally developed software is amortised on a straight-line basis over ~~their~~its estimated useful ~~lives not exceeding ten years from when~~life of between three and five years.

F-11
Notes to the ~~software is available for use.~~Consolidated Financial Statements (Continued)

~~(3)~~(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 ~~and~~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 ~~30 years.~~20 years, using a depreciation method that reflects the pattern of their consumption.

~~(4)~~(5) Pre-publication ~~costs~~assets— 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~~recognised as current intangible assets where the title will generate probable future economic benefits and costs can be measured reliably. ~~These costs~~Pre-publication assets are ~~amortized~~amortised upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected operating life cycle of the title, with a higher proportion of the ~~amortization~~amortisation taken in the earlier years. The investment in pre-publication assets has been disclosed as part of ~~the investing activities~~cash generated from operations in the cash flow ~~statement.~~
~~F-11~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~statement (see note 33).
The assessment of the recoverability of pre-publication assets 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 18.
f. Other financial assets
~~Up to 31 December 2004~~ — Other financial assets include investments in companies other than subsidiaries and associates and other securities. Financial fixed assets are recorded at historical cost less provisions for diminution in value.
~~From 1 January 2005~~ — Other financial assets, designated as available for sale investments, are non-derivative financial assets measured at estimated fair value. Changes in the fair value are recorded in equity in the fair value reserve. On the subsequent disposal of the asset, the net fair value gains or losses are taken through the income statement.
g. Inventories

Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first in first out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, ~~and~~ other direct costs and related production overheads. Net realisable value is the estimated selling price in the ordinary course of business, less estimated costs necessary to make the sale. ~~Provision is~~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 ~~bring~~adjust the ~~amount down~~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. ~~This represents the operating cycle of consumer publishing titles.~~ Royalty advances which will be consumed after one year are held in non-current assets.
i. Newspaper development costs

Investment in the development of newspaper titles consists of measures to increase the volume and geographical spread of circulation. The measures include additional and enhanced editorial content, extended distribution and remote printing. These ~~extra~~ costs ~~arising~~ are expensed as incurred as they do not meet the criteria under IAS 38 to be capitalised as intangible assets.

F-12
Notes to the Consolidated Financial Statements (Continued)
j. Cash and cash equivalents

Cash and cash equivalents in the ~~statement of~~ cash ~~flows~~flow statement include cash in hand, deposits held at call with banks, other ~~short term~~short-term highly liquid investments with original maturities of three months or less, and bank overdrafts. Bank overdrafts are ~~shown within~~included in borrowings in current liabilities in the balance sheet.
Short-term deposits and marketable securities with maturities of greater than three months do not qualify as cash and cash equivalents. Movements on these financial instruments are classified as cash flows from financing activities in the cash flow statement as these amounts are used to offset the borrowings of the Group.
k. Share capital

Ordinary shares are classified as equity.

Incremental costs directly attributable to the issue of new shares or options are shown in equity as a deduction, net of tax, from the proceeds.

Where any Group company purchases the Company’s equity share capital (Treasury shares) the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the Company’s equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable ~~incremental~~ transaction costs and the related income tax effects, is included in equity attributable to the Company’s equity holders.
~~F-12~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
l. Borrowings

Borrowings are recognised initially at fair value, which is proceeds received net of transaction costs incurred. Borrowings are subsequently stated at amortised cost with any difference between the proceeds (net of transaction costs) and the redemption value being recognised in the income statement over the period of the borrowings using the effective interest method. ~~From 1 January 2005, accrued~~Accrued interest is ~~also~~ included as part of ~~the borrowing.~~borrowings. Where a debt instrument is in a fair value hedging relationship, an adjustment is made to ~~the bond~~its carrying value to reflect the hedged risk. Interest on borrowings is expensed as incurred.
m. Derivative financial instruments
~~Upto 31 December 2004~~ — Amounts payable or receivable in respect of interest rate derivatives are accrued within net interest payable over the period of the contract. Where the derivative instrument is terminated early, the gain or loss is spread over the remaining maturity of the original instrument. Where the underlying exposure ceases to exist, any termination gain or loss is taken to the income statement. Foreign currency borrowings together with their related cross currency derivatives are carried in the balance sheet at the relevant exchange rates at the balance sheet date. Gains or losses in respect of the hedging of overseas subsidiaries are taken to reserves. Gains or losses arising from foreign exchange contracts are taken to the income statement in line with the transactions which they are hedging.
~~From 1 January 2005~~ — Derivatives are ~~initially~~ recognised at fair value ~~at the date of transition to IAS 39 or, if later, on the date a derivative is entered into. Derivatives are subsequently~~and remeasured at ~~their fair value.~~each balance sheet date. The fair value of derivatives ~~has been~~is determined by using market data and the use of established estimation techniques such as discounted ~~cashflow~~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 immediately in finance income or finance costs in the income ~~statement immediately.~~statement.

F-13
Notes to the Consolidated Financial Statements (Continued)
n. Taxation

Current tax is ~~recognized~~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 in the consolidated financial statements.~~amounts. Deferred income tax is determined using tax rates ~~(and laws)~~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.
~~F-13~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
Current and deferred tax are recognised in the income statement, except when the tax relates to items charged or credited directly to equity, in which case the tax is also ~~recognized~~recognised in equity.
o. ~~Employee benefits~~
~~(1) Retirement benefit obligations~~ — The Group has elected to early adopt the amendment to IAS 19 “Employee Benefits’ with effect from the date of transition to IFRS. The liability in respect of defined benefit pension plans is the present value of the defined benefit obligations at the balance sheet date minus the fair value of plan assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting estimated future cash flows using yields on high quality corporate bonds which have terms to maturity approximating the terms of the related liability.
      Actuarial gains and losses arising from differences between actual and expected returns on plan assets, experience adjustments on liabilities and changes in actuarial assumptions are recognised immediately in the statement of recognised income and expense.
      The service cost, representing benefits accruing over the year, is included as an operating cost and the unwinding of the discount rate on the scheme liabilities and the expected return on scheme assets as a financing charge or financing income.
      ~~Obligations for contributions to defined contribution pension plans are recognised as an expense in the income statement as incurred.~~
~~(2) Other post-retirement obligations~~ — The Group provides certain healthcare and life assurance benefits. The principal plans are unfunded. The expected costs of these benefits are accrued over the period of employment, using an accounting methodology which is the same as that for defined benefit pension plans. The liabilities and costs relating to other post-retirement obligations are assessed annually by independent qualified actuaries.
~~(3) Share-based compensation~~ — The Group has a number of employee option and performance share schemes. The fair value of options granted is recognised as an employee expense after taking into account the Company’s best estimate of the number of awards expected to vest. Fair value is measured at the date of grant and is spread over the vesting period of the instrument. The fair value of the options granted is measured using whichever of the Black-Scholes, Binomial and Monte Carlo model is most appropriate to the award. Any proceeds received are credited to share capital and share premium when the options are exercised. The Group has applied IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the date of transition to IFRS.
p. ~~Provisions~~
      Provisions are recognized when the Group has a present legal or constructive obligation as a result of past events, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are discounted to present value where the effect is material.
      ~~The Group recognises a provision for deferred consideration in the period that an acquisition is made and the Group becomes legally committed to making the payment.~~
      ~~The Group recognises a provision for integration and reorganisation costs in the period in which the Group becomes legally or constructively committed to making the payment.~~
      The Group recognises a provision for onerous lease contracts when the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under the contract. The provision is based on the present value of future payments for surplus leased properties under non-cancellable operating leases, net of estimated sub-leasing revenue.
~~F-14~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
q. ~~Revenue recognition~~
      Revenue comprises the fair value of the consideration received or receivable for the sale of goods and services net of value-added tax and other sales taxes, rebates and discounts, and after eliminating sales within the Group. Revenue is recognized as follows:
      Revenue from the sale of books is recognized when title passes. Anticipated returns are estimated based primarily on historical return rates. Circulation and advertising revenue is recognised when the newspaper or other publication is published. Subscription revenue is recognised on a straight-line basis over the life of the subscription.
      Where a contractual arrangement consists of two or more separate elements that can be provided to customers either on a stand-alone basis or as an optional extra, such as the provision of supplementary materials with textbooks, revenue is recognised for each element as if it were an individual contractual arrangement.
      Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognised as performance occurs. Certain of these arrangements, either as a result of a single service spanning more than one reporting period or where the contract requires the provision of a number of services that together constitute a single project, are treated as long-term contracts with revenue recognised on a percentage of completion basis. Losses on contracts are recognised in the period in which the loss first becomes foreseeable. Contract losses are determined to be the amount by which estimated total costs of the contract exceed the estimated total revenues that will be generated by the contract.
      On certain contracts, where the Group acts as agent, only commissions and fees receivable for services rendered are recognised as revenue. Any third party costs incurred on behalf of the principal that are rechargeable under the contractual arrangement are not included in revenue.
r. ~~Leases~~
      Leases of property, plant and equipment where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalised at the commencement of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of finance charges, are included in other long-term payables. The interest element of the finance cost is charged to the income statement over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The property, plant and equipment acquired under finance leases is depreciated over the shorter of the useful life of the asset or the lease term.
      Leases where a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases by the lessee. Payments made under operating leases (net of any incentives received from the lessor) are charged to the income statement on a straight-line basis over the period of the lease.
s. ~~Dividends~~
      Dividends are recorded in the Group’s financial statements in the period in which they are approved by the Company’s shareholders. Interim dividends are recorded in the period in which they are approved and paid.
~~F-15~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
t. ~~Non-current assets held for sale and discontinued operations~~
      Non-current assets are classified as assets held for sale and stated at the lower of carrying amount and fair value less costs to sell if it is intended to recover their carrying amount principally through a sale transaction rather than through continuing use. No depreciation is charged in respect of non-current assets classified as held for sale.
u. ~~Trade receivables~~
      ~~Trade receivables are recognised at fair value less provision for bad and doubtful debts and anticipated future sales returns (see also note 1q).~~
~~Critical accounting assumptions and judgements~~
      The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting assumptions. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas requiring a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements, are discussed below.
~~Critical accounting estimates and assumptions~~
~~(1) Revenue recognition~~ — Revenue from the sale of books is recognized when title passes. A provision for anticipated returns is made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period. The provision for sales returns is set out in note 19.
~~(2) Pre-publication costs~~ — The assessment of the useful life of pre-publication costs and the calculation of amortisation involve a significant amount of judgement based on historical trends and management estimation of their future potential sales, in accordance with the accounting policy stated in note 1e~~(4).~~ The overstatement of useful lives could result in excess amounts being carried forward as intangible assets that would otherwise have been written off to the income statement in an earlier period. Reviews are performed regularly to estimate recoverability of pre-publication costs. The carrying amount of pre-publication costs is set out in note 17.
~~(3) Royalty advances~~ — The realisable value of royalty advances relies on a degree of management judgement in determining the profitability of individual author contracts, in accordance with the accounting policy stated in note 1h. If the estimated realisable value of author contracts is overstated then this will have an adverse effect on operating profits as these excess amounts will be written off. The carrying amount of royalty advances is set out in note 19.
~~(4) Income taxes~~ — The Group is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the estimates in relation to the worldwide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.
~~(5) Goodwill~~ ~~— The Group tests annually whether goodwill has suffered any impairment, in accordance with the accounting policy stated in note 1e~~~~(1).~~ ~~The recoverable amounts of cash generating units have been determined based on value in use calculations. These calculations require the use of estimates (see note 12).~~
~~F-16~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Critical judgements in applying the Group’s accounting policies~~
~~(1) Revenue recognition~~ — Revenue from multi-year contractual arrangements is recognised as performance occurs. The assumptions, risks, and uncertainties inherent in long-term contract accounting can affect the amounts and timing of revenue and related expenses reported.
~~(2) Retirement benefit obligations~~ — The determination of the pension cost and defined benefit obligation of the Group’s defined benefit pension schemes depends on the selection of certain assumptions, which include the discount rate, inflation rate, salary growth, longevity and expected return on scheme assets. Differences arising from actual experience or future changes in assumptions will be reflected in subsequent periods.
~~(3) Deferred income tax~~ — Deferred tax assets and liabilities require management judgement in determining the amounts to be recognised. In particular, significant judgement is 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.
~~Financial risk management~~
o.   Employee benefits
(1) Pension obligations— The Group’s treasury policy governs the management of financial risks within the Group. The policy, which is approved by the treasury committee, covers interest rate risk, liquidity and refinancing risk, counterparty risk and foreign currency risk. In accordance with the treasury policy, the Group actively monitors and manages its financial risk exposures. The policy permits the use of financial instruments such as derivatives, where appropriate. The policy only permits transactions related to underlying positions and speculative transactions are not permitted.
~~Interest rate risk~~ ~~— A change in market interest rates can cause fluctuations~~retirement benefit asset/obligation recognised in the ~~Group’s net income or financial position. The Group is predominantly funded through bonds issued at fixed rates and nearly all of these bonds have been swapped to a floating rate for~~balance sheet represents the ~~term~~present value of the ~~debt. The Group’s policy (as updated in September 2005) requires that interest rates on its net debt position are fixed for~~defined benefit obligation, less the ~~next four years such that the fixed rate portion is within a range~~fair value of 65% to 40% in the first year, with the lower end of the range declining by 10% each year such that the fixed rate portion falls within a range of 65% to 10% in year four. The Group also uses derivatives to change the currency profile of its debt and to alter the timing of floating interest rate resets in order to comply with its policy. The Group manages the derivatives and debt to achieve policy objectives on a portfolio basis. The Group designates derivatives as hedges under IAS 39 where hedge accounting is possible, so long as a designation will not have an adverse effect on the balancing of the portfolio.
~~Liquidity and refinancing risk~~ — The Group’s funding objective is to ensure that committed funding is available to the Group at a reasonable cost, with an extended maturity profile and that funding is available from diverse sources. To assist with the diversity of funding objective, the Group has ratings with Moody’s and Standard & Poor’s, which provides greater access to international capital markets.
~~Counterparty risk~~ — The Group’s risk of loss on deposits or derivative contracts with individual banks is managed in part through the use of counterparty limits reflecting published credit ratings. Exposures to individual counterparties are monitored on a regular basis. Where appropriate, ISDA Master Agreements permitting the netting of transactions in the event of counterparty failure are entered into with derivative counterparties.
~~Foreign currency risk~~ — The Group has operations overseas and is therefore exposed to movements in foreign currencies, particularly the US dollar. For transactional foreign exchange exposure, the policy allows the use of derivatives where appropriate. The Group mainly converts foreign currencies at spot rate and had no cash flow hedges in placeplan assets at the balance sheet date. ~~Translational foreign exchange exposure~~The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of ~~more significance~~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.
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 assets 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 expected costs of post-retirement healthcare and life assurance benefits are accrued over the period of employment, using a similar accounting methodology as for defined benefit

F-14
Notes to the ~~Group. It seeks~~Consolidated Financial Statements (Continued)
pension obligations. The liabilities and costs relating to ~~offset this exposure through its policy~~material other post-retirement obligations are assessed annually by independent qualified actuaries.
(3) Share-based payments —The fair value of ~~aligning approximately~~options or shares granted under the ~~currency composition~~Group’s share and option plans is recognised as an employee expense after taking into account the Group’s best estimate of ~~its core~~the number of awards expected to vest. Fair value is measured at the date of grant and is spread over the vesting period of the option or share. The fair value of the options granted is measured using an option model that 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 if the Group has a present legal or constructive obligation as a result of past events, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are discounted to present value where the effect is material.
The Group recognises a provision for deferred consideration in the period in which the payment of the deferred consideration is probable.
The Group recognises a provision for onerous lease contracts when the expected benefits to be derived from a contract are less than the unavoidable costs of meeting the obligations under the contract. The provision is based on the present value of future payments for surplus leased properties under non-cancellable operating leases, net ~~borrowings~~of estimated sub-leasing revenue.
q.   Revenue recognition
Revenue comprises the fair value of the consideration received or receivable for the sale of goods and services net of value-added tax and other sales taxes, rebates and discounts, and after eliminating sales within the Group.
Revenue from the sale of books is recognised when title passes. A provision for anticipated returns is made based primarily on historical return rates. If these estimates do not reflect actual returns in future periods then revenues could be understated or overstated for a particular period.
Circulation and advertising revenue is recognised when the newspaper or other publication is published. Subscription revenue is recognised on a straight-line basis over the life of the subscription.
Where a contractual arrangement consists of two or more separate elements that can be provided to customers either on a stand-alone basis or as an optional extra, such as the provision of supplementary materials with ~~its forecast operating profit. This policy~~textbooks, revenue is recognised for each element as if it were an individual contractual arrangement.
Revenue from multi-year contractual arrangements, such as contracts to process qualifying tests for individual professions and government departments, is recognised as performance occurs. 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 total costs of the contract exceed the estimated total revenues that will be generated by the contract.
On certain contracts, where the Group acts as agent, only ~~applies~~commissions and fees receivable for services rendered are recognised as revenue. Any third party costs incurred on behalf of the principal that are rechargeable under the contractual arrangement are not included in revenue.

F-15
Notes to the Consolidated Financial Statements (Continued)
Income from recharges of freight and other activities which are incidental to the normal revenue generating activities is included in other income.
r.   Leases
Leases of property, plant and equipment where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalised at the commencement of the lease at the lower of the fair value of the leased property and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges 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 income statement over the lease period to produce a constant periodic rate of interest on the remaining balance of the liability for each period. The property, plant and equipment acquired under finance leases is depreciated over the shorter of the useful life of the asset or the lease term.
Leases where a ~~currency accounts for more than 15% of Group operating profit and currently is only applicable to the~~
~~F-17~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~US dollar. The Group uses its dollar denominated debt and the foreign exchange~~significant portion of ~~certain cross currency rate derivatives~~the risks and rewards of ownership are retained by the lessor are classified as ~~net investment hedges~~operating leases by the lessee. Payments made under operating leases (net of ~~foreign operations. Unremitted profits~~any incentives received from the lessor) are ~~not hedged with foreign exchange contracts,~~charged to the income statement on a straight-line basis over the period of the lease.
s.   Dividends
Dividends are recorded in the Group’s financial statements in the period in which they are approved by the Company’s shareholders. Interim dividends are recorded in the period in which they are approved and paid.
t.   Non-current assets held for sale and discontinued operations
Non-current assets are classified as assets held for sale and stated at the ~~Company judges~~lower of carrying amount and fair value less costs to sell if it ~~inappropriate~~is intended to ~~hedge non-cash flow translational exposure with cash flow instruments.~~
~~2     Segment information~~recover their carrying amount principally through a sale transaction rather than through continuing use. No depreciation is charged in respect of non-current assets classified as held for sale. Amounts relating to non-current assets held for sale are classified as discontinued operations in the income statement where appropriate.

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, ~~business is~~ the Group’s primary segment reporting ~~segment. At 31 December 2005 the~~format is by business. The Group is organised into the following five business segments:
School— publisher of textbooks and web-based learning tools, provider of testing and software services for primary ~~business segments, School,~~ 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).The~~— 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

F-16
Notes to the Consolidated Financial Statements (Continued)
meet the criteria for classification as a ~~“segment”~~‘segment’ under IFRS. For more detail on the services and products included in each business segment refer to Item 4 of this Form20-F.
~~Primary reporting format — business segments~~

Higher FT 2005
School Education Professional Penguin Publishing IDC Corporate Group

(All figures in £ millions)
Continuing operations

Sales (external) 1,295 779 589 804 332 297 — 4,096
Sales (inter-segment) — — — 16 — — — 16

Operating profit before joint ventures and associates 138 156 44 60 49 75 — 522
Share of results of joint ventures and associates 4 — 1 — 9 — — 14

Operating profit
142 156 45 60 58 75 — 536

Finance costs (132 )

Finance income �� 62
Profit before tax
466

Income tax (124 )

Profit for the year from continuing operations
342

Reconciliation to adjusted operating profit

Operating profit 142 156 45 60 58 75 — 536
Amortisation of acquired intangibles 5 — — — 1 5 — 11
Other net gains and losses — — — — (40 ) — — (40 )
Other net finance costs of associates — — — — 2 — — 2
Adjusted operating profit — continuing operations 147 156 45 60 21 80 — 509

Segment assets 2,067 1,402 1,705 960 154 291 985 7,564
Joint ventures 6 — — 2 4 — — 12
Associates 6 — — — 18 — — 24

Total assets
2,079 1,402 1,705 962 176 291 985 7,600

Total liabilities
(557 ) (341 ) (263 ) (280 ) (336 ) (109 ) (1,981 ) (3,867 )

Other segment items

Capital expenditure (notes 11, 12 and 17) 114 96 43 34 14 19 — 320
Depreciation (note 11) 26 8 17 7 11 11 — 80
Amortisation (notes 12 and 17) 91 78 20 24 3 5 — 221

Primary reporting format — business segments

2007
Higher
FT
Interactive

Notes School Education Professional Publishing Data Penguin Corporate Group
All figures in £ millions

Continuing operations

Sales (external) 1,537 793 298 344 344 846 — 4,162
Sales (inter-segment) 1 — — — — 19 — 20

Operating profit before joint ventures and associates 169 159 26 34 90 73 — 551
Share of results of joint ventures and associates 6 — 1 16 — — — 23

Operating profit
175 159 27 50 90 73 — 574

Finance costs 7 (150 )
Finance income 7 44

Profit before tax
468

Income tax 8 (131 )

Profit for the year from continuing operations
337

Reconciliation to adjusted operating profit

Operating profit 175 159 27 50 90 73 — 574
Amortisation of acquired intangibles 28 2 1 6 7 1 — 45

Adjusted operating profit — continuing operations 203 161 28 56 97 74 — 619

Segment assets 2,780 1,742 318 397 330 937 651 7,155
Joint ventures 13 5 — — 4 — 2 — 11
Associates 13 3 1 — 5 — — — 9

Assets — continuing operations 2,788 1,743 318 406 330 939 651 7,175
Assets — discontinued operations — — 117 — — — — 117

Total assets
2,788 1,743 435 406 330 939 651 7,292

Total liabilities
(798 ) (266 ) (130 ) (251 ) (129 ) (220 ) (1,624 ) (3,418 )

Other segment items

Capital expenditure 11, 12, 18 147 98 20 28 19 44 — 356
Depreciation 11 22 11 9 9 10 7 — 68
Amortisation 12, 18 124 80 11 9 8 30 — 262

F-17
~~F-18~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

Higher FT 2004
School Education Professional Penguin Publishing IDC Corporate Group

(All figures in £ millions)
Continuing operations

Sales (external) 1,087 729 507 786 318 269 — 3,696
Sales (inter-segment) — — — 15 — — — 15

Operating profit before joint ventures and associates 109 133 42 46 4 62 — 396
Share of results of joint ventures and associates 3 — — 1 4 — — 8

Operating profit
112 133 42 47 8 62 — 404

Finance costs (96 )
Finance income 17

Profit before tax
325

Income tax (63 )

Profit for the year from continuing operations
262

Reconciliation to adjusted operating profit

Operating profit 112 133 42 47 8 62 — 404
Amortisation of acquired intangibles — — — — — 5 — 5
Other net gains and losses (4 ) (4 ) (2 ) 5 (4 ) — — (9 )

Adjusted operating profit — continuing operations 108 129 40 52 4 67 — 400

Segment assets 1,860 1,224 1,345 892 502 247 461 6,531
Joint ventures 7 — — 5 2 — — 14
Associates 5 — — — 28 — — 33

Total assets
1,872 1,224 1,345 897 532 247 461 6,578

Total liabilities
(439 ) (286 ) (212 ) (259 ) (435 ) (110 ) (1,823 ) (3,564 )

Other segment items

Capital expenditure (notes 11,12 and 17) 104 79 62 36 15 12 — 308
Depreciation (note 11) 25 9 16 9 16 9 — 84
Amortisation (notes 12 and 17) 74 65 18 29 2 5 — 193

2006
Higher
FT
Interactive

Notes School Education Professional Publishing Data Penguin Corporate Group
All figures in £ millions

Continuing operations

Sales (external) 1,455 795 280 280 332 848 — 3,990
Sales (inter-segment) 1 — — — — 18 — 19

Operating profit before joint ventures and associates 161 161 23 13 82 58 — 498
Share of results of joint ventures and associates 6 — 1 17 — — — 24

Operating profit
167 161 24 30 82 58 — 522

Finance costs 7 (133 )
Finance income 7 59

Profit before tax
448

Income tax 8 (4 )

Profit for the year from continuing operations
444

Reconciliation to adjusted operating profit

Operating profit 167 161 24 30 82 58 — 522
Adjustment to goodwill on recognition of pre-acquisition deferred tax — — — — — 7 — 7
Amortisation of acquired intangibles 17 — 1 2 7 1 — 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 25 27 89 66 — 552

Segment assets 2,684 1,347 580 317 314 954 703 6,899
Joint ventures 13 5 — — 4 — 3 — 12
Associates 13 4 — — 4 — — — 8

Assets — continuing operations 2,693 1,347 580 325 314 957 703 6,919
Assets — discontinued operations — — 294 — — — — 294

Total assets
2,693 1,347 874 325 314 957 703 7,213

Total liabilities
(662 ) (268 ) (177 ) (300 ) (131 ) (269 ) (1,762 ) (3,569 )

Other segment items

Capital expenditure 11, 12, 18 124 88 30 19 20 38 — 319
Depreciation 11 21 8 19 9 13 7 — 77
Amortisation 12, 18 117 78 21 4 7 34 — 261

F-18
~~F-19~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

Higher FT 2003
School Education Professional Penguin Publishing IDC Corporate Group

(All figures in £ millions)
Continuing operations

Sales (external) 1,149 770 503 840 315 273 — 3,850
Sales (inter-segment) — — 1 15 — — — 16

Operating profit before joint ventures and associates 112 140 33 81 (28 ) 66 — 404
Share of results of joint ventures and associates 2 — — 1 (1 ) — — 2

Operating profit
114 140 33 82 (29 ) 66 — 406

Finance costs (100 )
Finance income 7

Profit before tax
313

Income tax (61 )

Profit for the year from continuing operations
252

Reconciliation to adjusted operating profit

Operating profit 114 140 33 82 (29 ) 66 — 406
Amortisation of acquired intangibles — — — — — 4 — 4
Other net gains and losses 2 2 1 1 — — — 6

Adjusted operating profit — continuing operations 116 142 34 83 (29 ) 70 — 416

Segment assets 2,072 1,157 1,387 907 358 240 551 6,672
Joint ventures 6 — — 4 2 — — 12
Associates 5 — — — 47 — — 52

Total assets
2,083 1,157 1,387 911 407 240 551 6,736

Total liabilities
(458 ) (318 ) (158 ) (398 ) (203 ) (113 ) (1,927 ) (3,575 )

Other segment items

Capital expenditure (notes 11, 12 and 17) 101 65 21 47 26 17 — 277
Depreciation (note 11) 26 9 13 6 19 12 — 85
Amortisation (notes 12 and 17) 68 58 18 39 2 5 — 190

2005
Higher
FT
Interactive

Notes School Education Professional Publishing Data Penguin Corporate Group
All figures in £ millions

Continuing operations

Sales (external) 1,295 779 238 249 297 804 — 3,662
Sales (inter-segment) — — — — — 16 — 16

Operating profit before joint ventures and associates 138 156 9 45 75 60 — 483
Share of results of joint ventures and associates 4 — 1 9 — — — 14

Operating profit
142 156 10 54 75 60 — 497

Finance costs 7 (132 )
Finance income 7 62

Profit before tax
427

Income tax 8 (108 )

Profit for the year from continuing operations
319

Reconciliation to adjusted operating profit

Operating profit 142 156 10 54 75 60 — 497
Amortisation of acquired intangibles 5 — — 1 5 — — 11
Other net gains and losses 5 — — — (40 ) — — — (40 )
Other net finance costs of associates — — — 2 — — — 2

Adjusted operating profit — continuing operations 147 156 10 17 80 60 — 470

Segment assets 2,347 1,648 1,179 154 291 960 985 7,564
Joint ventures 6 — — 4 — 2 — 12
Associates 6 — — 18 — — — 24

Total assets
2,359 1,648 1,179 176 291 962 985 7,600

Total liabilities
(557 ) (341 ) (263 ) (336 ) (109 ) (280 ) (1,981 ) (3,867 )

Other segment items

Capital expenditure 114 96 43 14 19 34 — 320
Depreciation 26 8 17 11 11 7 — 80
Amortisation 91 78 20 3 5 24 — 221

In 2007, sales from the provision of goods were £3,086m (2006: £3,031m; 2005: £2,873m) and sales from the provision of services were £1,076m (2006: £959m; 2005: £789m). 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, market pricing, 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 ~~result.~~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, retirement benefit assets and deferred taxation and exclude cash and cash equivalents and derivative assets. Segment liabilities comprise operating liabilities and retirement benefit obligations and exclude borrowings and derivative liabilities. Corporate assets and liabilities comprise cash and cash equivalents, marketable securities,
F-19
Notes to the Consolidated Financial Statements (Continued)
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)~~18).

Property, plant and equipment and intangible assets acquired through business ~~combinations~~combination were ~~£111m (2004: £16m; 2003: £54m)(see notes 11, 12 and 17)~~£226m (2006: £173m) (see note 30). Capital expenditure, depreciation and amortisation
~~F-20~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~includes~~ include amounts relating to discontinued operations. ~~In April 2005, Pearson sold its 79% interest in~~Discontinued operations relate to Recoletos, ~~Grupo de Communicación S.A. This operation is now disclosed as a ‘discontinued’ operation. The related assets~~Government Solutions, Datamark, Les Echos, and ~~liabilities are disclosed within~~ the ~~FT Publishing segment in 2004 and 2003.~~Data Management business (see note 3).
~~Secondary reporting format — geographical segments~~
      ~~Although the~~The Group’s business segments are managed on a worldwide basis ~~they all~~and operate in the following main ~~geographical~~geographic areas:

Sales Total assets Capital expenditure

2005 2004 2003 2005 2004 2003 2005 2004 2003

(All figures in £ millions)
Continuing operations

European countries 963 835 768 1,711 1,112 1,003 60 79 63
North America 2,717 2,504 2,742 5,476 4,716 5,015 242 208 188
Asia Pacific 300 263 255 325 302 301 13 10 11
Other countries 116 94 85 52 43 37 2 3 4

Total
4,096 3,696 3,850 7,564 6,173 6,356 317 300 266

Discontinued operations (European countries) 27 190 169 — 358 316 3 8 11
Joint ventures and associates — — — 36 47 64 — — —

Total
4,123 3,886 4,019 7,600 6,578 6,736 320 308 277

Sales Total assets Capital expenditure
2007 2006 2005 2007 2006 2005 2007 2006 2005
All figures in £ millions

Continuing operations

European countries 1,102 1,003 868 1,827 1,608 1,711 90 70 63
North America 2,591 2,585 2,388 4,867 4,908 5,476 248 231 242
Asia Pacific 351 295 300 365 327 325 14 12 13
Other countries 118 107 106 96 56 52 2 2 2

Total
4,162 3,990 3,662 7,155 6,899 7,564 354 315 320

Discontinued operations

European countries 83 103 122 — 9 — 1 1 —
North America 78 314 329 117 281 — 1 2 —
Other countries 6 16 10 — 4 — — 1 —

Total
167 �� 433 461 117 294 — 2 4 —
Joint ventures and associates — — — 20 20 36 — — —

Total
4,329 4,423 4,123 7,292 7,213 7,600 356 319 320

Sales are allocated based on the country in which the customer is located. This does not differ materially from the location where the order is received. ~~Total assets and capital expenditure are allocated to where the assets are located.~~
~~F-21~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
33.   Discontinued operations

Discontinued operations relate to the following disposals made in the year (see note 32):
• Government Solutions (sold 15 February 2007)
• Datamark (acquired with eCollege and subsequently sold on 31 July 2007)
• Les Echos (sold 24 December 2007)
The results of Government Solutions (previously included in the Professional segment) and Les Echos (previously included in the FT Publishing segment) have been included in discontinued operations for both 2006 and 2007 and have been consolidated up to the date of sale. Datamark was sold immediately following its acquisition as part of the eCollege transaction and consequently none of the results for this business have been consolidated.
On 22 February 2008 the Group completed the sale of its Data Management business (previously included in the Professional segment) and this business has been included in discontinued operations for the full year in both 2006 and 2007. In ~~April~~anticipation of the loss on sale, an impairment to held for sale goodwill has been charged to the income statement in 2007.

F-20
Notes to the Consolidated Financial Statements (Continued)
The assets and liabilities of the Data Management business have been reported as held for sale in the 31 December 2007 balance sheet. At 31 December 2006 held for sale assets and liabilities relate to Government Solutions (see note 31).
Discontinued operations in 2005 ~~Pearson sold its~~also relate ot the sale of Pearson’s 79% interest in Recoletos Grupo de ~~Communicación S.A. to Retos Cartera, a consortium of investors. This operation is disclosed as a ‘discontinued’ operation (see note 28).~~Communicacíon S. A..

An analysis of the ~~result~~results and cash flows of discontinued operations isare as follows:

2005 2004 2003

(All figures in £ millions)
Sales 27 190 169

Operating (loss)/profit (3 ) 26 43
Net finance income — 3 3

(Loss)/profit before tax
(3 ) 29 46

Attributable tax benefit/(expense) 1 (7 ) (23 )

(Loss)/profit after tax
(2 ) 22 23
Profit on disposal of discontinued operations (note 28) 306 — —
Attributable tax expense (2 ) — —

Profit for the year from discontinued operations
302 22 23

Operating cash flows (6 ) 12 11
Investing cash flows — 17 47
Financing cash flows — — (92 )

Total cash flows
(6 ) 29 (34 )

2007
Government
Data

Solutions Management Les Echos Datamark Total
All figures in £ millions

Sales 29 56 82 — 167

Operating profit 2 12 1 — 15
Goodwill impairment — (97 ) — — (97 )

(Loss)/profit before tax
2 (85 ) 1 — (82 )

Attributable tax expense (1 ) (4 ) — — (5 )

(Loss)/profit after tax
1 (89 ) 1 — (87 )
Profit/(loss) on disposal of discontinued operations before tax (19 ) — 165 — 146
Attributable tax (expense)/benefit (93 ) — — 7 (86 )

(Loss)/profit for the year from discontinued operations
(111 ) (89 ) 166 7 (27 )

Operating cash flows (8 ) 11 4 — 7
Investing cash flows — (1 ) 4 — 3
Financing cash flows (4 ) (10 ) (7 ) — (21 )

Total cash flows
(12 ) — 1 — (11 )

F-21
Notes to the Consolidated Financial Statements (Continued)

2006
Government
Data

Solutions Management Les Echos Total
All figures in £ millions

Sales 286 61 86 433

Operating profit 22 13 5 40

Profit before tax
22 13 5 40

Attributable tax expense (8 ) (5 ) (2 ) (15 )

Profit after tax
14 8 3 25
Profit/(loss) on disposal of discontinued operations before tax — — — —
Attributable tax expense — — — —

Profit for the year from discontinued operations
14 8 3 25

Operating cash flows 20 9 4 33
Investing cash flows (8 ) (2 ) — (10 )
Financing cash flows (1 ) (7 ) (7 ) (15 )

Total cash flows
11 — (3 ) 8

2005
Government
Data

Solutions Management Les Echos Recoletos Total
All figures in £ millions

Sales 288 63 83 27 461

Operating profit 20 15 4 (3 ) 36

Profit before tax
20 15 4 (3 ) 36

Attributable tax expense (8 ) (6 ) (2 ) 1 (15 )

Profit after tax
12 9 2 (2 ) 21
Profit/(loss) on disposal of discontinued operations before tax — — — 306 306
Attributable tax expense — — — (2 ) (2 )

Profit for the year from discontinued operations
12 9 2 302 325

Operating cash flows 22 9 1 (6 ) 26
Investing cash flows (13 ) (2 ) 1 — (14 )
Financing cash flows (1 ) (7 ) (21 ) — (29 )

Total cash flows
8 — (19 ) (6 ) (17 )

F-22
Notes to the Consolidated Financial Statements (Continued)
44.   Operating expenses

2007 2006 2005
All figures in £ millions

By function:

Cost of goods sold 1,910 1,841 1,713

Operating expenses

Distribution costs 264 288 281
Administrative and other expenses 1,538 1,462 1,309
Other income (101 ) (99 ) (84 )

Total operating expenses
1,701 1,651 1,506

Total
3,611 3,492 3,219

Notes 2007 2006 2005
All figures in £ millions

By nature:

Utilisation of inventory 19 732 702 754
Depreciation of property, plant and equipment 11 65 68 73
Amortisation of intangible assets — Pre-publication 18 192 210 192
Amortisation of intangible assets — Other 12 70 48 26
Employee benefit expense 6 1,288 1,225 1,128
Operating lease rentals 129 122 108
Other property costs 122 121 84
Royalties expensed 365 360 362
Advertising, promotion and marketing 195 190 186
Information technology costs 70 71 81
Other costs 484 474 309
Other income (101 ) (99 ) (84 )

Total
3,611 3,492 3,219

During the year the Group obtained the following services from the Group’s auditor:

2007 2006 2005
All figures in £ millions

Fees payable to the Company’s auditor for the audit of parent company and consolidated accounts 1 1 1
The audit of the Company’s subsidiaries pursuant to legislation 2 4 3
Other services pursuant to legislation 1 4 —
Tax services 2 1 1
Other services 1 1 2

Total
7 11 7

F-23
Notes to the Consolidated Financial Statements (Continued)
Reconciliation between audit and non-audit service fees is shown below:

2007 2006 2005
All figures in £ millions

Group audit fees including fees for attestation under section 404 of the Sarbanes-Oxley Act 4 9 4
Non-audit fees 3 2 3

Total audit fees
7 11 7

Other services pursuant to legislation represent 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 attestation under section 404 of the Sarbanes-Oxley Act.
Tax services include services related to tax planning and various other tax advisory services.
Other services include services related to the disposal of the Data Management business, due diligence on acquisitions and advisory services in relation to information technology and section 404.
5.   Other net gains and losses

2005 2004 2003

(All figures in £
millions)
Profit on sale of interest in MarketWatch 40 — —
Other items — 9 (6 )

Total other net gains and losses
40 9 (6 )

2007 2006 2005
All figures in £ millions

Profit on sale of interest in MarketWatch — — 40

Other net gains and losses represent profits and losses on the sale of subsidiaries, joint ventures, associates and other financial assets that are included within continuing operations.
~~F-22~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
56.   ~~Operating expenses~~Employee information

2005 2004 2003

(All figures in £ millions)
By function:

Cost of goods sold 2,022 1,789 1,846

Operating expenses

Distribution costs 249 201 206
Administrative and other expenses 1,384 1,365 1,439
Other income (41 ) (46 ) (51 )

Total operating expenses
1,592 1,520 1,594

Total
3,614 3,309 3,440

By nature:

Utilisation of inventory 768 700 710
Depreciation of property, plant and equipment (note 11) 80 78 79
Amortisation of intangible assets — pre-publication (note 17) 192 168 158
Amortisation of intangible assets — other (note 12) 29 25 32
Employee benefit expense (note 6) 1,273 1,154 1,156
Operating lease rentals 119 126 148
Other property costs 88 73 61
Royalties expensed 363 331 354
Advertising, promotion and marketing 202 181 193
Information technology costs 84 76 85
Other costs 457 443 515
Other income (41 ) (46 ) (51 )

Total
3,614 3,309 3,440

~~During the year the Group obtained the following services from the Group’s auditor:~~

2005 2004 2003

(All figures in £ millions)
Statutory audit 4 3 3
Audit-related regulatory reporting services 1 1 —
Non-audit services:
Tax compliance 1 1 1
Tax advisory — 1 1
Other non-audit services 1 — —

Notes 2007 2006 2005
All figures in £ millions

Employee benefit expense

Wages and salaries (including termination benefits and restructuring costs) 1,087 1,035 954
Social security costs 100 101 91
Share-based payment costs 26 30 25 23
Pension costs — defined contribution plans 25 39 36 34
Pension costs — defined benefit plans 25 31 29 25
Other post-retirement benefits 25 1 (1 ) 1

1,288 1,225 1,128

      Audit-related regulatory reporting services were £700,000 (2004: £600,000; 2003: £nil). This relates to services in respect of the transition to IFRS and Sarbanes-Oxley section 404 compliance services. Other non-audit services were £700,000 (2004: £100,000; 2003: £400,000) and mainly relate to due diligence work performed at IDC.
      Non-audit fees in the UK were £1.0m (2004: £1.0m; 2003: £300,000) and were in respect of tax advisory, tax compliance and other advisory services. The remainder of the non-audit fees related to overseas subsidiaries.

F-24
~~F-23~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
6 ~~Employee information~~

2005 2004 2003

(All figures in £ millions)
Employee benefit expense

Wages and salaries (including termination benefits and restructuring costs) 1,088 983 988
Social security costs 101 89 87
Share-based payment costs (note 24) 23 25 29
Pension costs — defined contribution plans (note 24) 35 32 28
Pension costs — defined benefit plans (note 24) 25 24 23
Other post-retirement benefits (note 24) 1 1 1

1,273 1,154 1,156

The details of the emoluments of the directors of Pearson plc are shown ~~on pages 21 to 37.~~

2005 2004 2003

(Average number employed)
School 10,133 10,403 9,348
Higher Education 4,196 4,087 3,912
Professional 8,342 7,491 6,434
Penguin 4,051 4,085 4,318
FT Publishing 1,952 1,989 2,283
IDC 1,956 1,826 1,628
Other 1,573 1,365 928

Continuing operations
32,203 31,246 28,851

Discontinued operations
— 1,840 1,733

32,203 33,086 30,584

~~F-24~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~in Item 6 of this Form20-F.

2007 2006 2005
Average number employed
Employee numbers

School 12,906 11,064 10,133
Higher Education 5,098 4,368 4,196
Professional 3,458 3,204 3,259
Penguin 4,163 3,943 4,051
FT Publishing 2,083 1,766 1,434
Interactive Data 2,300 2,200 1,956
Other 1,614 1,669 1,573

Continuing operations
31,622 28,214 26,602

Discontinued operations
1,070 6,127 5,601

32,692 34,341 32,203

77.   Net finance costs

2005 2004 2003

(All figures in £ millions)
Interest payable (98 ) (91 ) (91 )
Finance costs re employee benefits (7 ) (5 ) (9 )
Net foreign exchange losses (9 ) — —
Other losses on financial instruments in a hedging relationship:
— fair value hedges (1 ) — —
— net investment hedges — — —
Other losses on financial instruments not in a hedging relationship:
— derivatives (17 ) — —

Finance costs
(132 ) (96 ) (100 )

Interest receivable 21 17 7
Net foreign exchange gains 21 — —
Other gains on financial instruments in a hedging relationship:
— fair value hedges 1 — —
— net investment hedges 3 — —
Other gains on financial instruments not in a hedging relationship:
— amortisation of transitional adjustment on bonds 7 — —
— derivatives 9 — —

Finance income
62 17 7

Net finance costs
(70 ) (79 ) (93 )

Analysed as:

Net interest payable (77 ) (74 ) (84 )
Finance costs re employee benefits (7 ) (5 ) (9 )

Net finance costs reflected in adjusted earnings (84 ) (79 ) (93 )
Other net finance income 14 — —

Total net finance costs
(70 ) (79 ) (93 )

Notes 2007 2006 2005
All figures in £ millions

Interest payable (114 ) (117 ) (98 )
Net foreign exchange losses (25 ) (2 ) (9 )
Finance cost in respect of employee benefits 25 — — (7 )
Other losses on financial instruments in a hedging relationship:
— fair value hedges (1 ) — (1 )
— net investment hedges (1 ) (2 ) —
Other losses on financial instruments not in a hedging relationship:
— derivatives (9 ) (12 ) (17 )

Finance costs
(150 ) (133 ) (132 )

Interest receivable 19 23 21
Finance income in respect of employee benefits 25 10 4 —
Net foreign exchange gains 8 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 1 8 7
— derivatives 6 3 9

Finance income
44 59 62

Net finance costs
(106 ) (74 ) (70 )

Analysed as:

Net interest payable (95 ) (94 ) (77 )
Finance income/(costs) in respect of employee benefits 25 10 4 (7 )

Net finance costs reflected in adjusted earnings (85 ) (90 ) (84 )
Other net finance (costs)/income (21 ) 16 14

Total net finance costs
(106 ) (74 ) (70 )

F-25
Notes to the Consolidated Financial Statements (Continued)
The £1m net loss on fair value hedges comprises a £20m loss on the underlying bonds offset by a £19m gain on the related derivative financial instruments.
88.   Income tax

2005 2004 2003

(All figures in £ millions)
Current tax

Charge in respect of current year (76 ) (65 ) (45 )
Adjustments in respect of prior years (1 ) 25 13

Total current tax charge
(77 ) (40 ) (32 )

Deferred tax

In respect of timing differences (66 ) (46 ) (72 )
Adjustments in respect of prior years 19 23 43

Total deferred tax charge (note 14)
(47 ) (23 ) (29 )

Total tax charge
(124 ) (63 ) (61 )

~~F-25~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

Notes 2007 2006 2005
All figures in £ millions
Current tax

Charge in respect of current year (71 ) (81 ) (60 )
Recognition of previously unrecognised trading losses — 23 —
Other adjustments in respect of prior years 27 35 (1 )

Total current tax charge
(44 ) (23 ) (61 )

Deferred tax

In respect of timing differences (96 ) (73 ) (66 )
Recognition of previously unrecognised capital losses — 76 —
Recognition of previously unrecognised trading losses — 37 —
Other adjustments in respect of prior years 9 (21 ) 19

Total deferred tax (charge)/benefit
14 (87 ) 19 (47 )

Total tax charge
(131 ) (4 ) (108 )

The tax on the Group’s profit before tax differs from the theoretical amount that would arise using the UK tax rate as follows:

2005 2004 2003

(All figures in £ millions)
Profit before tax 466 325 313
Tax calculated at UK rate (140 ) (97 ) (94 )
Effect of overseas tax rates (22 ) (8 ) (6 )
Joint venture and associate income reported net of tax 5 2 —
Income not subject to tax 16 6 11
Expenses not deductible for tax purposes (9 ) (5 ) (7 )
Utilisation of previously unrecognised tax losses 11 5 15
Unutilised tax losses (3 ) (14 ) (36 )
Prior year adjustments 18 48 56

Total tax charge
(124 ) (63 ) (61 )

UK (26 ) 5 (13 )
Overseas (98 ) (68 ) (48 )

Total tax charge
(124 ) (63 ) (61 )

Add back: tax benefit on other gains and losses (4 ) (36 ) (35 )
Add back: tax benefit on amortisation of acquired intangibles (4 ) (2 ) (1 )
Add back: tax charge on other finance income 3 — —

Adjusted income tax charge — continuing operations (129 ) (101 ) (97 )
Adjusted income tax charge — discontinued operations 1 (7 ) (19 )

Total adjusted income tax charge
(128 ) (108 ) (116 )

Tax rate reflected in adjusted earnings
30.3 % 30.9 % 32.5 %

2007 2006 2005
All figures in £ millions

Profit before tax 468 448 427
Tax calculated at UK rate (141 ) (135 ) (128 )
Effect of overseas tax rates (25 ) (17 ) (18 )
Joint venture and associate income reported net of tax 7 7 5
Income not subject to tax 3 5 16
Expenses not deductible for tax purposes (12 ) (18 ) (9 )
Utilisation of previously unrecognised tax losses 3 7 11
Recognition of previously unrecognised tax losses — 136 —
Unutilised tax losses (2 ) (3 ) (3 )
Prior year adjustments 36 14 18

Total tax charge
(131 ) (4 ) (108 )

UK (42 ) (15 ) (26 )
Overseas (89 ) 11 (82 )

Total tax charge
(131 ) (4 ) (108 )

The tax benefit on items charged to equity is as follows:

2005 2004 2003

(All figures in £ millions)
Deferred tax on stock options 3 4 —
Current tax on foreign exchange gains and losses 9 5 —

12 9 —

2007 2006 2005
All figures in £ millions

Share-based payments 7 2 3
Pension contributions and actuarial gains and losses 28 9 —
Net investment hedges and other foreign exchange gains and losses (6 ) 1 9

29 12 12

F-26
Notes to the Consolidated Financial Statements (Continued)
99.   Earnings per share
~~Basic~~

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

Diluted earnings per share is calculated by adjusting the weighted average number of ordinary shares to take account of all dilutive potential ordinary shares and adjusting the profit attributable, if applicable, to account for any tax consequences that might arise from conversion of those shares.
~~F-26~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

2005 2004 2003

(All figures in £ millions)
Earnings 624 262 252
Adjustments to exclude profit for the year from discontinued operations:
Profit for the year from discontinued operations (302 ) (22 ) (23 )
Minority interest share of above — 5 5

Earnings — continuing operations
322 245 234

Earnings 624 262 252

Weighted average number of shares (millions) 797.9 795.6 794.4
Effect of dilutive share options (millions) 1.1 1.1 0.9

Weighted average number of shares (millions) for diluted earnings 799.0 796.7 795.3

Earnings per share from continuing and discontinued operations

Basic 78.2 p 32.9 p 31.7 p
Diluted 78.1 p 32.9 p 31.7 p

Earnings per share from continuing operations

Basic 40.4 p 30.8 p 29.4 p
Diluted 40.3 p 30.8 p 29.4 p

Earnings per share from discontinued operations

Basic 37.8 p 2.1 p 2.3 p
Diluted 37.8 p 2.1 p 2.3 p

Notes 2007 2006 2005
All figures in £ millions

Profit for the year from continuing operations 337 444 319
Minority interest (26 ) (23 ) (20 )

Earnings from continuing operations
311 421 299

(Loss)/profit for the year from discontinued operations 3 (27 ) 25 325

Earnings
284 446 624

Weighted average number of shares (millions) 796.8 798.4 797.9
Effect of dilutive share options (millions) 1.3 1.5 1.1
Weighted average number of shares (millions) for diluted earnings 798.1 799.9 799.0

Earnings per share from continuing and discontinued operations 2007 2006 2005
Basic 35.6p 55.9p 78.2p
Diluted 35.6p 55.8p 78.1p

Earnings per share from continuing operations

Basic 39.0p 52.7p 37.5p
Diluted 39.0p 52.6p 37.4p

Earnings per share from discontinued operations

Basic (3.4p ) 3.2p 40.7p

1010.   Dividends

2005 2004 2003

(All figures in £ millions)
Final paid in respect of prior year 15.7p (2004: 14.8p; 2003: 14.3p) 125 119 115
Interim paid in respect of current year 10p (2004: 9.7p; 2003: 9.4p) 80 76 73

205 195 188

2007 2006 2005
All figures in £ millions

Final paid in respect of prior year 18.8p (2006: 17p; 2005: 15.7p) 150 136 125
Interim paid in respect of current year 11.1p (2006: 10.5p; 2005: 10p) 88 84 80

238 220 205

The directors are proposing a final dividend in respect of the financial year ~~ending~~ended 31 December ~~2005~~2007 of ~~17.0p~~20.5p per share which will absorb an estimated ~~£136m~~£164m of shareholders’ funds. It will be paid on 59 May ~~2006~~2008 to shareholders who are on the register of members on 711 April ~~2006.~~2008. These financial statements do not reflect this ~~dividend payable (see note 34~~k).dividend.

F-27
~~F-27~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
1111.   Property, plant and equipment

Assets in
Land and Plant and course of
buildings equipment construction Total

(All figures in £ millions)
Cost

At 1 January 2003
319 619 20 958
Exchange differences (19 ) (28 ) (3 ) (50 )
Additions 12 52 14 78
Disposals (15 ) (55 ) — (70 )
Acquisition through business combination 5 19 — 24
Disposal through business disposal (2 ) (6 ) — (8 )
Reclassifications 1 9 (10 ) —

At 31 December 2003
301 610 21 932

Exchange differences (9 ) (10 ) (1 ) (20 )
Additions 14 81 8 103
Disposals (13 ) (39 ) — (52 )
Acquisition through business combination 1 4 — 5
Disposal through business disposal (4 ) — — (4 )
Reclassifications — 13 (13 ) —
Transfer to non-current assets held for sale (14 ) (81 ) (2 ) (97 )

At 31 December 2004
276 578 13 867

Exchange differences 18 40 — 58
Transfers — 13 — 13
Additions 32 41 1 74
Disposals (5 ) (28 ) — (33 )
Acquisition through business combination 3 6 — 9
Reclassifications — 7 (7 ) —

At 31 December 2005
324 657 7 988

Assets in

Land and
Plant and
course of

buildings equipment construction Total
All figures in £ millions

Cost

At 1 January 2006 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

Exchange differences (2 ) — — (2 )
Additions 20 62 11 93
Disposals (24 ) (65 ) — (89 )
Acquisition through business combination — 27 — 27
Disposal through business disposal (1 ) (25 ) — (26 )
Reclassifications — 6 (6 ) —
Transfer to non-current assets held for sale (8 ) (14 ) — (22 )

At 31 December 2007
298 622 16 936

F-28
~~F-28~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

Assets in
Land and Plant and course of
buildings equipment construction Total

(All figures in £ millions)
Depreciation

At 1 January 2003 (104 ) (419 ) — (523 )
Exchange differences 10 17 — 27
Charge for the year (16 ) (69 ) — (85 )
Disposals 7 53 — 60
Acquisition through business combination — (14 ) — (14 )
Disposal through business disposal 1 4 — 5

At 31 December 2003
(102 ) (428 ) — (530 )

Exchange differences 4 5 — 9
Charge for the year (16 ) (68 ) — (84 )
Disposals 6 38 — 44
Acquisition through business combination — (4 ) — (4 )
Disposal through business disposal 4 — — 4
Transfer to non-current assets held for sale 2 47 — 49

At 31 December 2004
(102 ) (410 ) — (512 )

Exchange differences (7 ) (33 ) — (40 )
Charge for the year (17 ) (63 ) — (80 )
Disposals — 30 — 30
Acquisition through business combination — (2 ) — (2 )

At 31 December 2005
(126 ) (478 ) — (604 )

Carrying amounts

At 1 January 2003 215 200 20 435
At 31 December 2003 199 182 21 402
At 31 December 2004 174 168 13 355
At 31 December 2005
198 179 7 384

Assets in

Land and
Plant and
course of

buildings equipment construction Total
All figures in £ millions

Depreciation

At 1 January 2006 (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 )

Exchange differences — 1 — 1
Charge for the year (14 ) (54 ) — (68 )
Disposals 11 63 — 74
Acquisition through business combination — (16 ) — (16 )
Disposal through business disposal — 20 — 20
Transfer to non-current assets held for sale 5 10 — 15

At 31 December 2007
(126 ) (455 ) — (581 )

Carrying amounts

At 1 January 2006 198 179 7 384
At 31 December 2006 185 152 11 348
At 31 December 2007
172 167 16 355

Depreciation expense of ~~£19m (2004: £17m; 2003: £15m)~~£13m (2006: £18m) has been included in the income statement in cost of goods sold, ~~£7m (2004: £6m; 2003:~~£5m (2006: £6m) in distribution expenses and ~~£54m (2004: £55m; 2003: £58m)~~£50m (2006: £53m) in administrative and other expenses. In ~~2004 £6m (2003: £6m)~~2007 £3m (2006: £9m) relates to discontinued operations.

The Group leases certain equipment under a number of finance lease agreements. The net carrying amount of leased plant and equipment included within property, plant and equipment was ~~£3m (2004: £3m; 2003: £5m)~~£6m (2006: £4m).
F-29
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
1212.   Intangible assets

Acquired Other Total
publishing intangibles intangibles
Goodwill Software rights acquired acquired Total

(All figures in £ millions)
Cost

At 1 January 2003 3,610 146 — — — 3,756
Exchange differences (275 ) (10 ) — — — (285 )
Additions 113 26 — — — 139
Disposals (4 ) (2 ) — — — (6 )
Acquisition through business combination — — — 44 44 44

At 31 December 2003
3,444 160 — 44 44 3,648

Exchange differences (201 ) (8 ) — (3 ) (3 ) (212 )
Additions 22 24 — — — 46
Disposals (4 ) (11 ) — — — (15 )
Acquisition through business combination — — 10 5 15 15
Transfer to non-current assets held for sale (101 ) — — — — (101 )

At 31 December 2004
3,160 165 10 46 56 3,381

Exchange differences 345 15 2 4 6 366
Transfers — (13 ) — — — (13 )
Additions 155 24 — — — 179
Disposals (6 ) (10 ) — — — (16 )
Acquisition through business combination — — 56 33 89 89

At 31 December 2005
3,654 181 68 83 151 3,986

Acquired
Other
Total

publishing
intangibles
intangibles

Goodwill Software rights acquired acquired Total
All figures in £ millions

Cost

At 1 January 2006 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

Exchange differences (4 ) (2 ) 3 1 4 (2 )
Additions — 33 — — — 33
Disposals (34 ) (19 ) (3 ) — (3 ) (56 )
Acquisition through business combination 304 4 40 155 195 503
Transfer to non-current assets held for sale (194 ) — — — — (194 )

At 31 December 2007
3,343 217 136 348 484 4,044

F-30
~~F-30~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

Acquired Other Total
publishing intangibles intangibles
Goodwill Software rights acquired acquired Total

(All figures in £ millions)
Amortisation

At 1 January 2003 — (75 ) — — — (75 )
Exchange differences — 7 — — — 7
Charge for the year — (28 ) — (4 ) (4 ) (32 )
Disposals — 2 — — — 2
Acquisition through business combination — — — — — —

At 31 December 2003
— (94 ) — (4 ) (4 ) (98 )

Exchange differences — 8 — 1 1 9
Charge for the year — (20 ) — (5 ) (5 ) (25 )
Disposals — 11 — — — 11
Acquisition through business combination — — — — — —

At 31 December 2004
— (95 ) — (8 ) (8 ) (103 )

Exchange differences — (10 ) — — — (10 )
Charge for the year — (18 ) (5 ) (6 ) (11 ) (29 )
Disposals — 10 — — — 10
Acquisition through business combination — — — — — —

At 31 December 2005
— (113 ) (5 ) (14 ) (19 ) (132 )

Carrying amounts

At 1 January 2003 3,610 71 — — — 3,681
At 31 December 2003 3,444 66 — 40 40 3,550
At 31 December 2004 3,160 70 10 38 48 3,278

At 31 December 2005
3,654 68 63 69 132 3,854

Acquired
Other
Total

publishing
intangibles
intangibles

Goodwill Software rights acquired acquired Total
All figures in £ millions

Amortisation

At 1 January 2006 — (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 )

Exchange differences — 1 — 1 1 2
Charge for the year — (25 ) (17 ) (28 ) (45 ) (70 )
Disposals — 19 — — — 19
Acquisition through business combination — (2 ) — — — (2 )
Transfer to non-current assets held for sale — — — — — —

At 31 December 2007
— (142 ) (32 ) (56 ) (88 ) (230 )

Carrying amounts

At 1 January 2006 3,654 68 63 69 132 3,854
At 31 December 2006 3,271 66 81 163 244 3,581
At 31 December 2007
3,343 75 104 292 396 3,814

Other intangibles acquired include customer lists and relationships, software rights, technology, trade names and trademarks. Amortisation of ~~£4m (2004: £3m; 2003: £5m)~~£3m (2006: £4m) is included in the income statement in cost of ~~sales~~goods sold and ~~£25m (2004: £22m; 2003: £27m)~~£67m (2006: £47m) in administrative and other expenses. In 2007 £nil (2006: £3m) of software amortisation 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.
F-31

Notes to the Consolidated Financial Statements (Continued)
Goodwill is allocated to the Group’s cash-generating units identified according to the business segment.
~~F-31~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
Goodwill has been allocated as follows:

2005 2004 2003

(All figures in £ millions)
Higher Education 1,106 950 1,007
School Book 861 739 783
School Assessment and Testing 271 232 246
School Technology 385 330 350
Other Assessment and Testing 245 211 223
Other Government Solutions 234 201 213
Other Book 70 60 63

Pearson Education total
3,172 2,723 2,885

Penguin US 149 122 138
Penguin UK 146 146 146
Pearson Australia 45 42 44

Penguin total
340 310 328

IDC
138 123 127

FT Publishing
4 4 4

Recoletos
— — 100

Total goodwill
3,654 3,160 3,444

The Group has adopted IFRS 3 ‘Business Combinations’ with effect from the date of transition to IFRS. In accordance with IFRS 3, goodwill is no longer amortised but rather tested for impairment on an annual basis.

Notes 2007 2006
All figures in £ millions

Higher Education 1,031 780
School Curriculum (2006: School Book) 867 683
School Assessment and Information (2006: School Assessment and Testing) 540 342
School Technology — 356
Other Assessment and Testing 247 490
Technology and Business Publishing (2006: Other Book) 55 56

Pearson Education total
2,740 2,707

Penguin US 155 156
Penguin UK 111 114
Pearson Australia 52 44

Penguin total
318 314

Financial Times 12 4
Mergermarket 126 97
Interactive Data 147 149

FT Group total
285 250

Total goodwill — continuing operations
3,343 3,271

Goodwill held for sale 30 96 221

Total goodwill
3,439 3,492

Goodwill has been allocated for impairment purposes to ~~twelve cash generating units.~~11 cash-generating units (CGUs). During 2007, three CGUs, School Book, School Assessment and Testing and Other Book were renamed following the reorganisation of the School segment. The reorganisation resulted in the School Technology CGU being allocated between School Assessment and Information (formerly School Assessment and Testing) and School Curriculum (formerly School Book). The recoverable amount of each ~~cash generating unit~~CGU is based on value in use ~~calculations,~~calculations. Goodwill is tested for impairment annually. Other than goodwill there are no intangible assets with ~~the exception of IDC which is assessed on a market value basis.~~indefinite lives.

Key assumptions
The value in use calculations use cash flow projections based on financial budgets approved by management covering a five year period. The key assumptions used by management in the value in use calculations were:
Discount rate — The discount rate is based on the risk-free rate for government bonds, adjusted for a risk premium to reflect the increased risk in investing in equities. The risk premium adjustment is assessed for each specific cash-generating unit. The average pre-tax discount rates used are in the range of 10.5% to 12.0% for the Pearson Education businesses, 8.9% to 11.7% for the Penguin businesses and 10.4% to 17.2% for the FT Group 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 CGU operates and reflect the long-term growth prospects of the sectors in which the CGU 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.

F-32
Notes to the Consolidated Financial Statements (Continued)
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.
Sensitivities
The Group’s impairment review is sensitive to a change in the key assumptions used, most notably the discount rates and the perpetuity rates. Based on the Group’s sensitivity analysis, a reasonable possible change in a single factor will not cause impairment in any of the Group’s CGUs.
However, a significant adverse change in our key assumptions could result in an impairment in our School Curriculumand/or Penguin UK CGUs as their fair value currently exceeds their carrying value only by between 10% and 20%.
13.   ~~Discount rate~~ — The discount rate is based on the risk-free rate for government bonds, adjusted for a risk premium to reflect the increased risk in investing in equities. The risk premium adjustment is assessed for each specific cash generating unit. The average pre-tax discount rates used are in the range of 8.5% to 11.5% for the Pearson Education businesses, 8% to 13% for the Penguin businesses and 8.5% to 11.5% for the FT Publishing businesses.
~~Perpetuity growth rates~~ — The cash flows subsequent to the approval budget period are based upon the long-term historic growth rates of the underlying territories in which the cash generating unit operates and reflect the long-term growth prospects of the sectors in which the cash generating unit operates. The perpetuity growth rates used vary between 3.0% to 4.0%. The perpetuity growth rates are consistent with appropriate external sources for the relevant markets.
~~Cash flow growth rates~~ — The cash flow growth rates are derived from forecast sales growth taking into consideration past experience of operating margins achieved in the cash generating unit. Historically, such forecasts have been reasonably accurate.
      ~~The valuation of IDC is determined using an observable market price for each share. Other than goodwill there are no intangible assets with indefinite lives.~~
~~F-32~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
13 Investments in joint ventures and associates
Joint ventures

2005 2004 2003

(All figures in £ millions)
At beginning of year 14 12 12
Exchange differences (3 ) 1 4
Share of loss after tax (1 ) (5 ) (9 )
Dividends (4 ) (3 ) (2 )
Additions or further investment 6 9 7

At end of year
12 14 12

2007 2006
All figures in

£ millions

At beginning of year 12 12
Exchange differences — (3 )
Share of profit after tax 4 3
Dividends (8 ) (4 )
Additions and further investment 3 4

At end of year
11 12

Investments in joint ventures are accounted for byusing the equity method of accounting and are initially recognised at cost.

The aggregate of the Group’s share in its joint ventures, none of which are individually significant, are as follows:

2005 2004 2003

(All figures in £ millions)
Assets

Non-current assets 3 3 —
Current assets 26 19 18

Liabilities

Current liabilities (17 ) (8 ) (6 )

Net assets
12 14 12

Income 46 37 33
Expenses (47 ) (42 ) (42 )

Loss after income tax
(1 ) (5 ) (9 )

2007 2006
All figures in

£ millions

Assets

Non-current assets 3 3
Current assets 23 24

Liabilities

Current liabilities (15 ) (15 )

Net assets
11 12

Income 61 52
Expenses (57 ) (49 )

Profit after income tax
4 3

F-33
~~Associates~~Notes to the Consolidated Financial Statements (Continued)

2005 2004 2003

(All figures in £ millions)
At beginning of year 33 52 94
Share of profit after tax 15 15 13
Dividends (10 ) (9 ) (8 )
Loan repayment — — (2 )
Additions — 1 —
Disposals (14 ) (24 ) (45 )
Transfer to non-current assets held for sale — (2 ) —

At end of year
24 33 52

Associates

2007 2006
All figures in

£ millions

At beginning of year 8 24
Exchange differences (1 ) (1 )
Share of profit after tax 19 21
Dividends (24 ) (41 )
Additions 1 —
Distribution from associate in excess of carrying value 6 5

At end of year
9 8

Investments in associates ~~at 31 December 2005 include~~are accounted for using the equity method of accounting. There is no acquisition goodwill ~~of £nil (2004: £6m; 2003: £7m). The share of profit after tax includes £nil (2004: £2m; 2003: £2m)~~relating to the Group’s investments in ~~respect of discontinued operations.~~
~~F-33~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~associates.

The Group’s interests in its principal associates, all of which are unlisted, were as follows:

%
2005 Country of incorporation Interest held Assets Liabilities Revenues Profit

(All figures in £ millions)
The Economist Newspaper Ltd England 50 79 (67 ) 105 12
Other 42 (30 ) 49 3

Total
121 (97 ) 154 15

%
2004 Country of incorporation Interest held Assets Liabilities Revenues Profit

(All figures in £ millions)
The Economist Newspaper Ltd England 50 71 (62 ) 98 11
Other 42 (18 ) 192 4

Total
113 (80 ) 290 15

%
2003 Country of incorporation Interest held Assets Liabilities Revenues Profit

(All figures in £ millions)
The Economist Newspaper Ltd England 50 103 (101 ) 95 9
Other 81 (31 ) 139 4

Total
184 (132 ) 234 13

%

2007
Country of incorporation Interest held Assets Liabilities Revenues Profit
All figures in £ millions

The Economist Newspaper Ltd England 50 63 (63 ) 131 15
Other 30 (21 ) 56 4

Total
93 (84 ) 187 19

%

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

The interest held in associates is equivalent to voting rights.
1414.   Deferred income tax

2005 2004 2003

(All figures in £ millions)
Deferred tax assets

Deferred tax asset to be recovered after more than 12 months 343 318 313
Deferred tax asset to be recovered within 12 months 42 41 29

385 359 342

Deferred tax liabilities

Deferred tax liability to be settled after more than 12 months (204 ) (139 ) (140 )
Deferred tax liability to be settled within 12 months — — —

(204 ) (139 ) (140 )

Net deferred tax
181 220 202

2007 2006
All figures in

£ millions

Deferred income tax assets

Deferred income tax assets to be recovered after more than 12 months 262 288
Deferred income tax assets to be recovered within 12 months 66 129

328 417

Deferred income tax liabilities

Deferred income tax liabilities to be settled after more than 12 months (287 ) (245 )
Deferred income tax liabilities to be settled within 12 months — —

(287 ) (245 )

Net deferred income tax
41 172

Deferred income tax assets to be recovered within 12 months relate to the utilisation of losses in the US.

F-34
Notes to the Consolidated Financial Statements (Continued)
Deferred income tax assets and liabilities may be offset when there is a legally enforceable right to offset current tax assets against current income tax liabilities and when the deferred income taxes relate to the same fiscal authority. The Group has ~~unprovided~~unrecognised deferred income tax assets at 31 December ~~2005~~2007 in respect of UK losses ~~(£32m) and US losses (£37m) and has not recognised a~~of £34m (2006: £35m). None of these unrecognised deferred income tax asset on the net pension deficit on the basis that it is not sufficiently certain that suitable future profits will arise against which to offset the liability. The related unprovided deferred tax asset is £96m.assets have expiry dates associated with them.

The recognition of the deferred income tax assets is supported by management’s forecasts of the future profitability of the relevant business units.
~~F-34~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
The ~~gross~~ movement on the net deferred income tax account is as follows:

2005 2004 2003

(All figures in £
millions)
At beginning of year 220 202 255
Transition adjustment on adoption of IAS 39 5 — —
Exchange differences 21 (13 ) (34 )
Acquisition through business combination (21 ) — (15 )
Transfer between current and deferred taxation — 41 25
Income statement charge (note 8) (47 ) (23 ) (29 )
Tax benefit to equity (note 8) 3 4 —
Transfer to non-current assets held for sale — 9 —

At end of year
181 220 202

Notes 2007 2006
All figures in

£ millions

At beginning of year 172 181
Exchange differences (4 ) (16 )
Income statement (charge)/benefit 8 (87 ) 19
Acquisition through business combination 30 (45 ) (26 )
Disposal through business disposal 32 2 —
Tax benefit to equity 3 14

At end of year
41 172

The movement in deferred income tax assets and liabilities during the year is as follows:

Goodwill
Tax and
losses intangibles Other Total

(All figures in £ millions)
Deferred income tax assets

At 1 January 2003 131 57 186 374
Exchange differences (16 ) (4 ) (22 ) (42 )
Transfer between current and deferred taxation 25 — (17 ) 8
Income statement (charge)/release (27 ) (7 ) 36 2

At 31 December 2003
113 46 183 342

Exchange differences (10 ) (3 ) (11 ) (24 )
Transfer between current and deferred taxation 41 — (11 ) 30
Income statement release/(charge) 6 (6 ) 7 7
Tax benefit to equity — — 4 4

At 31 December 2004
150 37 172 359

Transition adjustment on adoption of IAS 39 — — 5 5
Exchange differences 16 4 18 38
Acquisition through business combination — — 1 1
Transfer between current and deferred taxation — — 23 23
Income statement charge (32 ) (6 ) (6 ) (44 )
Tax benefit to equity — — 3 3

At 31 December 2005
134 35 216 385

Capital
Trading
Goodwill and
Returns

losses losses intangibles provisions Other Total
All figures in £ millions

Deferred income tax asset

At 1 January 2006 — 134 35 83 133 385
Exchange differences — (17 ) (4 ) (10 ) (11 ) (42 )
Income statement benefit/(charge) 76 12 (6 ) (7 ) (12 ) 63
Tax benefit to equity — — — — 11 11
At 31 December 2006 76 129 25 66 121 417
Exchange differences — (5 ) — (1 ) (2 ) (8 )
Acquisition through business combination — 10 — — 1 11
Income statement (charge)/benefit (76 ) (47 ) (5 ) 14 19 (95 )
Tax benefit to equity — — — — 3 3

At 31 December 2007
— 87 20 79 142 328

Other deferred income tax assets include temporary differences on share-based payments, inventory, ~~sales returns~~retirement benefit obligations and other provisions.

F-35
~~F-35~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

Goodwill and
intangibles Other Total

(All figures in £ millions)
Deferred income tax liabilities

At 1 January 2003 (25 ) (94 ) (119 )
Exchange differences — 8 8
Acquisition through business combination (15 ) — (15 )
Transfer between current and deferred taxation — 17 17
Income statement charge (19 ) (12 ) (31 )

At 31 December 2003
(59 ) (81 ) (140 )

Exchange differences 8 3 11
Transfer between current and deferred taxation — 11 11
Income statement charge (8 ) (22 ) (30 )
Transfer to non-current assets held for sale — 9 9

At 31 December 2004
(59 ) (80 ) (139 )

Exchange differences (8 ) (9 ) (17 )
Acquisition through business combination (24 ) 2 (22 )
Transfer between current and deferred taxation — (23 ) (23 )
Income statement (charge)/release (26 ) 23 (3 )

At 31 December 2005
(117 ) (87 ) (204 )

Goodwill and

intangibles Other Total
All figures in £ millions

Deferred income tax liabilities

At 1 January 2006 (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 )

Exchange differences 3 1 4
Acquisition through business combination (56 ) — (56 )
Disposal through business disposal — 2 2
Income statement (charge)/benefit (12 ) 20 8
Tax benefit to equity — — —

At 31 December 2007
(214 ) (73 ) (287 )

Other deferred tax liabilities include temporary differences ~~on capital allowances~~in respect of depreciation and royalty advances.
1515.   ~~Other financial assets~~Financial instruments and risk management

2005 2004 2003

(All figures in £
millions)
At beginning of year 15 21 22
Exchange differences 1 (1 ) (3 )
Additions 4 5 3
Disposals (2 ) (8 ) (1 )
Transfer to non-current assets held for sale — (2 ) —

At end of year
18 15 21

~~Other~~
Treasury policy
The Group holds financial instruments for two principal purposes: to finance its operations and to manage the interest rate and currency risks arising from its operations and its sources of finance. The Group finances its operations by a mixture of cash flows from operations, short-term borrowings from banks and commercial paper markets, and longer term loans from banks and capital markets. The Group borrows principally in US dollars and sterling, at both floating and fixed rates of interest, using derivative financial instruments (‘derivatives’), where appropriate, to generate the desired effective currency profile and interest rate basis. The derivatives used for this purpose are principally rate swaps, rate caps and collars, currency rate 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. All the treasury policies remained unchanged throughout 2007. The audit committee and a group of external treasury advisers, receives reports on the Group’s treasury activities, policies and procedures. The treasury department is not a profit centre and its activities are subject to regular internal audit.
Interest rate risk management
The Group’s exposure to interest rate fluctuations on its borrowings is managed by borrowing on a fixed rate basis and by entering into rate swaps, rate caps and forward rate agreements. The Group’s policy objective has continued to be to set a target proportion of its forecast borrowings (taken at the year end, with cash netted against floating rate debt and before any adjustments for IFRS) to be hedged (i.e. fixed or capped at the year end) over the next four years, subject to a maximum of 65% and a minimum that starts at 40% and falls by 10% at each year end. At the end of 2007 the hedging ratio, on the above basis, was approximately 58%. A simultaneous 1% change on 1 January in the Group’s variable interest rates in each of US dollar, euro and sterling, taking into account forecast seasonal debt, would have a £6m effect on profit before tax.
F-36
Notes to the Consolidated Financial Statements (Continued)
Use of interest rate derivatives
The policy in the section above creates a group of derivatives, under which the Group is a payer of fixed rates and a receiver of floating rates. The Group also aims to avoid undue exposure to a single interest rate setting. Reflecting this objective, the Group has swapped its fixed rate bond issues to floating rate at their launch. This creates a second group of derivatives, under which the Group is a receiver of fixed rates and a payer of floating rates.
The Group’s accounting objective in its use of interest rate derivatives is to minimise the impact on the income statement of changes in the mark-to-market value of its derivative portfolio as a whole. It uses duration calculations to estimate the sensitivity of the derivatives to movements in market rates. The Group also identifies which derivatives are eligible for fair value hedge accounting (which reduces sharply the income statement impact of changes in the market value of a derivative). The Group then balances the total portfolio between hedge-accounted and pooled segments, so that the expected movement on the pooled segment is minimal.
Interest rate derivative sensitivity analysis
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.

2007
Net carrying

amount +1% change −1% change
£ millions

Interest rate derivatives — in a fair value hedge relationship 10 (24 ) 26
Interest rate derivatives — not in hedge relationship (1 ) 1 (1 )
Cross currency rate derivatives — in a net investment hedge relationship 17 — —
Cross currency rate derivatives — not in hedge relationship 9 — —

Total 35 (23 ) 25

2006
Net carrying

amount +1% change −1% change
£ millions

Interest rate derivatives — in a fair value hedge relationship 3 (28 ) 31
Interest rate derivatives — not in hedge relationship 7 1 (1 )
Cross currency rate derivatives — in a net investment hedge relationship 40 — —
Cross currency rate derivatives — not in hedge relationship 17 (1 ) 1

Total 67 (28 ) 31

Liquidity and refinancing risk management
The Group’s objective is to secure 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 ten years. At the end of 2007 the average maturity of gross borrowings was 4.6 years of which bonds represented 72% of these borrowings (up from 4.5 years and down from 90% respectively at the beginning of the year).
The Group believes that ready access to different funding markets also helps to reduce its liquidity risk, and that published credit ratings and published financial policies improve such access. All of the Group’s credit ratings

F-37
Notes to the Consolidated Financial Statements (Continued)
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’s policy is to strive to maintain a rating of Baa1/BBB+ 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 and cash flow to debt measures.
The Group also maintains undrawn committed borrowing facilities. During the year the Group extended the maturity date of its main revolving credit facility by one year and entered into a short-term bridge financing facility. At the end of 2007 the committed facilities amounted to £1,369m and their weighted average maturity was 3.2 years.
Analysis of group debt, including the impact of derivatives
The following tables analyse the Group’s sources of funding and the impact of derivatives on the Group’s debt instruments. Net borrowings fixed and floating rate stated after the impact of rate derivatives:

2007 2006
£ millions

Fixed rate 567 514
Floating rate 406 545

Total 973 1,059

Gross borrowings:

2007 2006
£ millions

Bank debt 458 177
Bonds 1,150 1,566

Total 1,608 1,743

Gross borrowings by currency:

2007
Currency
2006
As reported derivatives Combined Combined
£ millions

US dollar 1,251 150 1,401 1,253
Sterling 357 (150 ) 207 206
Euro — — — 284

Total 1,608 — 1,608 1,743

Financial counterparty risk management
The 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 within guidelines approved by the board. In addition, prior to their maturity in February 2007, for a currency rate swap that transformed a major part of the 6.125% Euro Bonds due 2007 into a US dollar liability, the Group entered into a mark-to-market agreement which significantly reduced the counterparty risk of that rate swap transaction.
Foreign currency risk management
Although the Group is based in the UK, it has its most significant investment in overseas operations. The most significant currency for the Group is the US dollar. The Group’s policy on routine transactional conversions

F-38
Notes to the Consolidated Financial Statements (Continued)
between currencies (for example, the collection of receivables, and the settlement of payables or interest) remains that these should be transacted at the relevant spot exchange rate. The majority of our operations are domestic within their country of operation. No unremitted profits are hedged with foreign exchange contracts, as the company judges it inappropriate to hedge non-cash flow translational exposure with cash flow instruments. However, the Group does seek to create a natural hedge of this exposure through its policy of aligning approximately the currency composition of its core net borrowings with its forecast operating profit before depreciation and amortisation. This policy aims to dampen the impact of changes in foreign exchange rates on consolidated interest cover and earnings.
The policy above applies only to currencies that account for more than 15% of Group operating profit before depreciation and amortisation, which currently is only the US dollar. However, the Group still borrows small amounts in other currencies, typically for seasonal working capital needs. In addition, the Group currently expects to hold legacy borrowings in sterling to their maturity dates: our policy does not require existing currency debt to be terminated to match declines in that currency’s share of Group operating profit before depreciation and amortisation. Included within year end net debt, the net borrowings in the two principal currencies above (taking into account the effect of cross currency swaps) were: US dollar £1,119m and sterling £45m.
Use of currency debt and currency derivatives
The Group uses both currency denominated debt and derivative instruments to implement the above policy. Its intention is that gains/losses on the derivatives and debt offset the losses/gains on the foreign currency assets and income. Each quarter the value of hedging instruments is monitored against the assets in the relevant currency and, where practical, a decision is made whether to treat the debt or derivative as a net investment hedge (permitting foreign exchange movements on it to be taken to reserves) for the purposes of IAS 39.
Financial instruments — sensitivity analysis
The sensitivity of the Group’s financial instruments to fluctuations in interest rates and exchange rates is as follows:

2007
Impact of 1%
Impact of 1%
Impact of 10%
Impact of 10%

Carrying
increase in
decrease in
strengthening in
weakening in

value interest rates interest rates sterling sterling
All amounts in £ millions

Investments in unlisted securities 52 — — (4 ) 5
Cash and cash equivalents 560 — — (36 ) 44
Marketable securities 40 — — (3 ) 4
Derivative financial instruments 35 (23 ) 25 11 (13 )
Bonds (1,150 ) 24 (26 ) 71 (87 )
Other borrowings (458 ) — — 42 (51 )
Other net financial assets 408 — — (29 ) 35

Total financial instruments (513 ) 1 (1 ) 52 (63 )

F-39
Notes to the Consolidated Financial Statements (Continued)

2006
Impact of 1%
Impact of 1%
Impact of 10%
Impact of 10%

Carrying
increase in
decrease in
strengthening in
weakening in

value interest rates interest rates sterling sterling
All amounts in £ millions

Investments in unlisted securities 17 — — (1 ) 1
Cash and cash equivalents 592 — — (38 ) 46
Marketable securities 25 — — (2 ) 2
Derivative financial instruments 67 (28 ) 31 8 (10 )
Bonds (1,566 ) 28 (31 ) 108 (132 )
Other borrowings (177 ) — — 16 (19 )
Other net financial assets 425 — — (31 ) 38

Total financial instruments (617 ) — — 60 (74 )

The table shows the sensitivities of the fair values of each class of financial instruments to an isolated change in either interest rates or foreign exchange rates. The class ‘Other net financial assets’ comprises trade assets less trade liabilities.
The sensitivities of derivative instruments are calculated using established estimation techniques such as discounted cash flow and option valuation models.
A large proportion of the movements shown above would impact equity rather than the income statement, depending on the location and functional currency of the entity in which they arise and the availability of net investment hedge treatment.
The changes in valuations are estimates of the impact of changes in market variables and are not a prediction of future events or anticipated gains or losses.
F-40
Notes to the Consolidated Financial Statements (Continued)
The accounting classification of each class of the Group’s financial assets ~~are non-current unlisted securities.~~and financial liabilities, together with their fair values, is as follows:

2007
Fair value
Derivatives
Derivatives
Amortised cost Total
Total

Available
deemed held
in hedging
Loans and
Other
carrying
market

Notes for sale for trading relationships receivables liabilities value value
All figures in £ millions

Investments in unlisted securities 16 52 — — — — 52 52
Marketable securities 40 — — — — 40 40
Derivative financial instruments 17 — 16 35 — — 51 51
Trade receivables 20 — — — 750 — 750 750
Cash and cash equivalents 21 — — — 560 — 560 560

Total financial assets
92 16 35 1,310 — 1,453 1,453

Derivative financial instruments 17 — (8 ) (8 ) — — (16 ) (16 )
Trade payables 24 — — — — (342 ) (342 ) (342 )
Bank loans and overdrafts 22 — — — — (444 ) (444 ) (444 )
Borrowings due within one year 22 — — — — (115 ) (115 ) (112 )
Borrowings due after more than one year 22 — — — — (1,049 ) (1,049 ) (1,046 )

Total financial liabilities
— (8 ) (8 ) — (1,950 ) (1,966 ) (1,960 )

F-41
~~F-36~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

2006
Fair value
Derivatives
Derivatives
Amortised cost Total
Total

Available
deemed held
in hedging
Loans and
Other
carrying
market

Notes for sale for trading relationships receivables liabilities value value
All figures in £ millions

Investments in unlisted securities 16 17 — — — — 17 17
Marketable securities 25 — — — — 25 25
Derivative financial instruments 17 — 25 61 — — 86 86
Trade receivables 20 — — — 768 — 768 768
Cash and cash equivalents 21 — — — 592 — 592 592

Total financial assets
42 25 61 1,360 — 1,488 1,488

Derivative financial instruments 17 — (2 ) (17 ) — — (19 ) (19 )
Trade payables 24 — — — — (343 ) (343 ) (343 )
Bank loans and overdrafts 22 — — — — (173 ) (173 ) (173 )
Borrowings due within one year 22 — — — — (422 ) (422 ) (400 )
Borrowings due after more than one year 22 — — — — (1,148 ) (1,148 ) (1,157 )

Total financial liabilities
— (2 ) (17 ) — (2,086 ) (2,105 ) (2,092 )

Certain of the Group’s derivative financial instruments are deemed to be held for trading either as they do not meet the hedge accounting criteria specified in IAS 39 or the Group has chosen not to seek hedge accounting for these instruments. None of these derivatives are held for speculative trading purposes. Transactions in derivative financial instruments are only undertaken to manage risks arising from underlying business activity, in accordance with the Group’s treasury policy outlined above. The Group designates certain qualifying derivative financial instruments as hedges of the fair value of its bonds (fair value hedges). Changes in the fair value of these derivative financial instruments are recorded in the income statement, together with any change in the fair value of the hedged liability attributable to the hedged risk.
The Group also designates certain of its borrowings and derivative financial instruments as hedges of its investments in foreign operations (net investment hedges). Movements in the fair value of these financial instruments (to the extent they are effective) are recognised in equity.
None of the Group’s financial assets or liabilities are designated at fair value through the profit & loss account upon initial recognition.
More detail on the Group’s accounting for financial instruments is included in the Group’s accounting policies in note 1.
F-42
Notes to the Consolidated Financial Statements (Continued)
The maturity of contracted cash flows on the Group’s borrowings and all of its derivative financial instruments are as follows:

2007
USD GBP EUR Total
All figures in £ millions

Not later than one year 153 (30 ) — 123
Later than one year and not later than five years 966 70 — 1,036
Later than five years 420 285 — 705

Total
1,539 325 — 1,864

Analysed as:
Revolving credit facilities and commercial paper 429 — — 429
Bonds 1,017 483 — 1,500
Rate derivatives — inflows (268 ) (160 ) — (428 )
Rate derivatives — outflows 361 2 — 363

Total
1,539 325 — 1,864

2006
USD GBP EUR Total
All figures in £ millions

Not later than one year 166 18 265 449
Later than one year and not later than five years 758 60 — 818
Later than five years 478 242 — 720

Total
1,402 320 265 1,987

Analysed as:
Revolving credit facilities and commercial paper 99 — — 99
Bonds 1,045 511 423 1,979
Rate derivatives — inflows (318 ) (329 ) (192 ) (839 )
Rate derivatives — outflows 576 138 34 748

Total
1,402 320 265 1,987

All cash flow projections shown above are on an undiscounted basis. Any cash flows based on a floating rate are calculated using interest rates as set at the date of the last rate reset. Where this is not possible, floating rates are based on interest rates prevailing at 31 December in the relevant year. All derivative amounts are shown gross, although the company net settles these amounts wherever possible.
Amounts drawn under revolving credit facilities and commercial paper are assumed to mature at the maturity date of the relevant facility, with interest calculated as payable in each calendar year up to and including the date of maturity of the facility.
1616.   Other financial assets

Notes 2007 2006
All figures in £ millions

At beginning of year 17 18
Exchange differences — (1 )
Equity interest received on sale of Government Solutions 32 35 —

At end of year
52 17

Other financial assets comprise non-current unlisted securities.

F-43
Notes to the Consolidated Financial Statements (Continued)
17.   Derivative financial instruments

2005 2005
Assets Liabilities

(All figures in £
millions)
Interest rate derivatives — in a fair value hedging relationship 31 (16 )
Interest rate derivatives — not in a hedging relationship 18 (6 )
Cross currency rate derivatives — in a net investment hedging relationship 13 —
Cross currency rate derivatives — not in a hedging relationship 21 —

83 (22 )

Analysed as:

Non-current 79 (22 )
Current (expiring in less than 1 year) 4 —

83 (22 )

The ~~fair~~Group’s approach to the management of financial risks is set out in note 15. The Group’s outstanding derivative financial instruments are as follows:

2007 2006
Gross notional
Gross notional

amounts Assets Liabilities amounts Assets Liabilities

Interest rate derivatives — in a fair value hedge relationship 522 18 (8 ) 953 20 (17 )
Interest rate derivatives — not in a hedge relationship 796 7 (8 ) 1,026 9 (2 )
Cross currency rate derivatives — in a net investment hedge relationship 100 17 — 230 40 —
Cross currency rate derivatives — not in a hedge relationship 50 9 — 180 17 —

Total
1,468 51 (16 ) 2,389 86 (19 )

Analysed as expiring:

In less than one year 320 28 — 976 50 —
Later than one year and not later than five years 796 13 (8 ) 1,005 26 (4 )
Later than five years 352 10 (8 ) 408 10 (15 )

Total
1,468 51 (16 ) 2,389 86 (19 )

The carrying value of the above derivative financial instruments isequals their fair value. Fair values are determined by using market data and the ~~same~~use of established estimation techniques such as ~~the carrying value.~~discounted cash flow and option valuation models.

At the end of 2007, the currency split of the mark-to-market values of rate derivatives, including the exchange of principal on cross currency rate derivatives, was US dollar £(119)m, and sterling £154m (2006: US dollar £(247)m, euro £157m and sterling £157m).
The fixed interest rates on outstanding rate derivative contracts at the end of 2007 range from 4.45% to 7.00% (2006: 3.02% to 7.00%) and the floating rates are based on LIBOR in US dollar and sterling.
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 ~~reduces~~reduce the risk of income statement volatility.

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 of 2006, the Group ~~had received~~held an amount of ~~£43m equivalent~~£29m as collateral under a~~mark-to-market~~ mark-to-market agreement. This reflected the amount, at market rates prevailing at the end of October ~~2005,~~2006, owed to the Group by ~~the~~a counterparty for a set of three related rate derivatives. ~~Under these~~The amount was settled at the ~~Group is due to exchange $209m for~~€~~204m in~~beginning of February ~~2007. There are no restrictions on~~2007, along with repayment of the ~~Group’s use of these funds, which have been recorded in borrowings as a current bank loan.~~€591m bond.

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-44
~~F-37~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
1718.   Intangible assets — ~~pre-publication~~Pre-publication

2005 2004 2003

(All figures in £ millions)
Cost

At beginning of year 1,109 1,104 1,189
Exchange differences 112 (63 ) (90 )
Acquisition through business combination 27 — —
Additions 222 181 173
Disposals (113 ) (113 ) (168 )

At end of year
1,357 1,109 1,104

Amortisation

At beginning of year (753 ) (742 ) (809 )
Exchange differences (87 ) 44 57
Acquisition through business combination (12 ) — —
Charge for the year (192 ) (168 ) (158 )
Disposals 113 113 168

At end of year
(931 ) (753 ) (742 )

Carrying amounts

At end of year
426 356 362

2007 2006
All figures in £ millions

Cost

At beginning of year 1,152 1,357
Exchange differences (7 ) (148 )
Transfers — 6
Additions 230 213
Disposals (125 ) (280 )
Acquisition through business combination 19 4
Transfer to non-current assets held for sale (5 ) —

At end of year
1,264 1,152

Amortisation

At beginning of year (750 ) (931 )
Exchange differences 1 111
Charge for the year (192 ) (210 )
Disposals 125 280
Acquisition through business combination (1 ) —
Transfer to non-current assets held for sale 3 —

At end of year
(814 ) (750 )

Carrying amounts

At end of year
450 402

Included in the above are pre-publication assets amounting to £292m (2006: £243m) 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 2007 and 2006.
1819.   Inventories

2005 2004 2003

(All figures in £ millions)
Raw materials 23 23 19
Work in progress 43 35 30
Finished goods 307 256 270

373 314 319

2007 2006
All figures in £ millions

Raw materials 24 26
Work in progress 30 28
Finished goods 314 300

368 354

The cost of inventories relating to continuing operations recognised as an expense and included in the income statement in cost of goods sold amounted to ~~£768m (2004: £700m; 2003: £710m)~~£732m (2006: £702m; 2005: £754m). In ~~2005 £42m (2004: £41m; 2003: £37m)~~2007 £47m (2006: £46m; 2005: £42m) of inventory provisions ~~were~~was charged in the income statement. None of the inventory is pledged as security.

F-45
~~F-38~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
1920.   Trade and other receivables

2005 2004 2003

(All figures in £ millions)
Current

Trade receivables 825 725 814
Royalty advances 124 114 110
Prepayments and accrued income 38 41 38
Other receivables 42 51 62
Receivables from related parties 2 2 1

1,031 933 1,025

Non-current

Royalty advances 67 70 83
Prepayments and accrued income 4 1 1
Other receivables 37 31 16

108 102 100

2007 2006
All figures in £ millions

Current

Trade receivables 750 768
Royalty advances 84 91
Prepayments and accrued income 48 34
Other receivables 59 58
Receivables from related parties 5 2

946 953

Non-current

Royalty advances 68 80
Prepayments and accrued income 4 4
Other receivables 57 40

129 124

Trade receivables are stated at fair value, net of provisions for bad and doubtful debts and anticipated future sales ~~returns of £313m (2004: £354m; 2003: £339m).~~returns. The ~~carrying amounts~~movements on the provision for bad and doubtful debts are ~~stated at their fair value.~~ as follows:

2007 2006
All figures in £ millions

At beginning of year (46 ) (45 )
Exchange differences (1 ) 3
Income statement movements (19 ) (23 )
Utilised 15 21
Acquisition through business combination (3 ) (2 )
Disposal through business disposal 2 —

At end of year
(52 ) (46 )

Concentrations of credit risk with respect to trade receivables are limited due to the Group’s large number of customers, who are internationally dispersed.

F-46
Notes to the Consolidated Financial Statements (Continued)
The ageing of the Group’s trade receivables is as follows:

2007 2006
All figures in £ millions

Within due date 811 810
Up to three months past due date 161 177
Three to six months past due date 43 62
Six to nine months past due date 7 6
Nine to 12 months past due date 13 8
More that 12 months past due date 4 1

Total trade receivables
1,039 1,064

Less: provision for sales returns (281 ) (243 )
Transfer to non-current assets held for sale (8 ) (53 )

Net trade receivables
750 768

The Group’s provision for bad and doubtful debts is specific to individual debts identified during the bad debt review process. Consequently the ageing analysis above is presented after deducting the associated specific bad debt provision. The Group reviews its bad debt provision at least twice a year following a detailed review of receivable balances and historic payment profiles. Management believe all the remaining receivable balances are fully recoverable.
2021.   Cash and cash equivalents (excluding overdrafts)

2005 2004 2003

(All figures in £ millions)
Cash at bank and in hand 393 338 302
Short-term bank deposits 509 123 249

902 461 551

2007 2006
All figures in £ millions

Cash at bank and in hand 439 421
Short-term bank deposits 121 171

560 592

Short-term bank deposits are invested with banks and earn interest at the prevailing short-term deposit rates.
~~The~~
At the end of 2007 the currency split of cash and cash equivalents ~~in 2005~~ is ~~31%~~ US dollars ~~(2004: 38%), 38% Sterling (2004:~~37% (2006: 31%), ~~24% Euro (2004: 12%~~sterling 29% (2006: 35%), euros 16% (2006: 21%) and other ~~7% (2004: 19%~~18% (2006: 13%).
~~The fair value of cash~~
Cash and cash equivalents ~~is the same as the~~have fair values that approximate to their carrying ~~value.~~amounts due to their short-term nature.

Cash and cash equivalents include the following for the purpose of the cash flow statement:

2005 2004 2003

(All figures in £ millions)
Cash and cash equivalents 902 461 551
Cash and cash equivalents included in assets classified as held for sale — 141 —
Bank overdrafts (58 ) (58 ) (23 )

844 544 528

2007 2006
All figures in £ millions

Cash and cash equivalents 560 592
Bank overdrafts (68 ) (61 )

492 531

F-47
~~F-39~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
2122.   Financial liabilities — Borrowings

The Group’s current and non-current borrowings are as follows:

2005 2004 2003

(All figures in £ millions)
Non-current

Bank borrowings — 62 85
7.375% US Dollar notes 2006 (nominal amount $250m) — 130 139
6.125% Euro Bonds 2007 (nominal amount€591m)
436 390 343
10.5% Sterling Bonds 2008 (nominal amount £100m) 107 100 100
4.7% US Dollar Bonds 2009 (nominal amount $350m) 203 181 —
7% Global Dollar Bonds 2011 (nominal amount $500m) 307 260 278
7% Sterling Bonds 2014 (nominal amount £250m) 250 226 235
5.7% US Dollar Bonds 2014 (nominal amount $400m) 238 207 —
4.625% US Dollar notes 2018 (nominal amount $300m) 161 156 167
Finance lease liabilities 1 2 2

1,703 1,714 1,349

2007 2006
All figures in £ millions

Non-current

10.5% Sterling Bonds 2008 (nominal amount £100m) — 105
4.7% US Dollar Bonds 2009 (nominal amount $350m) 176 178
7% Global Dollar Bonds 2011 (nominal amount $500m) 264 266
7% Sterling Bonds 2014 (nominal amount £250m) 251 251
5.7% US Dollar Bonds 2014 (nominal amount $400m) 211 206
4.625% US Dollar notes 2018 (nominal amount $300m) 143 139
Finance lease liabilities 4 3

1,049 1,148

Current

Due within one year or on demand:

Bank loans and overdrafts 444 173
6.125% Euro Bonds 2007 (nominal amount €591m) — 421
10.5% Sterling Bonds 2008 (nominal amount £100m) 105 —
Loan notes 8 —
Finance lease liabilities 2 1

559 595

Total borrowings
1,608 1,743

Included in the non-current borrowings above is ~~£35m~~£6m of accrued interest ~~in 2005.~~

Current

Due within one year or on demand:

Bank loans and overdrafts 102 107 119
7.375% US Dollar notes 2006 152 — —
9.5% Sterling Bonds 2004 — — 108
4.625% Euro Bonds 2004 — — 348
Finance lease liabilities 2 2 3

256 109 578

Total borrowings
1,959 1,823 1,927

(2006: £12m). Included in the current borrowings above is ~~£3m~~£7m of accrued interest ~~in 2005.~~(2006: £22m).
The Group has elected to apply the provisions of IAS 32 and IAS 39 with effect from 1 January 2005. The comparative financial information is prepared in accordance with UKGAAP. The nature of the main adjustments that would make the information comply with IAS 32 and IAS 39 are set out in note 34.
      The 2004 and 2003 figures for the 2007 Euro Bonds and 2014 Sterling Bonds (together with the 2004 Sterling and Euro Bonds which have now been redeemed) include the effect of accounting for the foreign exchange element of the related derivatives.
      All of the Group’s borrowings are unsecured. In respect of finance lease obligations (£3m in 2005; £4m in 2004 and £5m in 2003) the rights to the leased asset revert to the lessor in the event of default.
~~F-40~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
The maturity of the Group’s non-current borrowing is as follows:

2005 2004 2003

(All figures in £ millions)
Between one and two years 437 131 86
Between two and five years 310 734 583
Over five years 956 849 680

1,703 1,714 1,349

2007 2006
All figures in £ millions

Between one and two years 178 107
Between two and five years 266 445
Over five years 605 596

1,049 1,148

As at 31 December ~~2005~~2007 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 1,959 256 747 956
Effect of interest rate swaps — 1,161 (473 ) (688 )

1,959 1,417 274 268

Less than
One to
More than

one year five years five years Total
All figures in £ millions

Carrying value of borrowings 559 444 605 1,608
Effect of rate derivatives 359 (7 ) (352 ) —

918 437 253 1,608

F-48
Notes to the Consolidated Financial Statements (Continued)
The carrying amounts and ~~fair~~market values of non-current borrowings are as follows:

Carrying Carrying Carrying
Effective amount Fair value amount Fair value amount Fair value
interest Rate 2005 2005 2004 2004 2003 2003

(All figures in £ millions)
Bank borrowings n/a — — 62 62 85 85
7.375% US Dollar notes 2006 7.75 % — — 130 138 139 157
6.125% Euro Bonds 2007 6.18 % 436 419 390 409 343 448
10.5% Sterling Bonds 2008 10.53 % 107 113 100 116 100 120
4.7% US Dollar Bonds 2009 4.86 % 203 200 181 185 — —
7% Global Dollar Bonds 2011 7.16 % 307 310 260 293 278 317
7% Sterling Bonds 2014 7.20 % 250 282 226 255 235 275
5.7% US Dollar Bonds 2014 5.88 % 238 234 207 217 — —
4.625% US Dollar notes 2018 4.69 % 161 155 156 142 167 151
Finance lease liabilities n/a 1 1 2 2 2 2

1,703 1,714 1,714 1,819 1,349 1,555

Carrying
Carrying

Effective
amount
Market value
amount
Market value

interest rate 2007 2007 2006 2006
All figures in £ millions

10.5% Sterling Bonds 2008 10.53 % — — 105 106
4.7% US Dollar Bonds 2009 4.86 % 176 176 178 176
7% Global Dollar Bonds 2011 7.16 % 264 267 266 269
7% Sterling Bonds 2014 7.20 % 251 261 251 265
5.7% US Dollar Bonds 2014 5.88 % 211 203 206 203
4.625% US Dollar notes 2018 4.69 % 143 135 139 135
Finance lease liabilities n/a 4 4 3 3

1,049 1,046 1,148 1,157

The ~~fair~~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 current borrowings approximate their fair value.~~

The carrying amounts of the Group’s borrowings are denominated in the following currencies:

2005 2004 2003

(All figures in £ millions)
US dollar 1,165 1,335 1,432
Sterling 357 202 201
Euro 437 284 292
Other currencies — 2 2

1,959 1,823 1,927

~~F-41~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

2007 2006
All figures in £ millions

US dollar 1,251 966
Sterling 357 356
Euro — 421

1,608 1,743

~~The maturity of the Group’s finance lease obligations is as follows:~~

2005 2004 2003

(All figures in £ millions)
Finance lease liabilities — minimum lease payments

Not later than one year 2 2 3
Later than one year and not later than five years 1 2 3
Later than five years — — —
Future finance charges on finance leases — — (1 )
Present value of finance lease liabilities 3 4 5
      ~~The present value of finance lease liabilities is as follows:~~

2005 2004 2003

(All figures in £ millions)
Not later than one year 2 2 3
Later than one year and not later than five years 1 2 2
Later than five years — — —

3 4 5

      ~~The carrying amount of the Group’s lease obligations approximates their fair value.~~
The Group has the following undrawn committed borrowing facilities as at 31 December:

2005 2004 2003

(All figures in £ millions)
Floating rate

— expiring within one year — — —
— expiring beyond one year 786 641 950

786 641 950

2007 2006
All figures in £ millions

Floating rate

— expiring within one year — —
— expiring beyond one year 1,007 894

1,007 894

During the year, the Group extended the maturity date of its main revolving credit facility by one year, and also entered into a short-term bridge financing facility.
In addition to the above facilities, there are a number of short-term facilities that are utilised in the normal course of business.
All of the Group’s borrowings are unsecured. In respect of finance lease obligations, the rights to the leased asset revert to the lessor in the event of default.

F-49
Notes to the Consolidated Financial Statements (Continued)
The maturity of the Group’s finance lease obligations is as follows:

2007 2006
All figures in £ millions

Finance lease liabilities — minimum lease payments

Not later than one year 2 1
Later than one year and not later than two years 2 3
Later than two years and not later than three years 1 —
Later than three years and not later than four years 1 —
Later than four years and not later than five years — —
Later than five years — —
Future finance charges on finance leases — —

Present value of finance lease liabilities 6 4

The present value of finance lease liabilities is as follows:

2007 2006
All figures in £ millions

Not later than one year 2 1
Later than one year and not later than five years 4 3
Later than five years — —

6 4

The carrying amounts of the Group’s lease obligations approximate their fair value.
2223.   Provisions for other liabilities and charges

Deferred Re-
consideration Integration organisations Leases Other Total

(All figures in £ millions)
At 1 January 2005 20 5 11 14 7 57
Exchange differences 2 — 1 1 — 4
Charged to consolidated income statement

— Additional provisions — — — 1 13 14
— Unused amounts reversed — — (1 ) (3 ) (1 ) (5 )
On acquisition/disposal 5 — — — — 5
Utilised during year (1 ) (2 ) (6 ) (1 ) (1 ) (11 )

At 31 December 2005
26 3 5 12 18 64

Deferred

consideration Leases Other Total
All figures in £ millions

At 1 January 2007 25 12 15 52
Exchange differences (1 ) — (1 ) (2 )
Charged to consolidated income statement

— Additional provisions: interest 2 — — 2
— Additional provisions: prior year adjustments 3 — — 3
— Additional provisions: other — — 12 12
— Unused amounts reversed — (1 ) (1 ) (2 )
Acquisition through business combination 12 — 2 14
Disposal through business disposal — — (1 ) (1 )
Utilised (4 ) (2 ) (5 ) (11 )

At 31 December 2007 37 9 21 67

F-50
~~F-42~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)

2005 2004 2003

(All figures in £ millions)
Analysis of provisions

Non-current 31 43 59
Current 33 14 18

64 57 77

2007 2006
All figures in £ millions

Analysis of provisions
Non-current 44 29
Current 23 23

67 52

Deferred consideration, ~~— During the~~ including interest and prior year ~~additional deferred consideration of £5m was incurred mainly relating~~adjustments, primarily relates to the acquisition of ~~Index books.~~
~~Integration~~ ~~— During~~Mergermarket in 2006. These amounts are payable in March 2009. Additional amounts incurred relate to the Group’s smaller acquisitions during the year ~~£2m of this balance has been utilised, primarily in relation to properties, severance and IT systems. The remaining provision should be utilised in the next two years.~~(see note 30).
~~Reorganisations~~ ~~— There were no additional provisions in 2005 and £5m has been utilised, mainly in respect of redundancies.~~
Lease commitments ~~— These~~ relate primarily to onerous lease contracts, acquired through business combinations, which have various expiry dates up to ~~2010.~~2017. The provision is based on current occupancy estimates.
2324.   Trade and other liabilities

2005 2004 2003

(All figures in £ millions)
Trade payables 348 316 405
Social security and other taxes 21 14 4
Accruals and deferred income 600 509 465
Other liabilities 156 128 139

1,125 967 1,013

Less: non-current portion

Accruals and deferred income 66 21 9
Other liabilities 85 78 61

151 99 70

Current portion
974 868 943

2007 2006
All figures in £ millions

Trade payables 342 343
Social security and other taxes 23 18
Accruals 402 345
Deferred income 290 276
Dividends payable to minority 12 —
Other liabilities 171 178

1,240 1,160

Less: non-current portion

Accruals 30 24
Deferred income 58 47
Other liabilities 102 91

190 162

Current portion
1,050 998

The carrying value of the Group’s trade and other liabilities approximates ~~their~~its 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;
• advertising income relating to future publishing days in newspaper businesses; and
• obligations to deliver digital content in future periods.
F-51
Notes to the Consolidated Financial Statements (Continued)
2425.   ~~Employee benefits~~Retirement benefit and other post-retirement obligations
~~Retirement benefit obligations~~Background

The Group operates a number of defined benefit and defined contribution retirement ~~benefit~~ plans throughout the ~~world,~~world. For the ~~principal ones being~~defined benefit plans, benefits are based on employees’ length of service and final pensionable pay. Defined contribution benefits are based on the amount of contributions paid in respect of an individual member, the UKinvestment returns earned and ~~US.~~ the amount of pension this money will buy when a member retires.
The ~~major schemes are self-administered with~~largest plan is the ~~schemes’ assets being held independently of the Group. Retirement benefit costs are assessed in accordance with the advice of independent qualified actuaries. The~~ Pearson Group Pension Plan (‘UK Group ~~scheme is a hybrid scheme~~plan’) with both defined benefit and defined contribution sections. From 1 November 2006, all sections ~~but, predominantly, consisting of defined benefit liabilities. There are a number of defined contribution schemes, principally overseas.~~
      ~~The most recent actuarial valuation~~ of the UK Group ~~scheme~~plan were closed to new members with the exception of a defined contribution section that was ~~completed on 1 January 2004.~~opened in 2003. This section is available to all new employees of participating companies. The other major defined benefit plans are based in the US.
~~F-43~~
Other defined contribution plans are operated principally overseas with the largest plan being in the US. The specific features of these plans vary in accordance with the regulations of the country in which employees are located.
Pearson also has several post-retirement medical benefit plans (PRMBs), principally in the US. PRMBs are unfunded but are accounted for and valued similarly to defined benefit pension plans.
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~Assumptions

The principal assumptions used for the UK Group ~~scheme~~plan and the US PRMB are shown below. Weighted average assumptions have been shown for the other ~~schemes.~~

2005 2005 2004 2004 2003 2003
UK Group Other UK Group Other UK Group Other
% scheme schemes scheme schemes scheme schemes

Inflation 2.80 2.95 2.80 2.98 2.75 2.98
Expected rate of increase in salaries 4.50 4.43 4.80 4.44 4.75 4.45
Expected rate of increase for pensions in payment and deferred pensions 2.50 to 4.00 — 2.80 to 4.00 — 2.75 to 4.00 —
Rate used to discount scheme liabilities 4.85 5.54 5.40 5.84 5.50 6.11
Expected return on assets 6.40 7.31 6.60 7.23 6.81 7.75

      ~~The amounts recognised in the income statement are as follows:~~

Defined
UK Group benefit Defined 2005
scheme other Sub Total contribution Total

(All figures in £ millions)
Current service cost (25 ) (2 ) (27 ) (35 ) (62 )
Past service cost — — — — —
Curtailments — 2 2 — 2

Total operating charge
(25 ) — (25 ) (35 ) (60 )

Expected return on plan assets 75 6 81 — 81
Interest on pension scheme liabilities (79 ) (6 ) (85 ) — (85 )

Net finance charge
(4 ) — (4 ) — (4 )

Net income statement charge
(29 ) — (29 ) (35 ) (64 )

Actual return on plan assets
214 7 221 — 221

Defined
UK Group benefit Defined 2004
scheme other Sub Total contribution Total

(All figures in £ millions)
Current service cost (22 ) (2 ) (24 ) (32 ) (56 )
Past service cost — — — — —

Total operating charge
(22 ) (2 ) (24 ) (32 ) (56 )

Expected return on plan assets 71 6 77 — 77
Interest on pension scheme liabilities (72 ) (6 ) (78 ) — (78 )

Net finance charge
(1 ) — (1 ) — (1 )

Net income statement charge
(23 ) (2 ) (25 ) (32 ) (57 )

Actual return on plan assets
135 9 144 — 144

~~F-44~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

Defined
UK Group benefit Sub Defined 2003
scheme other Total contribution Total

(All figures in £ millions)
Current service cost (21 ) (2 ) (23 ) (28 ) (51 )
Past service cost — — — — —

Total operating charge
(21 ) (2 ) (23 ) (28 ) (51 )

Expected return on plan assets 65 4 69 — 69
Interest on pension scheme liabilities (67 ) (7 ) (74 ) — (74 )

Net finance charge
(2 ) (3 ) (5 ) — (5 )

Net income statement charge
(23 ) (5 ) (28 ) (28 ) (56 )

Actual return on plan assets
145 12 157 — 157

      ~~The total operating charge is included in administrative and other expenses.~~plans, which primarily relate to US pension plans.
~~The amounts recognised in the balance sheet are as follows:~~

2005 2005 2005 2004 2004 2004 2003 2003 2003
UK Other Other UK Other Other UK Other Other
Group funded unfunded 2005 Group funded unfunded 2004 Group funded unfunded 2003
scheme plans plans Total scheme plans plans Total scheme plans plans Total

(All figures in £ millions)
Fair value of plan assets 1,390 110 — 1,500 1,198 82 — 1,280 1,089 75 — 1,164
Present value of plan liabilities (1,661 ) (131 ) (11 ) (1,803 ) (1,502 ) (104 ) (9 ) (1,615 ) (1,340 ) (105 ) (9 ) (1,454 )

Net pension liability
(271 ) (21 ) (11 ) (303 ) (304 ) (22 ) (9 ) (335 ) (251 ) (30 ) (9 ) (290 )

Other post-retirement medical benefit obligation (60 ) (58 ) (61 )
Other pension accruals (26 ) (15 ) (13 )

Total retirement benefit obligations
(389 ) (408 ) (364 )

2007 2006 2005
UK Group
Other
UK Group
Other
UK Group
Other

plan plans PRMB plan plans PRMB plan plans PRMB

%

Inflation 3.30 2.93 3.00 3.00 2.91 3.00 2.80 2.95 3.00
Rate used to discount plan liabilities 5.80 6.01 6.05 5.20 5.70 5.85 4.85 5.54 5.60
Expected return on assets 6.50 7.27 — 6.40 7.18 — 6.40 7.31 —
Expected rate of increase in salaries 5.00 4.36 — 4.70 4.37 — 4.50 4.43 —
Expected rate of increase for pensions in payment and deferred pensions 2.50 to 4.30 — — 2.10 to 4.60 — — 2.50 to 4.00 — —
Initial rate of increase in healthcare rate — — 9.50 — — 10.00 — — 10.00
Ultimate rate of increase in healthcare rate — — 5.00 — — 5.00 — — 5.00

      ~~The following amounts have been recognised in the statement of recognised income and expense:~~

2005 2004 2003

(All figures in
£ millions)
Amounts recognised for defined benefit schemes 21 (60 ) (25 )
Amounts recognised on post-retirement medical benefit schemes 5 (1 ) (3 )

Total recognised in year
26 (61 ) (28 )

Cumulative amounts recognised
(63 ) (89 ) (28 )

      ~~The fair value of plan assets comprises the following:~~

2005 2005 2004 2004 2003 2003
UK Other UK Other UK Other
group funded 2005 Group funded 2004 Group funded 2003
% scheme plans Total scheme plans Total scheme plans Total

Equities 47.4 4.3 51.7 49.7 4.2 53.9 50.5 4.2 54.7
Bonds 24.7 2.0 26.7 21.5 2.1 23.6 22.5 2.1 24.6
Properties 8.9 — 8.9 8.9 — 8.9 9.2 — 9.2
Other 11.7 1.0 12.7 13.5 0.1 13.6 11.4 0.1 11.5
~~F-45~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

The ~~plan~~UK discount rate is based on the annualised yield on the iBoxx over15-year AA-rated corporate bond index. The US discount rate is set by reference to a US bond portfolio matching model. The expected return on assets ~~do not include any~~is based on market expectations of long-term asset returns for the defined portfolio at the end of the ~~Group’s own financial instruments, nor any property occupied by the Group.~~year.
~~Changes in the values of plan assets and liabilities are as follows:~~

2005 2004 2003
UK Group 2005 2005 UK Group 2004 2004 UK Group 2003 2003
scheme Other Total scheme Other Total scheme Other Total

(All figures in £ millions)
Fair value of assets

Opening fair value of plan assets 1,198 82 1,280 1,089 75 1,164 974 57 1,031
Exchange differences — 9 9 — (5 ) (5 ) — (5 ) (5 )
Expected return on plan assets 75 6 81 71 6 77 65 4 69
Actuarial gains and losses 139 1 140 64 3 67 80 8 88
Contributions by employer 35 10 45 30 9 39 24 9 33
Contributions by employee 6 — 6 6 — 6 6 — 6
Benefits paid (63 ) (6 ) (69 ) (62 ) (6 ) (68 ) (60 ) (6 ) (66 )
Acquisition through business combination — 8 8 — — — — 8 8

Closing fair value of plan assets
1,390 110 1,500 1,198 82 1,280 1,089 75 1,164

Present value of defined benefit obligation

Opening defined benefit obligation (1,502 ) (113 ) (1,615 ) (1,340 ) (114 ) (1,454 ) (1,207 ) (96 ) (1,303 )
Exchange differences — (12 ) (12 ) — 6 6 — 9 9
Current service cost (25 ) (2 ) (27 ) (22 ) (2 ) (24 ) (21 ) (2 ) (23 )
Curtailment — 2 2 — — — — — —
Interest cost (79 ) (6 ) (85 ) (72 ) (6 ) (78 ) (67 ) (7 ) (74 )
Contributions by employee (6 ) — (6 ) (6 ) — (6 ) (6 ) — (6 )
Acquisition through business combination — (10 ) (10 ) — — — — (10 ) (10 )
Benefits paid 63 6 69 62 6 68 60 6 66
Actuarial gains and losses (112 ) (7 ) (119 ) (124 ) (3 ) (127 ) (99 ) (14 ) (113 )

Closing defined benefit obligation
(1,661 ) (142 ) (1,803 ) (1,502 ) (113 ) (1,615 ) (1,340 ) (114 ) (1,454 )

      ~~The history of the defined benefit plans is as follows:~~

2005 2004 2003

(All figures in £ millions)
Present value of defined benefit obligation (1,803 ) (1,615 ) (1,454 )
Fair value of plan assets 1,500 1,280 1,164

Net pension liability
(303 ) (335 ) (290 )

Experience adjustments on plan liabilities (119 ) (127 ) (113 )
Experience adjustments on plan assets 140 67 88

~~F-46~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
The expected rates of return on categories of plan assets are determined by reference to relevant indices. The overall expected rate of return is calculated by weighting the individual rates in accordance with the anticipated balance in the plan’s investment portfolio.

The UK mortality assumptions have been derived by adjusting standard mortality tables (PMFA 92 tables projected forward with medium cohort improvement factors). The Group ~~expects~~changed its mortality assumptions in the UK in 2007 to ~~contribute approximately £41m~~reflect an assumed increased life expectancy of pensioners by adding a 1% floor to ~~its defined benefit~~the medium cohort projections.
For the US plans, ~~in 2006.~~the assumptions used were based on standard US mortality tables (GAM94).

F-52
~~Other post-retirement obligations~~Notes to the Consolidated Financial Statements (Continued)
~~The~~
Using the above tables, the remaining average life expectancy in years of a pensioner retiring at age 65 on the balance sheet date for the UK and US Group ~~operates a number of post-retirement medical benefit schemes, principally in the USA. These~~ plans ~~are unfunded. The method of accounting and the frequency of valuations are similar to those used for defined benefit pension schemes.~~is as follows:

UK US
2007 2006 2007 2006

Male 21.3 20.9 17.9 17.9
Female 21.6 21.3 21.3 21.3
The ~~principal assumptions used are shown below:~~remaining average life expectancy in years of a pensioner retiring at age 65, 20 years after the balance sheet date, for the UK and US Group plans is as follows:

% 2005 2004 2003

Inflation 3.0 3.0 3.0
Initial rate of increase in healthcare rates 10.0 12.0 12.0
Ultimate rate of increase in healthcare rates 5.0 5.0 5.0
Rate used to discount scheme liabilities 5.6 6.1 6.1

UK US
2007 2006 2007 2006

Male 23.1 22.2 17.9 17.9
Female 23.6 22.5 21.3 21.3
Financial statement information
The amounts recognised in the income statement are as follows:

2005 2004 2003

(All figures in £ millions)
Current service cost (1 ) (1 ) (1 )
Interest cost (3 ) (4 ) (4 )

Net income statement charge
(4 ) (5 ) (5 )

2007
Defined

UK Group
benefit
Defined

plan other Sub total contribution PRMB Total
All figures in £ millions

Current service cost 29 2 31 39 1 71

Total operating expense
29 2 31 39 1 71

Expected return on plan assets (96 ) (7 ) (103 ) — — (103 )
Interest on plan liabilities 84 7 91 — 2 93
Net finance (income)/expense
(12 ) — (12 ) — 2 (10 )

Net income statement charge
17 2 19 39 3 61

Actual return on plan assets
128 4 132 — — 132

2006
Defined

UK Group
benefit
Defined

plan other Sub total contribution PRMB Total
All figures in £ millions

Current service cost 27 2 29 36 1 66
Past service cost — — — — (2 ) (2 )

Total operating expense/(income)
27 2 29 36 (1 ) 64

Expected return on plan assets (85 ) (7 ) (92 ) — — (92 )
Interest on plan liabilities 78 7 85 — 3 88
Net finance (income)/expense
(7 ) — (7 ) — 3 (4 )

Net income statement charge
20 2 22 36 2 60

Actual return on plan assets
153 13 166 — — 166

F-53
Notes to the Consolidated Financial Statements (Continued)

2005
Defined

UK Group
benefit
Defined

plan other Sub total contribution PRMB Total
All figures in £ millions

Current service cost 25 2 27 34 1 62
Curtailments — (2 ) (2 ) — — (2 )

Total operating expense/(income)
25 — 25 34 1 60

Expected return on plan assets (75 ) (6 ) (81 ) — — (81 )
Interest on plan liabilities 79 6 85 — 3 88

Net finance (income)/expense
4 — 4 — 3 7

Net income statement charge
29 — 29 34 4 67

Actual return on plan assets
214 7 221 — — 221

The ~~current service cost has been~~total operating charge is included in administrative and other expenses.

2005 2004 2003

(All figures in £ millions)
Opening obligation (58 ) (61 ) (63 )
Exchange differences (7 ) 6 6
Current service cost (1 ) (1 ) (1 )
Interest cost (3 ) (4 ) (4 )
Benefits paid 4 3 4
Actuarial gains and losses 5 (1 ) (3 )

Closing obligation
(60 ) (58 ) (61 )

The amounts recognised in the balance sheet are as follows:

2007 2006
Other
Other
Other
Other

UK Group
funded
unfunded
UK Group
funded
unfunded

plan plans plans Total plan plans plans Total
All figures in £ millions

Fair value of plan assets 1,744 109 — 1,853 1,528 105 — 1,633
Present value of defined benefit obligation (1,682 ) (117 ) (12 ) (1,811 ) (1,683 ) (115 ) (12 ) (1,810 )

Net pension asset/(liability)
62 (8 ) (12 ) 42 (155 ) (10 ) (12 ) (177 )

Other post-retirement medical benefit obligation (47 ) (48 )
Other pension accruals (28 ) (25 )

Net retirement benefit obligations
(33 ) (250 )

Analysed as:

Retirement benefit asset
62 —

Retirement benefit obligations
(95 ) (250 )

The following gains have been recognised in the statement of recognised income and expense:

2007 2006 2005
All figures in £ millions

Amounts recognised for defined benefit plans 79 102 21
Amounts recognised for post-retirement medical benefit plans 1 5 5

Total recognised in year
80 107 26

Cumulative amounts recognised
124 44 (63 )

F-54
Notes to the Consolidated Financial Statements (Continued)
The fair value of plan assets comprises the following:

2007 2006
Other
Other

UK Group
funded
UK Group
funded

plan plans Total plan plans Total
%

Equities �� 34.3 3.4 37.7 46.6 3.9 50.5
Bonds 34.9 2.0 36.9 23.8 2.1 25.9
Properties 7.7 — 7.7 9.2 — 9.2
Other 17.2 0.5 17.7 14.0 0.4 14.4
The plan assets do not include any of the Group’s own financial instruments, or any property occupied by the Group.
Changes in the values of plan assets and liabilities of the retirement benefit plans are as follows:

2007 2006
UK Group
Other
UK Group
Other

plan plans Total plan plans Total
All figures in £ millions

Fair value of plan assets

Opening fair value of plan assets 1,528 105 1,633 1,390 110 1,500
Exchange differences — 1 1 — (12 ) (12 )
Expected return on plan assets 96 7 103 85 7 92
Actuarial gains and losses 32 (3 ) 29 68 6 74
Contributions by employer 152 5 157 43 2 45
Contributions by employee 8 — 8 7 — 7
Benefits paid (72 ) (6 ) (78 ) (65 ) (8 ) (73 )

Closing fair value of plan assets
1,744 109 1,853 1,528 105 1,633

Present value of defined benefit obligation

Opening defined benefit obligation (1,683 ) (127 ) (1,810 ) (1,661 ) (142 ) (1,803 )
Exchange differences — 1 1 — 15 15
Current service cost (29 ) (2 ) (31 ) (27 ) (2 ) (29 )
Interest cost (84 ) (7 ) (91 ) (78 ) (7 ) (85 )
Actuarial gains and losses 50 — 50 25 3 28
Contributions by employee (8 ) — (8 ) (7 ) — (7 )
Benefits paid 72 6 78 65 8 73
Acquisition through business combination — — — — (2 ) (2 )

Closing defined benefit obligation
(1,682 ) (129 ) (1,811 ) (1,683 ) (127 ) (1,810 )

F-55
Notes to the Consolidated Financial Statements (Continued)
Changes in the value of the US PRMB are as follows:

2007 2006
All figures in £ millions

Opening defined benefit obligation (48 ) (60 )
Exchange differences — 8
Current service cost (1 ) (1 )
Past service cost — 2
Interest cost (2 ) (3 )
Actuarial gains and losses 1 5
Benefits paid 3 4
Reclassifications — (3 )

Closing defined benefit obligation
(47 ) (48 )

The history of the defined benefit plans is as follows:

2007 2006 2005 2004 2003
All figures in £ millions

Fair value of plan assets 1,853 1,633 1,500 1,280 1,164
Present value of defined benefit obligation (1,811 ) (1,810 ) (1,803 ) (1,615 ) (1,454 )

Net pension asset/(liability)
42 (177 ) (303 ) (335 ) (290 )

Experience adjustments on plan assets 29 74 140 67 88
Experience adjustments on plan liabilities 50 28 (119 ) (127 ) (113 )
Funding
The UK Group plan is self-administered with the plans’ assets being held independently of the Group. The trustees of the plan are required to act in the best interest of the plan’s beneficiaries. The most recently completed triennial actuarial valuation for funding purposes was completed as at 1 January 2006 and revealed a funding shortfall. The Group has agreed that the funding shortfall will be eliminated by 31 December 2014. In 2007 the Group contributed £121m (including a special contribution of £100m) and has agreed to contribute £21m in 2008 and £21.9m per annum thereafter in excess of an estimated £30m of regular contributions.
The Group expects to contribute $70m in 2008 and $73m in 2009 to its US pension plans.
Sensitivities
The net retirement benefit obligations are calculated using a number of assumptions, the most significant being the discount rate used to calculate the defined benefit obligation. The effect of a one percentage point increase ~~(and decrease)~~and decrease in the discount rate on the defined benefit obligation and the total pension expense is as follows:

2007
1% increase 1% decrease
All figures in £ millions

Effect on:

(Decrease)/increase in defined benefit obligation — UK Group plan (222 ) 275
(Decrease)/increase of aggregate of service cost and interest cost — UK Group plan (4.6 ) 5.8
(Decrease)/increase in defined benefit obligation — US plan (6.7 ) 7.3

F-56
Notes to the Consolidated Financial Statements (Continued)
The effect of a one percentage point increase and decrease in the assumed medical cost trend rates is as follows:

2005 2005 2004 2004 2003 2003
1% increase 1% decrease 1% increase 1% decrease 1% increase 1% decrease

(All figures in £ millions)
Effect on:

Aggregate of service cost and interest cost 0.2 (0.2 ) 0.2 (0.2 ) 0.3 (0.3 )
Defined benefit obligation 4.7 4.1 4.1 (3.7 ) 4.8 (4.2 )
~~F-47~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

2007
1% increase 1% decrease
All figures in £ millions

Effect on:

(Decrease)/increase in post-retirement medical benefit obligation (3.7 ) 4.1
Increase/(decrease) of aggregate of service cost and interest cost 0.1 (0.1 )
~~Share-based compensation~~

26.   Share-based payments
The Group recognised the following charges in the income statement in respect of its equity-settled share-based payment plans:

2005 2004 2003

(All figures in £ millions)
Pearson plans 13 15 20
IDC plans 10 10 9

Total share-based payment costs
23 25 29

2007 2006 2005
All figures in £ millions

Pearson plans 23 18 13
Interactive Data plans 7 7 10

Total share-based payment costs
30 25 23

The Group operates the following equity-settled employee option and ~~performance~~share plans:
~~Profit Sharing Plan~~ ~~— The Group operates a profit sharing plan for all employees, the payment of which is at the discretion of the Pearson board and may be made in cash or Pearson shares.~~
~~Save for Shares Plans~~ — Since 1994 the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee’s participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.
~~Employee Stock Purchase Plan~~ — In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the United States to save a portion of their monthly salary over six month periods. At the end of the period the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.
~~Executive Share Option Plan~~ — Under this plan, options were granted to senior management at an exercise price equal to the market price of the shares on the date of grant. Options granted prior to 1996 are not subject to performance conditions. The exercise of options granted since 1996 is subject to growth in the Group’s adjusted earnings per share over a three year period prior to exercise. Options become exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth. No new awards will be made under this plan.
~~Reward Plan~~ — Awards of premium priced options were made under this plan in 1999 and 2000 with an exercise price above the market value of the shares at the grant date. The exercise of options is subject to Pearson’s share price remaining above certain thresholds for specified periods of time and to growth in the Group’s adjusted earnings per share over the three year period prior to exercise. Options became exercisable on the third anniversary of the date of grant and lapse if they remain unexercised at the tenth. No new awards will be made under this plan.
~~Special Share Option Plan~~ — In 2000, the Group made a special one-off award of share options with an exercise price equal to the market price of the shares on the grant date. They vested in tranches of 50% on the first anniversary of the date of grant and 25% on the second and third anniversaries of the grant date. Options lapse if they remain unexercised at the tenth anniversary of the grant date. No new awards will be made under this plan.
Worldwide Save for Shares Plan — Since 1994, the Group has operated a Save-As-You-Earn plan for UK employees. In 1998, the Group introduced a Worldwide Save for Shares Plan. Under these plans, employees can save a portion of their monthly salary over periods of three, five or seven years. At the end of this period, the employee has the option to purchase ordinary shares with the accumulated funds at a purchase price equal to 80% of the market price prevailing at the time of the commencement of the employee’s participation in the plan. Options that are not exercised within six months of the third, fifth or seventh anniversary after grant lapse unconditionally.
Employee Stock Purchase Plan — In 2000, the Group established an Employee Stock Purchase Plan which allows all employees in the US to save a portion of their monthly salary over six month periods. At the end of the period, the employee has the option to purchase ADRs with their accumulated funds at a purchase price equal to 85% of the lower of the market price prevailing at the beginning or end of the period.
Long-Term Incentive Plan — This plan was introduced in 2001 and renewed in 2006 and consists of two parts: share optionsand/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 serviceand/or upon the satisfaction of corporate performance targets over a three-year period. These targets may be based on marketand/or non-market performance criteria. Restricted shares awarded to senior management in October 2006 and July 2007 vest dependent on relative shareholder return, return on invested capital and earnings per share growth. The award was split equally across all three measures. Other restricted shares awarded in 2006 and 2007 vest depending on continuing service over a three-year period.
Annual Bonus Share Matching Plan — This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for every one held.

F-57
~~F-48~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
~~Long-Term Incentive Plan~~ ~~— This plan was introduced in 2001 and consists of two parts: share options and/or restricted shares.~~
      Options were granted under this plan in 2001 based on a pre-grant earnings per share growth test and are not subject to further performance conditions on exercise. The options became exercisable in tranches and lapse if they remain unexercised at the tenth anniversary of the date of grant.
      The vesting of restricted shares is normally dependent upon the satisfaction of corporate performance targets over a three year period. These targets may be based on market and/or non-market performance criteria. Restricted shares granted in 2001 vested based on Pearson’s three-year cumulative free cash flow per share performance. Awards made in December 2002 and September 2003 vest in tranches. One sixth of the award vests after three years with no performance conditions. The vesting of the balance depends on Pearson’s share price performance over the seven year period following the grants. Restricted shares awarded in December 2004 and September 2005 vest dependent on the following market and non-market performance criteria: relative shareholder return, return on invested capital and a combination of earnings per share and sales growth. The award is split equally across all three measures.
~~Annual Bonus Share Matching Plan~~ — This plan permits executive directors and senior executives around the Group to invest up to 50% of any after tax annual bonus in Pearson shares. If these shares are held and the Group meets an earnings per share growth target, the Company will match them on a gross basis of up to one share for everyone held after three years and another one for two originally held after five years.
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 ~~schemes~~plans are as follows:

2005 2005 2004 2004 2003 2003
Number of Weighted Number of Weighted Number of Weighted
share average share average share average
options exercise options exercise options exercise
000s price £ 000s price £ 000s price £

Outstanding at beginning of year 26,179 5.93 32,284 6.93 35,608 8.84
Granted during the year 606 5.06 886 4.56 2,309 5.16
Exercised during the year (324 ) 6.78 (254 ) 10.10 (89 ) 10.60
Forfeited during the year (4,352 ) 10.42 (6,301 ) 7.49 (5,053 ) 16.25
Expired during the year (432 ) — (436 ) — (491 ) —

Outstanding at end of year
21,677 5.05 26,179 5.93 32,284 6.93

Options exercisable at the end of year
7,634 7.80 9,071 9.23 9,882 9.44

2007 2006
Weighted
Weighted

Number of
average
Number of
average

share
exercise
share
exercise

options
price
options
price

000s £ 000s £

Outstanding at beginning of year 18,861 13.36 21,677 13.15
Granted during the year 773 6.90 837 6.30
Exercised during the year (1,326 ) 5.80 (1,396 ) 5.36
Forfeited during the year (1,434 ) 19.63 (1,828 ) 15.39
Expired during the year (93 ) 7.68 (429 ) 6.72

Outstanding at end of year
16,781 13.15 18,861 13.36

Options exercisable at end of year
13,999 14.63 15,595 14.14

Options were exercised regularly throughout the year. The weighted average share price during the year was ~~£6.52 (2004: £6.25; 2003: £5.72)~~£8.02 (2006: £7.45). Early exercises arising from redundancy, retirement or death are treated as an acceleration of vesting and the ~~remaining charge is~~Group therefore recognises in the income statement the amount that otherwise would have been recognised atfor services received over the ~~date~~remainder of ~~exercise.~~
~~F-49~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~the original vesting period.

The options outstanding at the end of the year have weighted average remaining contractual lives and exercise prices as follows:

2005 2005 2004 2004 2003 2003
Number of Weighted Number of Weighted Number of Weighted
share average share average share average
Range of exercise prices options contractual options contractual options contractual
£ 000s life years 000s life years 000s life years

0 — 5 2,773 2.08 3,251 2.97 2,740 3.66
5 — 10 5,555 4.48 6,538 5.44 7,797 6.02
10 — 15 8,237 4.63 9,604 5.57 11,758 6.63
15 — 20 1,168 3.80 1,469 4.81 2,210 5.78
20 — 25 930 3.80 1,346 4.92 2,210 6.02
>25 3,014 4.22 3,971 4.65 5,569 5.79

21,677 4.13 26,179 5.00 32,284 5.99

2007 2006
Weighted
Weighted

Number of
average
Number of
average

share
contractual
share
contractual

Range of exercise prices
options
life
options
life

£
000s Years 000s Years

0 — 5 930 1.56 1,649 1.94
5 — 10 4,909 3.22 5,254 3.85
10 — 15 7,257 2.62 7,638 3.63
15 — 20 980 1.85 1,050 2.88
20 — 25 400 2.19 424 3.19
>25 2,305 2.19 2,846 3.22

16,781 2.62 18,861 3.42

In ~~2005, 2004~~2007 and ~~2003~~2006 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-58

Notes to the Consolidated Financial Statements (Continued)
The weighted average estimated fair values and the inputs ~~in to~~into the Black-Scholes model are as follows:

2005 2004 2003
Weighted Weighted Weighted
average average average

Fair value £2.34 £2.70 £1.82

Weighted average share price £6.54 £6.58 £5.15
Weighted average exercise price £5.08 £4.96 £4.25
Expected volatility 33.69 % 41.95 % 48.74 %
Expected life 3.6 years 3.8 years 4.0 years
Risk free rate 4.48 % 4.77 % 3.84 %
Expected dividend yield 2.40 % 2.72 % 4.55 %
Forfeiture rate 20.0 % 21.1 % 18.7 %

2007
2006

Weighted
Weighted

average average

Fair value £2.53 £1.92
Weighted average share price £8.91 £7.66
Weighted average exercise price £6.90 £6.30
Expected volatility 19.72 % 23.12 %
Expected life 4.0 years 4.0 years
Risk free rate 5.34 % 4.42 %
Expected dividend yield 3.29 % 3.52 %
Forfeiture rate 3.5 % 5.0 %
The expected volatility is based on the historic volatility of the Company’s share price over the previous ~~3 — 7~~three to seven years depending on the vesting term of the options.
~~During the year the~~
The following shares were granted under restricted share arrangements:

2005 2005 2004 2003
Number Weighted 2004 Weighted 2003 Weighted
of shares average Number average Number average
000s fair value of shares fair value of shares fair value
£ 000s £ 000s £

Annual Bonus Share Matching Plan 71 5.57 53 5.42 108 4.36
Long-term Incentive Plan 3,987 5.05 2,413 4.54 1,711 5.21
~~F-50~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

2007 2006
Weighted
Weighted

Number
average
Number
average

of shares
fair value
of shares
fair value

000s £ 000s £

Annual Bonus Share Matching Plan 143 7.67 90 6.27
Long-Term Incentive Plan 3,377 7.12 3,585 6.96
~~The fair value of~~
Restricted shares ~~awarded~~granted under the Annual Bonus Share Matching Plan ~~was determined~~are valued using ~~a Black-Scholes model. Shares awarded~~the share price at the date of grant discounted by the dividend yield (2007: 3.26%; 2006: 3.66%) to take into account any dividends foregone. The fair value of shares granted under the Long-Term Incentive Plan ~~were also valued using a Black-Scholes model provided the shares vest unconditionally. The weighted average estimated fair values and the inputs into the Black-Scholes model are as follows:~~

2005 2004
Weighted Weighted
Average Average

Fair value £6.19 £4.54

Weighted average share price £6.69 £6.13
Weighted average exercise price — —
Expected volatility 32.79 % 38.39 %
Expected life 3.3 years 3.0 years
Risk free rate 4.19 % 4.59 %
Expected dividend yield 2.35 % 4.00 %
Forfeiture rate 9.9 % 4.5 %

      ~~In 2003, no restricted shares granted were valued using a Black-Scholes model. The fair value of restricted shares~~ that vest ~~conditionally upon~~unconditionally is determined using the ~~fulfilment~~share price at the date of grant. Participants of the Long-Term Incentive Plan are entitled to dividends during the vesting period. The number of shares to vest has been 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. ~~Shares~~Restricted shares with a non-market ~~vesting~~performance condition were fair valued based on the share price at the date of ~~grant taking into account any future dividend payments. The~~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,~~
Interactive Data, a ~~61%~~62% subsidiary of the Group, operates the following share-based payment plans:
~~2001 Employee Stock Purchase Plan~~In 2001, IDC adopted the 2001 Employee Stock Purchase Plan for all eligible employees worldwide. The 2001 Employee Stock Purchase Plan allows employees to purchase stock at a discounted price at specific times.
~~2000 Long-Term Incentive Plan~~Under this plan, the Compensation Committee of the Board of Directors can grant share-based awards representing up to 20% of the total number of shares of common stock outstanding at the date of grant. The plan provides for the discretionary issuance of share-base awards to directors, officers and employees of IDC, as well as persons who provide consulting or other services to IDC. The exercise price for all options granted to date has been equal to the market price of the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.
2001 Employee Stock Purchase Plan

The 2001 Employee Stock Purchase Plan allows all eligible employees worldwide 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 Interactive Data, as well as persons who provide consulting or other services to Interactive Data. The exercise price for all options granted to date has been equal to the market price of the underlying shares at the date of grant. Options expire ten years from the date of grant and generally vest over a three to four year period without any performance criteria attached.

F-59
Notes to the Consolidated Financial Statements (Continued)
In addition, grants of restricted stock can be made to certain executives and members of the Board of Directors of ~~IDC.~~Interactive Data. 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.
~~F-51~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
Interactive Data employees purchased 186,343 shares (2006: 206,324) under the 2001 Employee Stock Purchase Plan at an average share price of $17.77 (£8.93) (2006: $15.58; £7.96). The weighted average fair value at the date of grant was $4.76 (£2.39) (2006: $3.98; £2.03).

The number and weighted average exercise prices of share options granted under the 2000 Long-Term Incentive Plan isare as follows:

2005 2004 2003
2005 Weighted 2005 2004 Weighted 2004 2003 Weighted 2003
Number average Weighted Number average Weighted Number average Weighted
of share exercise average of share exercise average of share exercise average
options price exercise options price exercise options price exercise
000s $ price £ 000s $ price £ 000s $ price £

Outstanding at beginning of year 9,832 13.46 7.36 9,358 12.15 7.44 8,619 10.43 6.38
Granted during the year 1,940 21.38 11.80 1,937 17.48 9.56 2,107 16.40 10.04
Exercised during the year (1,412 ) 11.57 6.39 (1,157 ) 9.59 5.24 (1,195 ) 7.20 4.41
Forfeited during the year (292 ) 16.86 9.31 (306 ) 13.32 7.28 (173 ) 12.36 7.57

Outstanding at end of year
10,068 15.16 8.37 9,832 13.46 7.36 9,358 12.15 7.44

Options exercisable at end of year
6,052 12.58 6.94 5,321 11.41 6.24 4,259 9.93 6.08

2007 2006
Weighted
Weighted
Weighted
Weighted

Number
average
average
Number
average
average

of share
exercise
exercise
of share
exercise
exercise

options
price
price
options
price
price

000s $ £ 000s $ £

Outstanding at beginning of year 10,506 16.33 8.34 10,068 15.16 8.37
Granted during the year 1,560 27.17 13.65 1,835 20.58 10.52
Exercised during the year (1,935 ) 14.88 7.48 (1,252 ) 12.88 6.58
Forfeited during the year (293 ) 20.38 10.24 (139 ) 19.02 9.72
Expired during the year (11 ) 18.12 9.10 (6 ) 11.46 5.86

Outstanding at end of year
9,827 18.21 9.15 10,506 16.33 8.34

Options exercisable at end of year
6,199 15.27 7.67 6,547 14.11 7.21

The options outstanding at the end of the year have a weighted average remaining contractual life and exercise price as follows:

2005 2005 2004 2004 2003 2003
Number Weighted Number Weighted Number Weighted
of share average of share average of share average
Range of exercise prices options contractual options contractual options contractual
$ 000s life years 000s life years 000s life years

0 — 4.4 33 4.2 64 4.3 143 6.1
4.4 — 7.5 206 3.6 287 4.5 499 5.0
7.5 — 12 2,685 5.3 3,398 6.3 4,117 7.3
12 — 20 5,243 7.4 6,083 8.4 4,599 8.8
>20 1,901 9.5 — — — —

10,068 5.4 9,832 7.5 9,358 7.9

~~During~~

2007 2006
Weighted
Weighted

Number
average
Number
average

of share
contractual
of share
contractual

Range of exercise prices
options
life
options
life

$
000s Years 000s Years

0 — 4.4 — — 30 3.1
4.4 — 7.5 72 2.1 157 2.3
7.5 — 12 1,745 3.4 2,164 4.4
12 — 20 3,464 5.6 4,640 6.4
> 20 4,546 8.5 3,515 9.0

9,827 6.6 10,506 6.8

F-60
Notes to the ~~year IDC granted the following shares under restricted share arrangements:~~Consolidated Financial Statements (Continued)

2005
2005 Weighted 2005 2004 2004 2003 2003
Number average Weighted 2004 Weighted Weighted 2003 Weighted Weighted
of shares fair value average Number average average Number average average
000s $ fair value of shares fair value fair value of shares fair value fair value
£ 000s $ £ 000s $ £

2000 Long-Term Incentive Plan 148 20.57 11.35 69 17.57 9.61 76 16.97 10.39
2001 Employee Stock Purchase Plan 178 3.68 2.03 124 3.24 1.77 118 2.64 1.62
~~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 of the shares awarded under the 2001 Employee Stock Purchase Plan was estimated using a Black-Scholes model.
~~F-52~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
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

2005 2004 2003 2005 2004 2003
Weighted Weighted Weighted Weighted Weighted Weighted
average average average average average average

Fair value $ 5.56 $ 7.50 $ 8.09 $ 3.68 $ 3.24 $ 2.64

Weighted average share price $21.38 $17.48 $16.40 $15.46 $14.48 $11.24
Weighted average exercise price $21.38 $17.48 $16.40 $15.46 $14.48 $11.24
Expected volatility 24.50 % 32.20 % 61.10 % 20.00 % 20.00 % 25.00 %
Expected life 4.0 years 4.0 years 4.0 years 0.5 years 0.5 years 0.5 years
Risk free rate 3.86 % 3.45 % 2.00 % 2.33 % 1.03 % 1.20 %
Expected dividend yield 0.0 % 0.0 % 0.0 % 0.0 % 0.0 % 0.0 %
Forfeiture rate 0.0 % 0.0 % 0.0 % 0.0 % 0.0 % 0.0 %

Long-Term Incentive Plan Employee Stock Purchase Plan
2007
2006
2007
2006

Weighted
Weighted
Weighted
Weighted

average average average average

Fair value $ 6.60 $ 6.57 $ 4.76 $ 3.98
Weighted average share price $27.17 $20.58 $17.77 $15.58
Weighted average exercise price $27.17 $20.58 $17.77 $15.58
Expected volatility 23.40 % 25.90 % 20.50 % 18.32 %
Expected life 5.0 years 4.7 years 0.5 years 0.5 years
Risk free rate 4.2% to 4.9% 4.6% to 5.1% 4.3% to 5.1% 3.7% to 5.2%
Expected dividend yield 1.9 % 0.0 % 2.0 % 0.0 %
Forfeiture rate 0.0 % 0.0 % 0.0 % 0.0 %
The expected volatility is based on the historic volatility of ~~IDC’s~~Interactive Data’s share price over the vesting term of the options.
During the year Interactive Data granted the following shares under restricted share arrangements:

2007 2006
Weighted
Weighted
Weighted
Weighted

Number
average
average
Number
average
average

of shares
fair value
fair value
of shares
fair value
fair value

000s $ £ 000s $ £

2000 Long-Term Incentive Plan 185 27.07 13.60 196 20.82 10.64
Shares awarded under the 2000 Long-Term Incentive Plan were valued based on the share price prevailing at the date of grant.
2527.   Share capital and share premium

Number of Ordinary Share
shares shares premium
(thousands) £m £m

At 1 January 2003 801,662 200 2,465
Issue of shares — share option schemes 726 1 4

At 31 December 2003
802,388 201 2,469
Issue of shares — share option schemes 862 — 4

At 31 December 2004
803,250 201 2,473
Issue of shares — share option schemes 770 — 4

At 31 December 2005
804,020 201 2,477

Number
Ordinary
Share

of shares
shares
premium

000s £m £m

At 1 January 2006 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

Issue of ordinary shares — share option schemes 1,919 — 12

At 31 December 2007
808,028 202 2,499

The total authorised number of ordinary shares is ~~1,186 million~~1,194m shares ~~(2004: 1,182 million shares; 2003: 1,178 million~~(2006: 1,190m shares) with a par value of ~~25 pence~~25p per share ~~(2004: 25p per share;2003:~~(2006: 25p per share). All issued shares are fully paid. All shares have the same rights.
The Group manages its capital to ensure that entities in the Group will be able to continue as a going concern while maximising the return to shareholders through the optimisation of the debt and equity balance.
The capital structure of the Group consists of debt (see note 22), cash and cash equivalents (see note 21) and equity attributable to equity holders of the parent, comprising issued capital, reserves and retained earnings (see notes 27, 28 and 29).

F-61
~~F-53~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
The Group reviews its capital structure on a regular basis and will balance its overall capital structure through payments of dividends, new share issues as well as the issue of new debt or the redemption of existing debt in line with the financial risk policies outlined in note 15.
2628.   Treasury shares

Pearson plc Interactive Data Total
Number
Number

of shares
of shares

000s £m 000s £m £m

At 1 January 2006 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

Purchase of treasury shares 4,900 40 1,177 16 56
Release of treasury shares (1,900 ) (29 ) — — (29 )

At 31 December 2007
11,761 141 7,229 75 216

The Group holds Pearson plc shares in trust to satisfy its obligations under its restricted share plans (see note 26). These shares, representing 1.5% (2006: 1.1%) ofcalled-up share capital, are held as treasury shares and have a par value of 25p per share.
Interactive Data 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.
The nominal value of Pearson plc treasury shares amounts to £2.9m (2006: £2.2m). The nominal value of Interactive Data treasury shares amounts to £0.04m (2006: £0.03m).
At 31 December 2007 the market value of Pearson plc treasury shares was £86.1m (2006: £67.6m) and the market value of Interactive Data treasury shares was £119.9m (2006: £74.3m).

F-62
Notes to the Consolidated Financial Statements (Continued)
29.   Other reserves and retained earnings

Total
Treasury Translation Fair value other Retained
shares reserve reserve reserves earnings

(All figures in £ millions)
At 1 January 2003 (121 ) — — (121 ) 644
Net exchange differences on translation of foreign operations — (288 ) — (288 ) —
Purchase of treasury shares (1 ) — — (1 ) —
Profit for the year attributable to equity holders of the parent — — — — 252
Dividends paid — — — — (188 )
Equity settled transactions — — — — 29
Actuarial gains and losses on defined benefit schemes — — — — (28 )
Taxation on items taken directly to equity — — — — —

At 31 December 2003
(122 ) (288 ) — (410 ) 709

Net exchange differences on translation of foreign operations — (203 ) — (203 ) —
Purchase of treasury shares (10 ) — — (10 ) —
Profit for the year attributable to equity holders of the parent — — — — 262
Dividends paid — — — — (195 )
Equity settled transactions — — — — 25
Actuarial gains and losses on defined benefit schemes — — — — (61 )
Taxation on items taken directly to equity — — — — 9

At 31 December 2004
(132 ) (491 ) — (623 ) 749

Net exchange differences on translation of foreign operations — 327 — 327 —
Cumulative translation adjustment disposed — (14 ) — (14 ) —
Purchase of treasury shares (21 ) — — (21 ) —
Profit for the year attributable to equity holders of the parent — — — — 624
Dividends paid — — — — (205 )
Equity settled transactions — — — — 23
Actuarial gains and losses on defined benefit schemes — — — — 26
Taxation on items taken directly to equity — — — — 12
Transition adjustment on adoption of IAS 39 (note 34) — 3 — 3 (15 )

At 31 December 2005
(153 ) (175 ) — (328 ) 1,214

Total

Translation
Fair value
other
Retained

Notes reserve reserve reserves earnings
All figures in £ millions

At 1 January 2006 (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 26 — — — 25
Actuarial gains on retirement benefit obligations 25 — — — 107
Treasury shares released under employee share plans 28 — — — (16 )
Taxation on items charged to equity 8 — — — 12

At 31 December 2006
(592 ) — (592 ) 1,568

Net exchange differences on translation of foreign operations 25 — 25 —
Cumulative translation adjustment disposed 32 53 — 53 —
Profit for the year attributable to equity holders of the Company — — — 284
Dividends paid to equity holders of the Company 10 — — — (238 )
Equity settled transactions 26 — — — 30
Actuarial gains on retirement benefit obligations 25 — — — 80
Treasury shares released under employee share plans 28 — — — (29 )
Taxation on items charged to equity 8 — — — 29

At 31 December 2007
(514 ) — (514 ) 1,724

The translation reserve includes exchange differences arising from the translation of the net investment in foreign ~~entities,~~operations and of borrowings and other currency instruments designated as hedges of such investments.
~~F-54~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~ Included in the translation reserve is a £49m loss (2006: £53m loss) relating to net assets classified as held for sale.
2730.   Business combinations

On 224 May 2007, the Group announced that it had agreed to acquire Harcourt Assessment, a leading test provider, and Harcourt Education International, publisher of textbooks and online materials. The Harcourt Education International acquisition has closed in several stages, following regulatory reviews of the relevant authorities where required. The acquisition of Harcourt Assessment completed on 30 January 2008 and is therefore excluded from the numbers below (see note 37).
On 31 July ~~2005~~2007, the Group acquired ~~100% of~~eCollege, a leader in the ~~voting rights of AGS Publishing, an educational assessments and curriculum materials publisher.~~US online distance learning market. In addition, several other businesses were acquired in the current ~~and prior years, none~~year, mainly within the FT Group. None of ~~which~~these other acquisitions were individually material to the Group. The largest single acquisition in 2006 was Mergermarket.

F-63
Notes to the Consolidated Financial Statements (Continued)

The provisional assets and liabilities arising from acquisitions ~~in each of the years~~ are as follows:

2005
2004 2003
AGS AGS AGS Other Total Total Total
carrying fair value fair fair fair fair fair
amount adjs value value value value value

(All figures in £ millions)
Tangible fixed assets 1 — 1 6 7 1 10
Intangible assets — 58 58 31 89 15 44
Intangible assets — pre-publication 15 — 15 — 15 — —
Inventory 3 — 3 7 10 2 —
Receivables 7 — 7 25 32 3 32
Payables (5 ) (1 ) (6 ) (36 ) (42 ) (4 ) (95 )
Provisions (2 ) — (2 ) (1 ) (3 ) 1 (4 )
Deferred taxation — (20 ) (20 ) (1 ) (21 ) — (15 )
Cash and cash equivalents (1 ) — (1 ) 4 3 — 34
Equity minority interests — — — 8 8 (3 ) (8 )

Net assets/(liabilities) acquired at fair value
18 37 55 43 98 15 (2 )

Goodwill
105 — 105 50 155 22 113

Total
160 93 253 37 111

Satisfied by:

Cash (160 ) (89 ) (249 ) (39 ) (87 )
Deferred cash consideration — (5 ) (5 ) — (24 )
Costs provided for — 1 1 (1 ) —
Net prior year adjustments — — — 3 —

Total consideration
(160 ) (93 ) (253 ) (37 ) (111 )

Book value of net assets/(liabilities acquired) 18 40 58 4 (32 )
Fair value adjustments 37 3 40 1 30

Fair value to the Group
55 43 98 5 (2 )

2007 2006
Harcourt
eCollege
Other
Total
Total

Notes Fair value Fair value Fair value Fair value Fair value
All figures in £ millions

Property, plant and equipment 11 6 5 — 11 13
Intangible assets 12 81 100 16 197 156
Intangible assets — Pre-publication 18 16 2 — 18 4
Inventories 15 — — 15 14
Trade and other receivables 12 13 3 28 24
Cash and cash equivalents — — — — 28
Trade and other liabilities (23 ) (12 ) (3 ) (38 ) (52 )
Financial liabilities — Borrowings — (1 ) (1 ) (3 )
Current income tax 2 2 — 4 —
Net deferred income tax liabilities 14 (21 ) (24 ) — (45 ) (26 )
Retirement benefit obligations 25 — — — — (2 )
Provisions for other liabilities and charges 23 (1 ) — (1 ) (2 ) (3 )
Equity minority interest — — — — (9 )

Net assets acquired at fair value
87 85 15 187 144

Goodwill
12 68 181 55 304 246

Total
155 266 70 491 390

Satisfied by:
Cash (155 ) (266 ) (47 ) (468 ) (382 )
Deferred consideration — — (12 ) (12 ) (17 )
Net prior year adjustments — — (11 ) (11 ) 9

Total consideration
(155 ) (266 ) (70 ) (491 ) (390 )

Carrying value of net assets acquired 25 15 1 41 48
Fair value adjustments 62 70 14 146 96

Fair value to the Group
87 85 15 187 144

The goodwill arising on the acquisition of Harcourt and eCollege results from substantial cost and revenue synergies and from benefits that cannot be separately recognised, such as the assembled workforce.
The fair value adjustments relating to the acquisition of ~~AGS~~Harcourt and eCollege are provisional and will be finalised during ~~2006.~~2008. They include the valuation of intangible assets and the related deferred tax ~~effect and recognition of provisions. Adjustments to 2004 provisional fair values largely~~effect. Prior year adjustments relate to the ~~acquisition~~finalisation of ~~Dominie Press.~~fair value adjustments and increases in deferred consideration relating to Mergermarket.

F-64
Notes to the Consolidated Financial Statements (Continued)

Harcourt
Carrying
Fair
Provisional

value value adjs fair value
All figures in £ millions

Property, plant and equipment 6 — 6
Intangible assets — 81 81
Intangible assets — Pre-publication 14 2 16
Inventories 15 — 15
Trade and other receivables 12 — 12
Trade and other liabilities (23 ) — (23 )
Current income tax 2 — 2
Net deferred income tax liabilities — (21 ) (21 )
Provisions for other liabilities and charges (1 ) — (1 )

Net assets acquired at fair value
25 62 87

Goodwill
68

Total
155

eCollege
Carrying
Fair
Provisional

value value adjs fair value
All figures in £ millions

Property, plant and equipment 5 — 5
Intangible assets 2 98 100
Intangible assets — Pre-publication 2 — 2
Trade and other receivables 13 — 13
Trade and other liabilities (10 ) (2 ) (12 )
Financial liabilities — Borrowings (1 ) — (1 )
Current income tax 2 — 2
Net deferred income tax assets/(liabilities) 2 (26 ) (24 )

Net assets acquired at fair value
15 70 85

Goodwill
181

Total
266

Net cash outflow on acquisition:

2005 2004 2003

(All figures in £ millions)
Cash — current year acquisitions (249 ) (39 ) (87 )
Deferred payments for prior year acquisitions and other items — (2 ) (7 )
Cash and cash equivalents acquired 3 — 34

Cash outflow on acquisition
(246 ) (41 ) (60 )

~~F-55~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~The goodwill arising on the acquisition of AGS is attributable to the profitability of the acquired business and the significant synergies expected to arise.~~

2007 2006 2005
All figures in £ millions

Cash — Current year acquisitions (468 ) (382 ) (249 )
Deferred payments for prior year acquisitions and other items (4 ) (9 ) —
Cash and cash equivalents acquired — 28 3

Cash outflow on acquisition
(472 ) (363 ) (246 )

~~AGS~~
Harcourt contributed ~~£21m~~£71m of sales and ~~£6m~~£7m to the Group’s profit before tax between the date of acquisition and the balance sheet date. eCollege contributed £15m of sales and £4m to the Group’s profit before tax between the date of acquisition and the balance sheet date. Other businesses acquired contributed ~~£1m~~£4m to the Group’s sales and £2m to the Group’s profit before tax between the date of acquisition and the balance sheet date.
F-65

Notes to the Consolidated Financial Statements (Continued)
If the acquisitions had been completed on 1 January ~~2005, total~~2007, the Group estimates that sales for the period would have been ~~£4,168m,~~£4,307m and profit before tax would have been ~~£474m.~~£479m.
2831.   ~~Disposals~~Non-current assets classified as held for sale
~~In April 2005 the~~
The Group disposed of its ~~79% interest~~Data Management business on 22 February 2008 and this business is classified as held for sale in ~~Recoletos Grupo de Communicación S.A.~~2007. The Data Management business was formerly part of the Group’s Other Assessment and Testing cash-generating unit (CGU) and was carved out of this CGU in preparation for disposal. As a result, the Group has recognised an impairment on the goodwill allocated to the Data Management business in anticipation of the loss on disposal (see note 3). In 2006, assets classified as held for sale related to Government Solutions. The major classes of assets and liabilities comprising the operations classified as held for sale at the balance sheet date are as follows:

2005
2004 2003
Recoletos Other Total Total Total

(All figures in £ millions)
Disposal of subsidiaries

Property, plant and equipment (48 ) — (48 ) — (3 )
Other financial assets (2 ) — (2 ) — —
Associates (3 ) — (3 ) — —
Inventory (4 ) — (4 ) — (2 )
Receivables (59 ) — (59 ) (4 ) (9 )
Payables 68 3 71 2 10
Provisions 2 1 3 — —
Deferred taxation 8 — 8 — —
Net (cash and cash equivalents)/borrowings (132 ) (2 ) (134 ) 1 1
Equity minority interests 60 (6 ) 54 (4 ) —
Attributable goodwill (98 ) (6 ) (104 ) (4 ) (4 )
Currency translation adjustment 14 — 14 — —

Net assets disposed of
(194 ) (10 ) (204 ) (9 ) (7 )

Proceeds received 503 10 513 8 1
Costs (3 ) — (3 ) (2 ) (1 )
Deferred consideration — — — — 2
Net prior year adjustments — — — — 1

Profit/(loss) on sale
306 — 306 (3 ) (4 )

2005 2004 2003

Cash flow from disposals

Cash — current year disposals 513 8 1
Costs paid (3 ) (2 ) (2 )
Deferred receipts and payments from prior year disposals and other amounts — — (3 )
Cash and cash equivalents/net debt disposed of (134 ) 1 1

Net cash outflow
376 7 (3 )

Notes 2007 2006

Property, plant and equipment 11 7 9
Intangible assets — Goodwill 96 221
Intangible assets — Other 12 — 7
Intangible assets — Pre-publication 2 —
Inventories 4 1
Trade and other receivables 8 56

Non-current assets classified as held for sale
117 294

Other liabilities (9 ) (26 )

Liabilities directly associated with non-current assets classified as held for sale
(9 ) (26 )

Net assets classified as held for sale
108 268

F-66
~~F-56~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS~~Notes to the Consolidated Financial Statements (Continued)
2932.   Disposals

2007
Government
2006 2005
Solutions Les Echos Datamark Other Total Total Total
All figures in £ millions

Disposal of subsidiaries

Property, plant and equipment (10 ) (3 ) (3 ) — (16 ) — (48 )
Intangible assets (6 ) — — — (6 ) — —
Investments in associates and other financial assets — — — — — — (5 )
Inventories — — (1 ) — (1 ) — (4 )
Trade and other receivables (63 ) (26 ) (5 ) (1 ) (95 ) — (59 )
Cash and cash equivalents — (14 ) — — (14 ) — (134 )
Deferred income tax liabilities — 2 — — 2 — 8
Trade and other liabilities 23 42 6 2 73 (1 ) 71
Retirement benefit obligations — 3 — — 3 — —
Provisions for other liabilities and charges — 1 — — 1 — 3
Equity minority interests — — — (8 ) (8 ) (4 ) 54
Attributable goodwill (221 ) (4 ) (17 ) (8 ) (250 ) (5 ) (104 )
Cumulative translation adjustment (53 ) — — — (53 ) — 14

Net (assets)/liabilities disposed
(330 ) 1 (20 ) (15 ) (364 ) (10 ) (204 )

Cash received 286 174 20 15 495 10 513
Other proceeds received 35 — — — 35 — —
Costs (10 ) (10 ) — — (20 ) — (3 )

(Loss)/profit on sale
(19 ) 165 — — 146 — 306

2007 2006 2005

Cash flow from disposals

Cash — Current year disposals 495 10 513
Costs paid (12 ) — (3 )
Cash and cash equivalents disposed (14 ) — (134 )

Net cash inflow
469 10 376

Details of the businesses disposed are shown in note 3.
The proceeds received for the sale of Government Solutions include £286m in cash, £20m in Loan Stock and a 10% interest in the acquiring company valued at £15m.
Other includes share options exercised in Interactive Data.

F-67
Notes to the Consolidated Financial Statements (Continued)
33.   Cash generated from operations

2005 2004 2003

(All figures in £ millions)
Net profit 644 284 275
Adjustments for:

Tax 125 70 84
Depreciation 80 84 85
Amortisation of purchased intangible assets 11 5 4
Amortisation of other intangible assets 18 20 28
Amortisation of pre-publication investment 192 168 158
Loss on sale of property, plant and equipment — 4 2
(Profit)/loss on sale of other financial assets — (16 ) 1
Net finance costs 70 76 90
Share of results of joint ventures and associates (14 ) (10 ) (4 )
(Profit)/loss on sale of subsidiaries and associates (346 ) 3 (8 )
Net foreign exchange losses/(gains) from transactions 39 (15 ) (51 )
Share-based payments 23 25 29
Inventories (17 ) (12 ) 10
Trade and other receivables (4 ) (18 ) (92 )
Trade and other payables 71 61 (50 )
Provisions (17 ) (24 ) (30 )

Cash generated from operations
875 705 531

Notes 2007 2006 2005
All figures in £ millions

Net profit 310 469 644
Adjustments for:

Income tax 222 19 125
Depreciation 11 68 77 80
Amortisation of purchased intangible assets 12 45 28 11
Adjustment on recognition of pre-acquisition deferred tax 12 — 7 —
Amortisation of other intangible assets 12 25 23 18
Investment in pre-publication assets 18 (230 ) (213 ) (222 )
Amortisation of pre-publication assets 18 192 210 192
Loss on sale of property, plant and equipment 1 2 —
Net finance costs 7 106 74 70
Share of results of joint ventures and associates 13 (23 ) (24 ) (14 )
Profit on sale of discontinued operations 3 (146 ) — (346 )
Goodwill impairment of discontinued operation 3 97 — —
Net foreign exchange gains/(losses) from transactions 11 (37 ) 39
Share-based payment costs 26 30 25 23
Inventories (1 ) (16 ) (17 )
Trade and other receivables (5 ) (60 ) (4 )
Trade and other liabilities 80 54 71
Retirement benefit obligations (126 ) (17 ) (17 )
Provisions 3 — —

Net cash generated from operations
659 621 653

Included in net cash generated from operations is an amount of £7m (2006: £33m; 2005: £26m) relating to discontinued operations.
In the cash flow statement, proceeds from sale of property, plant and equipment comprise:

2005 2004 2003

(All figures in
£ millions)
Net book amount 3 8 10
Loss on sale of property, plant and equipment — (4 ) (2 )

Proceeds from sale of property, plant and equipment
3 4 8

Non-cash transactions

The principal non-cash transactions are movements in finance lease obligations — (1 ) (1 )

2007 2006 2005
All figures in £ millions

Net book amount 15 10 3
Loss on sale of property, plant and equipment (1 ) (2 ) —

Proceeds from sale of property, plant and equipment
14 8 3

The principal other non-cash transactions are movements in finance lease obligations of £4m (2006: £4m; 2005: £nil).
3034.   Contingencies

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

F-68
~~F-57~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~31     Commitments~~
~~Capital commitments~~Notes to the Consolidated Financial Statements (Continued)

35.   Commitments
Capital commitments
Capital expenditure contracted for at the balance sheet date but not yet incurred is as follows:

2005 2004 2003

(All figures in
£ millions)
Property, plant and equipment 1 6 1

2007 2006
All figures in £ millions

Property, plant and equipment 3 —

The Group leases various offices and warehouses under non-cancellable operating lease agreements. The leases have varying terms and renewal rights. The Group also leases various plant and equipment under operating lease agreements, also with varying terms. The lease expenditure charged to the income statement during the year is disclosed in note 5.4.

The future aggregate minimum lease payments in respect of operating leases are as follows:

2005 2004 2003

(All figures in £ millions)
Not later than one year 129 117 123
Later than one year and not later than five years 397 353 375
Later than five years 869 584 529

1,395 1,054 1,027

~~32     Related party transactions~~

2007 2006
All figures in £ millions

Not later than one year 123 123
Later than one year and not later than two years 116 113
Later than two years and not later than three years 102 103
Later than three years and not later than four years 93 90
Later than four years and not later than five years 85 83
Later than five years 834 857

1,353 1,369

36.   Related party transactions
Joint ventures and associates — Amounts advanced to joint ventures and associates during the year and at the balance sheet date are set out in note 13. Amounts falling due from joint ventures and associates are set out in note ~~19.~~20.

Key management personnelare deemed to be the members of the board of directors of Pearson plc. It is this board which has responsibility for planning, directing and controlling the activities of the Group. Key management personnel compensation is disclosed in the directors’ remuneration report.

There were no other material related party transactions.

No guarantees have been provided to related parties.
~~33     Events after the balance sheet date~~
      On 9 January 2006 Pearson announced the purchase of 1,130,739 shares in Interactive Data Corporation (IDC) for $21.67 per share in cash. This purchase brings Pearson’s total holding in IDC to almost 62%. On 23 January 2006 Pearson announced the acquisition of Promissor, a leading professional testing business from Houghton Mifflin Company for $42m in cash. On April 25, 2006 Pearson announced the acquisition of National Evaluation Systems, Inc, a leading teacher certification testing company in the US. On May 5, 2006 Pearson announced the acquisition of an 80% stake in Paravia Bruno Mondadori, one of Italy’s leading educational publishing companies.
~~34     Explanation of transition to IFRS~~
      ~~These are the Group’s first consolidated financial statements prepared in accordance with IFRS as adopted by the EU.~~
      The accounting policies set out in note 1 have been applied in preparing the financial statements for the year ended 31 December 2005, the comparative information presented in these financial statements for the
~~F-58~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
years ended 31 December 2004 and 31 December 2003 and the preparation of an opening IFRS balance sheet at 1 January 2003 (the Group’s date of transition). IAS 39 ‘Financial Instruments: Recognition and Measurement’ and IAS 32 ‘Financial Instruments: Disclosure and Presentation’ have not been applied to the comparative periods because the Group has taken a transitional exemption and adopted those standards prospectively from 1 January 2005. The effect of the transitional adjustment on the balance sheet as at 1 January 2005 is set out in the tables below.
      In preparing its opening IFRS balance sheet, the Group has made adjustments to amounts previously reported in its financial statements under UK GAAP. An explanation of how the transition from previous UK GAAP to IFRS has affected the Group’s financial position and cash flows is set out in the tables and notes below. These adjustments include some reclassifications of items within the income statement and within the balance sheet in accordance with IFRS disclosure requirements.
~~F-59~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Balance sheet as at 1 January 2003 (date of transition)~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Assets
Non-current assets

Property, plant and equipment 503 (68 ) 435
Intangible assets 3,610 71 3,681
Investments in joint ventures and associates 113 (7 ) 106
Deferred income tax assets — 374 374
Other financial assets 22 — 22
Other receivables — 74 74

4,248 444 4,692

Current assets

Intangible assets — pre-publication — 380 380
Inventories 734 (380 ) 354
Trade and other receivables 1,059 (79 ) 980
Deferred income tax assets 174 (174 ) —
Cash and cash equivalents 575 (10 ) 565

2,542 (263 ) 2,279

Total assets
6,790 181 6,971

Liabilities
Non-current liabilities

Financial liabilities — Borrowings (1,734 ) (2 ) (1,736 )
Deferred income tax liabilities — (119 ) (119 )
Retirement benefit obligations — (351 ) (351 )
Provisions for other liabilities and charges (165 ) 120 (45 )
Other liabilities (60 ) (10 ) (70 )

(1,959 ) (362 ) (2,321 )

Current liabilities

Trade and other liabilities (1,114 ) 178 (936 )
Financial liabilities — Borrowings (249 ) (3 ) (252 )
Current income tax liabilities — (52 ) (52 )
Provisions for other liabilities and charges — (34 ) (34 )

(1,363 ) 89 (1,274 )
Total liabilities
(3,322 ) (273 ) (3,595 )

Net assets
3,468 (92 ) 3,376

Equity

Share capital 200 — 200
Share premium 2,465 — 2,465
Other reserves (121 ) — (121 )
Retained earnings 732 (88 ) 644

Total equity attributable to equity holders of the Company
3,276 (88 ) 3,188
Minority interest 192 (4 ) 188

Total equity
3,468 (92 ) 3,376

~~F-60~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Balance sheet as at 31 December 2003~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Assets
Non-current assets

Property, plant and equipment 468 (66 ) 402
Intangible assets 3,260 290 3,550
Investments in joint ventures and associates 64 — 64
Deferred income tax assets — 342 342
Other financial assets 21 — 21
Other receivables — 100 100

3,813 666 4,479

Current assets

Intangible assets — pre-publication — 362 362
Inventories 683 (364 ) 319
Trade and other receivables 1,134 (109 ) 1,025
Deferred income tax assets 145 (145 ) —
Cash and cash equivalents 561 (10 ) 551

2,523 (266 ) 2,257

Total assets
6,336 400 6,736

Liabilities
Non-current liabilities

Financial liabilities — Borrowings (1,347 ) (2 ) (1,349 )
Deferred income tax liabilities — (140 ) (140 )
Retirement benefit obligations — (364 ) (364 )
Provisions for other liabilities and charges (152 ) 93 (59 )
Other liabilities (45 ) (25 ) (70 )

(1,544 ) (438 ) (1,982 )

Current liabilities

Trade and other liabilities (1,129 ) 186 (943 )
Financial liabilities — Borrowings (575 ) (3 ) (578 )
Current income tax liabilities — (54 ) (54 )
Provisions for other liabilities and charges — (18 ) (18 )

(1,704 ) 111 (1,593 )
Total liabilities
(3,248 ) (327 ) (3,575 )

Net assets
3,088 73 3,161

Equity

Share capital 201 — 201
Share premium 2,469 — 2,469
Other reserves (122 ) (288 ) (410 )
Retained earnings 345 364 709

Total equity attributable to equity holders of the Company
2,893 76 2,969
Minority interest 195 (3 ) 192

Total equity
3,088 73 3,161

~~F-61~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Balance sheet as at 31 December 2004~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Assets
Non-current assets

Property, plant and equipment 473 (118 ) 355
Intangible assets 2,890 388 3,278
Investments in joint ventures and associates 48 (1 ) 47
Deferred income tax assets — 359 359
Other financial assets 17 (2 ) 15
Other receivables — 102 102

3,428 728 4,156

Current assets

Intangible assets — pre-publication — 356 356
Inventories 676 (362 ) 314
Trade and other receivables 1,104 (171 ) 933
Deferred income tax assets 165 (165 ) —
Cash and cash equivalents 613 (152 ) 461

2,558 (494 ) 2,064
Non-current assets classified as held for sale — 358 358

2,558 (136 ) 2,422

Total assets
5,986 592 6,578

Liabilities
Non-current liabilities

Financial liabilities — Borrowings (1,712 ) (2 ) (1,714 )
Deferred income tax liabilities — (139 ) (139 )
Retirement benefit obligations — (408 ) (408 )
Provisions for other liabilities and charges (123 ) 80 (43 )
Other liabilities (60 ) (39 ) (99 )

(1,895 ) (508 ) (2,403 )

Current liabilities

Trade and other liabilities (1,168 ) 300 (868 )
Financial liabilities — Borrowings (107 ) (2 ) (109 )
Current income tax liabilities — (89 ) (89 )
Provisions for other liabilities and charges — (14 ) (14 )

(1,275 ) 195 (1,080 )
Liabilities directly associated with non-current assets classified as held for sale — (81 ) (81 )

Total liabilities
(3,170 ) (394 ) (3,564 )

Net assets
2,816 198 3,014

Equity

Share capital 201 — 201
Share premium 2,473 — 2,473
Other reserves (132 ) (491 ) (623 )
Retained earnings 61 688 749

Total equity attributable to equity holders of the Company
2,603 197 2,800
Minority interest 213 1 214

Total equity
2,816 198 3,014

~~F-62~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Adjustments to equity~~

Notes 1 Jan 2003 31 Dec 2003 31 Dec 2004

(All figures in £ millions)
Total equity UK GAAP
3,468 3,088 2,816
Goodwill amortisation a 66 228 394
Intangible assets acquired b — 40 48
Intangible assets — capitalised software costs c 3 — —
Intangible assets — pre-publication expenditure d — — —
Share-based payments e 13 15 22
Employee benefits f (259 ) (284 ) (338 )
Leases g (12 ) (22 ) (33 )
Joint ventures h (3 ) (5 ) (6 )
Associates i (10 ) (10 ) (8 )
Income taxes j (3 ) (5 ) (7 )
Dividends k 115 119 125
Other (2 ) (3 ) 1
Discontinued operations l — — —

Total adjustments to equity
(92 ) 73 198

Total equity IFRS
3,376 3,161 3,014

~~Income statement for the year to 31 December 2003~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Continuing operations

Sales 4,048 (198 ) 3,850
Cost of goods sold (1,910 ) 64 (1,846 )

Gross profit
2,138 (134 ) 2,004
Operating expenses (1,912 ) 318 (1,594 )
Other net gains and losses 6 (12 ) (6 )
Share of results of joint ventures and associates — 2 2

Operating profit
232 174 406
Net finance costs (80 ) (13 ) (93 )

Profit before tax
152 161 313
Income tax (75 ) 14 (61 )

Profit for the year from continuing operations
77 175 252
Profit for the year from discontinued operations — 23 23

Profit for the year
77 198 275

~~F-63~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Income statement for the year to 31 December 2004~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Continuing operations

Sales 3,919 (223 ) 3,696
Cost of goods sold (1,866 ) 77 (1,789 )

Gross profit
2,053 (146 ) 1,907
Operating expenses (1,832 ) 312 (1,520 )
Other net gains and losses 9 — 9
Share of results of joint ventures and associates 10 (2 ) 8

Operating profit
240 164 404
Net finance costs (69 ) (10 ) (79 )

Profit before tax
171 154 325
Income tax (62 ) (1 ) (63 )

Profit for the year from continuing operations
109 153 262
Profit for the year from discontinued operations — 22 22

Profit for the year
109 175 284

~~Adjustments to profit~~

Notes 2003 2004

(All figures in £
millions)
Profit for the year UK GAAP
77 109

Goodwill amortisation a 242 204
Intangible assets acquired b (4 ) (5 )
Intangible assets — capitalised software costs c (1 ) (1 )
Intangible assets — pre-publication expenditure d — —
Share-based payments e (23 ) (16 )
Employee benefits f 1 6
Leases g (10 ) (12 )
Joint ventures h (2 ) (2 )
Associates i (2 ) (2 )
Income taxes j (2 ) (2 )
Other (1 ) 5
Discontinued operations l — —

Total adjustments to profit for the year
198 175

Profit for the year IFRS
275 284

~~F-64~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Cash flow for the year to 31 December 2003~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Cash flows from operating activities 228 172 400
Cash flows from investing activities (91 ) (172 ) (263 )
Cash flows from financing activities (228 ) 86 (142 )
Effects of exchange rate changes on cash and cash equivalents 37 8 45

Net (decrease)/increase in cash and cash equivalents
(54 ) 94 40

Cash and cash equivalents at beginning of year 340 148 488
Cash and cash equivalents at end of year
286 242 528

~~Cash flow for the year to 31 December 2004~~

UK GAAP Adjs IFRS

(All figures in £ millions)
Cash flows from operating activities 387 175 562
Cash flows from investing activities (102 ) (179 ) (281 )
Cash flows from financing activities (255 ) (6 ) (261 )
Effects of exchange rate changes on cash and cash equivalents (3 ) (1 ) (4 )

Net increase/(decrease) in cash and cash equivalents
27 (11 ) 16

Cash and cash equivalents at beginning of year 286 242 528
Cash and cash equivalents at end of year
313 231 544

~~Effect of IAS 32 and IAS 39 transitional adjustment (note 1m)~~

31 Dec 2004 Adj 1 Jan 2005

(All figures in £ millions)
Non-current assets

Deferred income tax assets 359 5 364
Financial assets — Derivative financial instruments — 145 145

Current assets

Financial assets — Derivative financial instruments — 1 1

Non-current liabilities

Financial liabilities — Borrowings (1,714 ) (134 ) (1,848 )
Financial liabilities — Derivative financial instruments — (40 ) (40 )

Current liabilities

Trade and other liabilities (868 ) 14 (854 )
Financial liabilities — Borrowings (109 ) — (109 )
Financial liabilities — Derivative financial instruments — (3 ) (3 )

Reserves
(126 ) 12 (114 )

~~First-time adoption exemptions applied~~
      IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ sets out the transition rules which must be applied when IFRS is adopted for the first time in reporting IFRS financial information. In
~~F-65~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
general the Group is required to select accounting policies in accordance with IFRS valid at its first IFRS reporting date and apply those polices retrospectively. The standard sets out certain mandatory exceptions to retrospective application and certain optional exemptions. The most significant optional exemptions adopted by the Group are set out below:
137.   ~~Business combinations~~Events after the balance sheet date
~~The~~
On 2 January 2008, the Group ~~has elected not to apply IFRS 3 ‘Business Combinations’ retrospectively to business combinations that occurred before~~completed its acquisition of Money-Media, a US-based company offering online news and commentary for the ~~date~~money management industry, for $64m.
On 30 January 2008, the Group completed its $647m acquisition of ~~transition. Subject to the transition adjustments to IFRS required by IFRS 1, the accounting for business combinations before the date of transition is grandfathered at the date of transition~~Harcourt Assessment from Reed Elsevier, after receiving clearance from the ~~UK GAAP financial statements.~~US Department of Justice.
2 ~~Employee benefits~~
      ~~All cumulative actuarial gains and losses have been recognised~~On 27 March 2008, the Group disposed of its 50% interest in ~~full in the period in which they occur in the statement~~Financial Times Deutschland (FTD) to its joint venture partner, Gruner + Jahr. The Group’s share of ~~recognised income and expense in accordance with IAS 19 ‘Employee Benefits’ (as amended on 16 December 2004).~~
3 ~~Share-based payments~~
      The Group has elected to apply IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the date of transition. Consequently the share-based payment charge from 2003 represents the charge for all options granted and not fully vestedFTD assets at 31 December ~~2002.~~2007 was €8m and a small profit on sale is expected.
4 ~~Financial instruments~~
On 22 February 2008, the Group completed the sale of its Data Management business to M & F Worldwide Corp. for $225m. The Group ~~has elected~~expects to ~~apply IAS 39 ‘Financial Instruments: Recognition and Measurement’ and IAS 32 ‘Financial Instruments: Disclosure and Presentation’ from 1 January 2005. After~~report a loss on this ~~date, where hedge accounting cannot be applied under IAS 39, changes~~transaction in the market value of financial instruments will be taken to the income statement. No adjustment to the 2003 or 2004 UK GAAP financial statements was required due to the chosen adoption date of IAS 32 and IAS 39.
5 ~~Cumulative translation differences~~
      ~~The Group has deemed~~2008 after taking into account the cumulative translation ~~differences for foreign operations to be zero at the date of transition. Any gains~~adjustment and ~~losses on disposals of foreign operations will exclude translation differences arising prior to the transition date.~~tax.
~~Significant adjustments~~

F-69
~~a. Goodwill amortisation~~ — IFRS 3 ‘Business Combinations’ requires that goodwill is not amortised but instead is subject to an impairment review annually or when there are indications that the carrying value may not be recoverable. The Group has elected not to apply IFRS 3 retrospectively to business combinations before the date of transition.
~~b. Intangible assets acquired~~ — Business combinations since the date of transition have been accounted for in accordance with IFRS 3 ‘Business Combinations’, with intangible assets recognised and amortised over their useful economic lives where they are separable or arise from a contractual or legal right. As part of the acquisition of Comstock Inc in February 2003, certain intangible assets were acquired, mainly relating to customer lists and acquired technology, which are being amortised over periods between two and 30 years. In addition, other less significant intangible assets, mainly relating to publishing rights, have been recognised for some of the smaller acquisitions made during 2004 and amortised over periods of up to 15 years.
~~c. Capitalised software costs~~ ~~— Under IAS 38 ‘Intangible Assets’ computer software which is not integral to a related item of hardware should be classified as an intangible asset. As such, certain computer~~
~~F-66~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
software costs have been re-classified from property, plant and equipment to intangible assets. In addition, certain costs relating to software development, previously expensed under UK GAAP, have been capitalised under IAS 38 and are being amortised over their estimated useful lives.
~~d. Pre-publication expenditure~~ — Under IAS 38 ‘Intangible Assets’, intangible assets are required to be recognized if they meet the criteria of identifiability, control over a resource and existence or probability of inflow of future economic benefits. As such pre-publication costs (the direct costs incurred in the development of educational programmes and titles prior to their publication) have been re-classified from inventory to intangible assets. They continue to be amortised upon publication of the title over estimated economic lives of five years or less, being an estimate of the expected operating life cycle of the title, with a higher proportion of the amortisation taken in the earlier years.
~~e. Share-based payments~~ — IFRS 2 ‘Share-based Payment’ requires that the expense incurred for equity instruments granted is recognised in the financial statements at their fair value measured at the date of grant and that the expense is recognised over the vesting period of the instrument. The Group has a number of employee option and performance share schemes. The Group has elected to apply IFRS 2 ‘Share-based Payment’ retrospectively to all options granted but not fully vested at the transition date. Consequently the share-based payment charge from 2003 represents the charge for all options granted and not fully vested at 31 December 2002.
~~f. Employee benefits~~ — IAS 19 ‘Employee Benefits’ was amended on 16 December 2004. The Group has elected to adopt the December 2004 amendments to the standard early and differences between the actual and expected return on assets, changes in the retirement benefit obligation due to experience and changes in actuarial assumptions are included in full in equity in the statement of recognised income and expense. Therefore the amount recognised on the balance sheet in respect of liabilities for defined benefit pension and other post-retirement benefit plans represents the present value of the obligations for past service offset by the fair value of scheme assets.
      The service cost of benefits accruing is accounted for as an operating cost and the unwinding of the discount rate on the scheme liabilities and the expected return on scheme assets as a financing charge or financing income. The Group has adopted the same assumptions under IAS 19 as were used for FRS 17 purposes under UK GAAP in 2003 and 2004.
      ~~The restated opening IFRS balance sheet reflects the fair value of the plan assets and the present value of the defined benefit obligation of the Group’s defined benefit schemes.~~
~~g. Leases~~ — IAS 17 ‘Leases’ sets out additional criteria to be considered in ascertaining whether a lease is a finance or operating lease. Following a review of all lease agreements no properties have been re-classified.
      In addition, IAS 17 requires that the expense is recognised on a straight line basis over the lease term, including any rent-free periods given at the inception of a lease. Contracted future lease increments must also be amortised evenly over the full period of the lease rather than the period to which the lease is estimated to revert to market rates. The profit and loss account has been adjusted to take into account the amortisation of lease incentives over longer periods than under UK GAAP and to accelerate the charge in respect of fixed contractual increments in lease payments.
~~h. Joint ventures~~ — Following a review, the Group has concluded that its 50% holding in Maskew Miller Longman should be accounted for as a joint venture under IFRS rather than its classification as a subsidiary under UK GAAP.
~~i. Joint ventures and associates~~ ~~— The results of all joint ventures and associates have been adjusted to take into account IFRS adjustments within their own financial statements.~~
~~j. Income taxes~~ — IAS 12 ‘Income Taxes’, requires that deferred taxation also be provided on all temporary differences, not just timing differences as required under UK GAAP. Deferred tax is provided, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and
~~F-67~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
their carrying amounts in the financial statements unless the initial recognition exemption applies. Deferred tax is not recognised for temporary differences arising on initial recognition of an asset or liability in a transaction other than a business combination if at the time of transaction neither accounting nor taxable profit is affected. Deferred taxation has been provided on the post-acquisition difference between the book and tax bases of intangible assets and goodwill if its amortisation is tax deductible. A deferred tax liability has also been recognised in respect of the undistributed earnings of subsidiaries other than where it is intended that those undistributed earnings will not be remitted in the foreseeable future.
      Deferred taxation has been recognised on the IFRS adjustments at the tax rates that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the asset is realised or the liability is settled. Deferred tax assets are recognised to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilised.
~~k. Dividends~~ — IAS 10 ‘Events after the Balance Sheet Date’ requires that dividends declared after the balance sheet date should not be recognised as a liability at the balance sheet date as they do not represent a present obligation at that date as defined by IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’.
      ~~The final dividends relating to the years to 31 December 2002, 2003 and 2004 have been reversed and recognised as a liability in the years 2003, 2004 and 2005 respectively.~~
~~l. Discontinued operations~~ — Consistent with the UK GAAP treatment, Recoletos has been treated as discontinued as at 31 December 2004 and met the criteria as ‘held for sale’ at that date. Accordingly the results are disclosed in one line in the income statement, ‘Profit for the year from discontinued operations’ for both 2003 and 2004 and, at 31 December 2004, it is disclosed in the balance sheet in two lines — ‘Non-current assets classified as held for sale’ and ‘Liabilities associated with non-current assets classified as held for sale’.
      When an asset’s carrying value will be recovered principally through a sale transaction rather than through continuing use and certain criteria regarding probability and proximity of the sale are satisfied, it is classified as held for sale and stated at the lower of carrying value and fair value less costs to sell. No depreciation is charged in respect of non-current assets classified as held for sale.
~~35.~~ ~~SUMMARY OF PRINCIPAL DIFFERENCES BETWEEN INTERNATIONAL ACCOUNTING STANDARDS AND UNITED STATES OF AMERICA GENERALLY ACCEPTED ACCOUNTING PRINCIPLES~~
      ~~The accompanying consolidated financial statements have been prepared in accordance withEU-adopted~~SIGNATURES International Financial Accounting Standards (“IFRS”), which differ in certain significant respects from generally accepted accounting principles in the United States of America (“US GAAP”). Such differences involve methods for measuring the amounts shown in the financial statements.
      The following is a summary of the adjustments to consolidated profit for the financial year and consolidated shareholders’ funds that would have been required in applying the significant differences between IFRS and US GAAP.
~~F-68~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
~~Reconciliation of consolidated profit for the financial year~~

Year ended December 31

Note 2005 2004 2003

£m £m £m
Profit for the financial year under IFRS
624 262 252
US GAAP adjustments:
Intangible amortization (i ) (60 ) (75 ) (97 )
Discontinued operations (ii ) — (1 ) (3 )
Disposal adjustments (iii ) (119 ) 3 (6 )
Pensions and other post-retirement benefits (iv ) (26 ) (23 ) (4 )
Deferred taxation (v ) 1 — (27 )
Share based payments (vi ) (4 ) (13 ) (4 )
Derivative financial instruments (vii ) (12 ) (23 ) 35
Acquisition adjustments (x ) 1 — —
Partnerships and associates (viii ) (2 ) — (3 )
Minority interests (ix ) 2 — (1 )
Other (9 ) (1 ) 4
Taxation effect of US GAAP adjustments (v ) 15 53 27

Total US GAAP adjustments (213 ) (80 ) (79 )

Profit for the financial year under US GAAP
411 182 173

Profit from continuing operations (less charge for applicable taxes 2005: £107m, 2004: £11m, 2003: £71m) 174 166 160
(Loss)/profit from discontinued operations (less charge for/(benefit from) applicable taxes 2005: £(1)m; 2004: £6m, 2003: £22m) (2 ) 16 16
Profit/(loss) on disposal of discontinued operations (less charge for applicable taxes 2005: £1m; 2004: £nil, 2003: £2m) 239 — (3 )

Profit for the financial year under US GAAP
411 182 173

~~F-69~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

Year ended December 31

Note 2005 2004 2003

Presentation of earnings per equity share under US GAAP
(xi )
Earnings per equity share (p ) (p ) (p )
Basic:
Continuing operations 21.8 20.9 20.1
Discontinued operations 29.7 2.0 1.7

Total 51.5 22.9 21.8

Diluted:
Continuing operations 21.7 20.8 20.1
Discontinued operations 29.7 2.0 1.7

Total 51.4 22.8 21.8

Average shares outstanding (millions) 797.9 795.6 794.4
Dilutive effect of stock options (millions) 1.1 1.1 0.9

Average number of shares outstanding assuming dilution (millions) 799.0 796.7 795.3

~~Reconciliation of consolidated shareholders’ funds~~

Year ended
December 31

Note 2005 2004

£m £m
Shareholders’ funds under IFRS
3,564 2,800
US GAAP adjustments:
Goodwill (i ) 88 136
Intangibles (i ) 231 267
Discontinued operations (ii ) — 49
Pensions and other post-retirement benefits (iv ) 61 62
Derivative financial instruments (vii ) 15 11
Acquisition adjustments (x ) 26 20
Partnerships and associates (viii ) 15 9
Minority interests (ix ) (30 ) (15 )
Other (6 ) 3
Taxation effect of US GAAP adjustments (v ) (126 ) (124 )

Total US GAAP adjustments 274 418

Shareholders’ funds under US GAAP
3,838 3,218

~~Restatements~~
      ~~The consolidated financial statements on pages~~ ~~F-3~~ to~~F-68~~ ~~are the Group’s first financial statements to be prepared in accordance withEU-adopted~~ IFRS. Consolidated financial statements of Pearson until December 31, 2004 had been prepared in accordance with UK GAAP. UK GAAP differs in certain respects from IFRS. When preparing the Group’s 2005 consolidated financial statements, management has amended certain accounting, valuation and consolidation methods applied in the UK GAAP financial statements to
~~F-70~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
comply with IFRS. The comparative figures in respect of 2004 and 2003 were restated to reflect these adjustments. Note 34 included in “Item 17. Financial Statements”, describes how, in preparing the consolidated financial statements, the Group has applied IFRS as adopted for use in the EU under the first-time adoption provisions as set out in IFRS 1. The reconciliations between IFRS and US GAAP for the years ended December 31, 2004 and 2003 have been restated accordingly.
      ~~A summary of the principal differences and additional disclosures applicable to the Group are set out below:~~
     ~~(i)~~ ~~Goodwill and intangibles~~
      Both IFRS and US GAAP require purchase consideration to be allocated to the net assets acquired at their fair value on the date of acquisition, with the difference between the consideration and the fair value of the identifiable net assets recorded as goodwill.
      Under UK GAAP, before the transition to IFRS on January 1, 2003, goodwill arising on acquisitions prior to January 1, 1998 was written off directly to reserves in the year of acquisition and goodwill arising from January 1, 1998 to December 31, 2002 was capitalized and amortized over its estimated useful life. Following the adoption of IFRS on January 1, 2003, goodwill is no longer required to be amortized but is tested for impairment on an annual basis in accordance with IFRS 3~~‘Business Combinations’. Goodwill arising on business combinations before January 1, 2003 has been grandfathered under the first time adoption provisions of IFRS 1.~~
      For the purposes of US GAAP, all goodwill written off against reserves before the transition to IFRS has been reinstated as an asset on the balance sheet. Prior to July 1, 2001, goodwill was amortized over its estimated useful life. In July 2001, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (“FAS”) 142,~~“Goodwill and Other Intangible Assets”~~ which required that goodwill no longer be amortized. SFAS 142 was effective for the Group on January 1, 2002. As a result, goodwill is no longer subject to amortization subsequent to the date of adoption, but is subject to the annual impairment testing provisions of FAS 142. Impairment reviews were performed and, consistent with IFRS, no cash-generating units were impaired.
      Under UK GAAP, before the transition to IFRS on January 1, 2003, intangible assets (other than goodwill) could only be recognized where they could be disposed of separately from the businesses to which they related. Consequently the Group did not recognize any acquired intangible assets prior to January 1, 2003. In accordance with IFRS 3, acquired intangible assets (such as publishing rights, customer relationships, technology and trademarks) in respect of acquisitions after January 1, 2003 have been capitalized and amortized over a range of estimated useful lives between 2 and 30 years. Under US GAAP, acquired intangible assets on all acquisitions have been capitalized and amortized. The identified intangibles have been valued based on independent appraisals and management evaluation and analysis. Under both IFRS and US GAAP pre-publication costs and software development costs (both of which are internally generated) are also recognized as intangible assets. Under US GAAP, all intangible assets would be classified as~~non-current.~~
      GAAP differences between IFRS and US GAAP arise from the following factors. In respect of acquisitions prior to January 1, 1998, goodwill has remained as a deduction to reserves under IFRS but has been capitalized under US GAAP. In respect of acquisitions between January 1, 1998 and December 31, 2002, no acquired intangible assets have been recognized under IFRS while they have been fully recognized under US GAAP. Amortization of goodwill ceased on December 31, 2001 under US GAAP but ceased a year later under IFRS. Also, contingent consideration is recognized as a cost of acquisition under IFRS, if it is probable that the contingent consideration will be paid and can be measured reliably. Under US GAAP, contingent consideration is only recognised when paid (see acquisition adjustments (x) below).
~~F-71~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
     ~~(ii)~~ ~~Discontinued operations~~
      ~~Discontinued operations comprise the differences between IFRS and US GAAP in respect of Recoletos for 2005, 2004 and 2003.~~
      ~~The operating profits, assets and liabilities in respect of discontinued operations under US GAAP are as follows:~~

2005 2004 2003

£m £m £m
Total operating profit/(loss) in respect of discontinued operations (3 ) 21 27
Assets in respect of discontinued operations — 413
Liabilities in respect of discontinued operations — (148 )
     ~~(iii)~~ ~~Disposal adjustments~~
      In 2005, 2004 and 2003 gains and losses were recognized under IFRS on the disposal of a number of the Group’s businesses and assets. Adjustments made to reconcile US GAAP and IFRS have an effect on the net assets of these businesses and, accordingly, a corresponding impact on the gain or loss on disposal.
      Under IFRS, goodwill previously written off to reserves, which has been grandfathered under the first time adoption provisions of IFRS 1, is not treated as part of the calculation of profit or loss on disposal when the business to which it relates is sold. This usually results in higher profits on disposal than under US GAAP, where the goodwill was capitalized and forms part of the calculation of profit or loss on disposal.
      Under both IFRS and US GAAP, it is necessary to factor into the disposal calculation any cumulative translation adjustment associated with the business. However, a GAAP difference arises on disposals of entities acquired before the adoption of IFRS as the translation reserve was reset to zero at the date of the adoption of IFRS in accordance with the transitional provisions in IFRS 1. Under US GAAP, the translation reserve runs from the date of acquisition.
      Differences can arise on the treatment of property disposals and sale and leaseback transactions. The timing of recognition of profits or losses on these transactions can differ between IFRS and US GAAP.
      ~~The reconciling items between IFRS and US GAAP in respect of disposals are summarised as follows:~~

2005 2004 2003

£m £m £m
Difference in carrying value on disposal (86 ) — —
Cumulative translation adjustment (33 ) — —
Timing on property disposals — 3 (6 )

Total US GAAP differences in respect of disposals
(119 ) 3 (6 )

     ~~(iv)~~ ~~Pensions and other post-retirement benefits~~
      ~~The Group operates defined benefit pension plans for its employees and former employees throughout the world. The largest defined benefit scheme is a funded scheme operated in the UK.~~
      Under IFRS, the expense of defined benefit pension schemes and other post-retirement benefits is charged to the income statement as an operating expense over the periods benefiting from the employee’s services. The charge is based on actuarial assumptions reflecting market conditions at the beginning of the financial year.
      ~~Under 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”~~~~. The methodology required is broadly similar to IFRS, however, different assumptions on the expected asset return are used in the~~
~~F-72~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
SFAS 87 pension calculation. Additionally, under US GAAP, where an accumulated benefit obligation exists in excess of the fair value plan assets and is not covered by a liability recognized on the balance sheet, an additional minimum pension liability has been booked with the offset as a reduction to equity through other comprehensive income. Under IFRS, there is no requirement to recognize a minimum pension liability in respect of the unfunded accumulated benefit obligation.
      Under IAS 19, the Group has recognized a pension obligation representing the excess of the defined benefit obligation over the fair value of assets as at 31 December 2005. Actuarial gains and losses, i.e. the difference between the expected development of the assets and liabilities and the actual development, are recognized immediately through the statement of recognized income and expenses.
      Under SFAS 87, the Group has recognized prepaid pension cost amounting to £57 million and a minimum pension liability of £298 million in respect of pensions. In respect of post-retirement benefit plans the accrued pension cost amounts to £49 million as at December 31, 2005. The difference between the net balance sheet position and the plans’ funded status (the difference between the fair value of the plan assets and liabilities) is held as an unrecognized off-balance sheet item and spread over the employees’ remaining service lifetimes. However, the unrecognized amount attributable to actuarial gains and losses falling within a 10% corridor (i.e. 10% of the greater of the market value of the plan assets or plan liabilities) is deferred and not spread.
     ~~(v)~~ ~~Deferred taxation~~
      ~~IAS 12~~~~“Income Taxes”~~ requires a full provision to be made for deferred taxes. Deferred taxes are to be accounted for on all temporary differences with deferred tax assets recognized to the extent that they are more likely than not recoverable against future taxable profits. Under US GAAP deferred tax assets not considered recoverable are adjusted for through a separate valuation allowance in the balance sheet. There are no separate valuation allowances under IFRS. Under US GAAP, deferred taxes are accounted for in accordance with SFAS 109,~~“Accounting for Income Taxes”~~ with a full provision also made for deferred taxes on all temporary 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 IAS 12.
      ~~The reconciling items in 2005 and 2004 reflect the impact of recording the full provision and deferred tax assets, net of valuation allowance, and are summarized below:~~

Income Equity Income Equity Income
2005 2005 2004 2004 2003

£m £m £m £m £m
Tax effect of GAAP adjustments on:

Goodwill and intangible amortization 18 (121 ) 17 (129 ) 20
Derivative financial instruments 3 (5 ) 38 (3 ) (21 )
Options, pensions, disposals and other adjustments (6 ) — (2 ) 8 28

Total taxation effect of US GAAP adjustments
15 (126 ) 53 (124 ) 27

      Income tax adjustments on the GAAP differences on goodwill and intangible amortization are calculated by reference to each specific acquisition. These adjustments arise on tax deductible goodwill and intangibles primarily on acquisitions prior to January 1, 2003 where intangibles have been recognized under US GAAP which have not been recognized under IFRS. The net effect of the adjustments is to recognize a smaller deferred tax liability under US GAAP.
      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.
~~F-73~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
The recognized deferred tax asset is based upon the expected future utilization of tax loss carryforwards and the reversal of other temporary differences. For financial reporting purposes, the Group has recognized a valuation allowance for those benefits for which realization does not meet the more likely than not criteria.
      The valuation allowance has been recognized in respect of the tax loss carryforwards. The Group regularly reviews the adequacy of the valuation allowance and is recognizing these benefits only as reassessment indicates that it is more likely than not that the benefits will be realized.
      The deferred tax item in 2003 also incorporates the effect of a change in estimate in respect of deferred tax assets relating to a purchase business combination in prior years, which was recorded through the profit and loss account under IFRS, but which was required to be adjusted against goodwill under US GAAP.
     ~~(vi)~~ ~~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. Differences between the US GAAP and IFRS charge are 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 £5.4 million. The remainder of the adjustment relates to the treatment of forfeitures.
     ~~(vii)~~ ~~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. The transitional effect of recording all the Group’s derivative financial instruments at fair value on January 1, 2005 is shown in note 34 to these financial statements.
      For both IFRS and US GAAP, the Group 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 hedge 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.
      In 2003, under US GAAP, the Group did not meet the prescribed designation requirements and hedge effectiveness tests to obtain hedge accounting. Consequently, for that year, the Group has recorded the changes in the fair values of its derivative contracts through earnings under US GAAP. Certain derivative financial instruments met the designation and testing requirements for hedge accounting for 2004 and 2005.
~~F-74~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
      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 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.
     ~~(viii)~~ ~~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 the results of the partnerships and associates, as well as the carrying value of the investment in these entities. Principal differences identified with respect to the Group’s investments in partnerships and associates include: historic goodwill, pensions and derivatives.
      ~~Under US GAAP, in accordance with Accounting Principles Board Opinion (“APB”) No. 18,~~~~“The Equity Method of Accounting for Investments in Common Stock”~~, the Group periodically reviews its equity method investments for impairment. These reviews are performed to determine whether declines in market values of investments below their carrying values are deemed to be other than temporary.
     ~~(ix)~~ ~~Minority interests~~
      Under IFRS, when less than 100% of a subsidiary has been acquired, minority interest is stated at the minority’s proportion of the net fair value of acquired assets, liabilities and contingent liabilities assumed. Under US GAAP, the minority interest is valued at historical book value. In the years ended December 31, 2005, 2004 and 2003, there was no difference between IFRS and US GAAP in the recognition of minority interest. In all years, minority interests represent the minority share of US GAAP adjustments.
      ~~Under IFRS, minority interest is classified as a component of shareholders’ equity. Under US GAAP, minority interest is classified outside of equity.~~
     ~~(x)~~ ~~Acquisition adjustments~~
      Under US GAAP, consideration related to the acquisition of businesses contingent on a future event such as achieving specific earnings levels in future periods, is recorded only when the specified conditions are met and the consideration determinable, in accordance with~~SFAS 141 “Business Combinations.”~~ Under IFRS, contingent consideration is treated as part of the purchase price on the date of acquisition, if it is probable that the contingent consideration will be paid and can be measured reliably. Additionally, certain post-acquisition restructuring costs are capitalized under US GAAP in accordance with Emerging Issues Task Force No. ~~95-3,~~ ~~“Recognition of Liabilities in Connection with a Purchase Business Combination”, but are charged to the income statement under IFRS.~~
     ~~(xi)~~ ~~Presentation of earnings per equity share~~
      Under US GAAP an entity that reports a discontinued operation or cumulative effect of an accounting change must present basic and diluted EPS for those line items. Accordingly, the Group has presented EPS for income from continuing operations, discontinued operations and net income.
     ~~(xii)~~ ~~Other disclosures required by US GAAP~~
~~Consolidation~~
      The consolidated financial statements include the accounts of the Group and majority-owned and controlled subsidiaries. Under IFRS, the investments in companies in which the Group is unable to exercise
~~F-75~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
control but has the ability to exercise significant influence over operating and financial policies are accounted for by the equity method, which is consistent with the equity method under US GAAP. Accordingly, the Group’s share of the net earnings of these companies is included in the consolidated profit and loss. The investments in other companies are carried at cost. 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, 2005, 2004 and 2003 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.
~~Recent U.S. Accounting Pronouncements~~
      ~~In November 2004, the FASB issued FASB Statement No. 151~~~~“Inventory Costs — An Amendment of ARB No. 43, Chapter 4”~~ (“FAS 151”). FAS 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, FAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. FAS 151 is effective for fiscal years beginning after June 15, 2005. The Group will adopt FAS 151 in 2006 but does not expect the adoption of the new standard to have a material impact.
      ~~In December 2004, the FASB issued FASB Statement No. 153~~~~“Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions”~~ (“FAS 153”). FAS 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 Nonmonetary Transactions,” and replaces it with an exception for exchanges that do not have commercial substance. FAS 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. FAS 153 is effective for the fiscal periods beginning after June 15, 2005. The Group will adopt FAS 153 in 2006 but does not expect the adoption of the new standard to have a material impact.
~~F-76~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
      ~~In December 2004, the FASB issued FASB Statement No. 123 (revised 2004)~~~~“Share-Based Payment”~~ ~~(“FAS 123(R)”), which replaces FAS No. 123~~~~“Accounting for Stock-Based Compensation”~~ ~~(“FAS 123”) and supersedes APB Opinion No. 25~~~~“Accounting for Stock Issued to Employees.”~~ FAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under FAS 123 no longer will be an alternative to financial statement recognition. The Group will adopt FAS 123(R) in 2006 but does not expect the adoption of the new standard to have a material impact as it already recognizes share-based payment cost in its income statement in accordance with FAS 123.
      ~~In March 2005, the FASB issued FASB Interpretation No. 47~~~~“Accounting for Conditional Asset Retirement Obligations — an interpretation of FASB Statement No. 143”~~ (“FIN 47”). FIN 47 clarifies the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and/or settlement are conditional on a future event. FIN 47 is effective for the fiscal periods ending after December 15, 2005. The adoption of FIN 47 did not have a material impact on the Group.
      ~~In May 2005, the FASB issued Statement No. 154,~~~~“Accounting Changes and Error Corrections — A replacement of APB Opinion No. 20 and FASB Statement No. 3”~~ (“FAS 154”). This statement requires retrospective application to prior periods’ financial statements of changes in accounting principles unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This statement applies to all voluntary changes in accounting principles and changes required by an accounting pronouncement that does not include specific transition provisions. FAS 154 is required to be adopted in fiscal years beginning after December 15, 2005. FAS 154 would not have had a material effect on the financial position, results of operations or cash flows of the Group under US GAAP as at December 31, 2005.
      ~~In October 2005, the FASB issued FASB Staff Position (FSP) 13-1~~~~“Accounting for Rental Costs Incurred during a Construction Period”~~ ~~(“FSP~~ ~~13-1”).~~ ~~FSP~~ ~~13-1~~ requires rental costs associated with ground or building operating leases that are incurred during a construction period to be recognized as rental expense and included in income from continuing operations. FSP ~~13-1~~ ~~is effective for the fiscal periods beginning after December 15, 2005. The Group will adopt FSP~~ ~~13-1~~ ~~in 2006 but does not expect the adoption of the new standard to have a material impact.~~
      ~~In January 2006 the FASB issued FASB Statement No. 155~~~~“Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140”~~ (“FAS 155”). FAS 155 provides entities with relief from having to separately determine the fair value of an embedded derivative that would otherwise be required to be bifurcated from its host contract. FAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Group is currently evaluating the impact the adoption of FAS 155 will have, but does not expect it to have a material impact.
~~Recent International Accounting Pronouncements~~
      ~~IFRS 7~~~~“Financial Instruments: Disclosures”~~. IFRS 7 introduces new disclosures of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk. IFRS 7 is effective for accounting periods beginning on or after 1 January 2007. The Group is currently assessing the impact of IFRS 7 on the Group’s financial statements, but does not expect it to be significant.
      ~~A complementary amendment of IAS 1~~~~“Presentation of Financial Statements — Capital Disclosures”~~. The amendment to IAS 1 introduces disclosures about the level of an entity’s capital and how it manages capital. The amendment to IAS 1 is effective for accounting periods beginning on or after 1 January 2007. The Group is currently assessing the impact of the amendment to IAS 1, but does not expect it to be significant.
~~F-77~~
~~NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~
      ~~IFRIC 4~~~~“Determining whether an Arrangement contains a Lease”~~. IFRIC 4 requires the determination of whether an arrangement is or contains a lease to be based on the substance of the arrangement. IFRIC 4 is effective for accounting periods beginning on or after 1 January 2006. The Group will implement IFRIC 4 from 1 January 2006 but does not expect it to have a significant impact on the Group’s operations.
      ~~IAS 21 (Amendment)~~~~“Net investment in a foreign operation”~~. This amendment deals with the requirement for a monetary item that forms part of a reporting entity’s net investment in a foreign operation to be denominated in the functional currency of either the reporting entity or the foreign operation. The amendment also clarifies the accounting treatment of exchange differences arising on a loan made between two “sister companies” within a group. The exchange differences would be taken to equity in the parent’s consolidated financial statements, irrespective of the currency in which the loan is made, provided that the nature of the loan is similar to an equity investment, that is, settlement of the loan is neither planned nor expected to occur in the foreseeable future.
      ~~IFRIC 8~~~~“Scope of IFRS 2”~~. IFRIC 8 clarifies that transactions within the scope of IFRS 2 “Share-based payment”, include those in which the entity cannot specifically identify some or all of the goods or services received. If the identifiable consideration given appears to be less than the fair value of the equity instruments granted or liability incurred, this situation generally indicates that other consideration has been or will be received.
~~F-78~~
~~SIGNATURES~~
The registrant hereby certifies that it meets the requirements for filing onForm 20-F and that it has caused and authorized the undersigned to sign this annual report on its behalf.
Pearson plc
~~Pearson plc~~
/s/   ~~Rona Fairhead~~
~~Rona Fairhead~~
~~Chief Financial Officer~~Robin Freestone
Robin Freestone
Chief Financial Officer
Date: ~~May 5, 2006~~April 25, 2008

F-70
~~F-79~~


(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, ~~2005~~2007
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~~ (as defined inRule 12-b2 of the Exchange Act). Yeso Noo


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


		Page

Item 8.	Financial Information		52
	Legal Proceedings		53
Item 9.	The Offer and Listing		53
Item 10.	Additional Information		54
	Memorandum and articles of association		54
	Material Contracts		58
	Exchange Controls		59
	Tax considerations		59
	Documents on Display		61
Item 11.	Quantitative and Qualitative Disclosures About Market Risk		61
	Introduction		61
	Interest Rates		61
	Currency Exchange Rates		62
	Forward Foreign Exchange Contracts		63
	Derivatives		63
	Quantitative Information about market risk		63
Item 12.	Description of Securities Other Than Equity Securities		63

	PART II
Item 13.	Defaults, Dividend Arrearages and Delinquencies		6463
Item 14.	Material Modifications to the Rights of Security Holders and Use of Proceeds		63
Item 15.	Controls and Procedures		64
	Disclosure Controls and Procedures		64
	Management’s Annual Report on Internal Control over Financial Reporting		64
	Change in Internal Control over Financial Reporting		64
Item ~~15.~~16A.	~~Controls and Procedures~~Audit Committee Financial Expert		64
Item ~~16A.~~16B.	Code of Ethics		64
~~Audit Committee Financial Expert~~Item 16C.	Principal Accountant Fees and Services		65
Item ~~16B.~~16D.	~~Code of Ethics~~Exemptions from the Listing Standards for Audit Committees		65
Item ~~16C.~~16E.	~~Principal Accountant Fees and Services~~		65
~~Item 16D.~~	~~Exemptions from the Listing Standards for Audit Committees~~		66
~~Item 16E.~~	Purchases of Equity Securities by the Issuer and Affiliated Purchases		6665

	PART III
Item 17.	Financial Statements		66
Item 18.	Financial Statements		66
Item 19.	Exhibits		66
Exhibit 1.1
Exhibit 8.1
Exhibit 12.1
Exhibit 12.2
Exhibit 13.1
Exhibit 13.2
Exhibit 15


*	~~Not for trading, but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the SEC.~~ New York Stock Exchange


þ Large accelerated filer	o Accelerated filer	o Non-accelerated filer


þo~~Large accelerated filer~~ US GAAP		oþ~~Accelerated filer~~ International financial Reporting Standards as Issued by the International Accounting Standards Board		o~~Non-accelerated filer~~ Other


		Page


	Introduction		4
	Forward-Looking Statements		4

	PART I
Item 1.	Identity of Directors, Senior Management and Advisers		6
Item 2.	Offer Statistics and Expected Timetable		6
Item 3.	Key Information		6
	Selected Consolidated Financial Data		6
	Dividend Information		7
	Exchange Rate Information		7
	Risk Factors		8
	~~Exchange Rate Information~~		8
	~~Risk Factors~~		9
Item 4.	Information on the Company		12
	Pearson		12
	Overview of Operating Divisions		12
	Our Strategy		1213
	Operating Divisions		13
	~~Pearson Education~~		13
	~~The FT Group~~		14
	~~The Penguin Group~~Operating Cycles		16
	Competition		1617
	Intellectual Property		17
	Raw Materials		17
	Government Regulation		17
	Licenses, Patents and Contracts		17
	Recent Developments		1718
	Organizational Structure		1718
	Property, Plant and Equipment		18
~~Item 4A.~~	~~Unresolved Staff Comments~~Capital Expenditures		19
Item 5.4A.	~~Operating and Financial Review and Prospects~~Unresolved Staff Comments		19
	~~General Overview~~		19
Item 5.	Operating and Financial Review and Prospects		20
	General Overview		20
	Results of Operations		2423
	Liquidity and Capital Resources		37
	Accounting Principles		3940
Item 6.	Directors, Senior Management and Employees		4240
	Directors and Senior Management		4240
	New Appointments		41
	Compensation of Senior Management		4441
	Share Options of Senior Management		4948
	Share Ownership of Senior Management		5150
	Employee Share Ownership Plans		51
	Board Practices		51
	Employees		52
Item 7.	Major Shareholders and Related Party Transactions		53
~~Item 8.~~	~~Financial Information~~		53
	~~Legal Proceedings~~		53
~~Item 9.~~	~~The Offer and Listing~~		53
~~Item 10.~~	~~Additional Information~~		54
~~Item 11.~~	~~Quantitative and Qualitative Disclosures About Market Risk~~		62
	~~Introduction~~		62
	~~Interest Rates~~		62
	~~Currency Exchange Rates~~		63
	~~Forward Foreign Exchange Contracts~~		63
~~Item 12.~~	~~Description of Securities Other Than Equity Securities~~		6452


Fiscal Year	Interim		Final		Total		Interim		Final		Total

	(Pence per ordinary share)						(Cents per ordinary share)
2005		10.0		17.0		27.0		17.2		29.2		46.4
2004		9.7		15.7		25.4		18.6		30.2		48.8
2003		9.4		14.8		24.2		16.7		26.4		43.1
2002		9.1		14.3		23.4		14.7		23.0		37.7
2001		8.7		13.6		22.3		12.6		19.7		32.3


Month	High		Low

April 2006	$	1.82	$	1.74
March 2006	$	1.76	$	1.73
February 2006	$	1.78	$	1.73
January 2006	$	1.79	$	1.74
December 2005	$	1.77	$	1.72
November 2005	$	1.78	$	1.71


	•	~~School — publisher, provider of testing and software services for primary and secondary schools~~

	•	~~Higher Education — publishes textbooks and related course materials for colleges and universities~~

	•	~~Professional — publishes texts, reference and interactive products for industry professionals. Provides various testing and service arrangements for government departments and professional bodies.~~


	•	FT Publishing ~~— publishes~~includes theFinancial Times~~, other~~and FT.com, one of the world’s premier sources of business ~~newspapers, magazines~~information, alongside a portfolio of financial magazines. It also includes an online financial information business Mergermarket, which provides early stage intelligence to financial institutions and ~~specialist information~~corporates, as well as several joint ventures and associates including 50% of both The Economist Group and the FTSE index business.


	•	Interactive Data ~~(“IDC”) —~~ provides specialist financial ~~and business information~~data to financial institutions and retail investors. Pearson owns a 62% interest in Interactive Data, which is publicly listed on the New York Stock Exchange (NYSE:IDC).


	•	~~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, through intellectual property;~~past five years, for example, we have invested $1.7bn in new content in our education business alone.

	•	~~to provide a combination~~Technology and services: We invested early and consistently in technology, believing that, in the digital world, content alone would not be enough. We now generate more than $1bn in sales from technology products and services, and our testing and assessment businesses, serving school students and professionals, make more than $1.2bn of ~~publishing, both in print and online, and related services that make our publishing more valuable and take us into new, faster-growing markets;~~sales, up from around $200m eight years ago.

	•	~~to continue to invest in the growth~~International markets: Though we currently generate approximately 60% of our ~~businesses, including:~~


Item 17o		Item 18o


Yeso		Noþ


	•	extending our lead in education publishing, investing in new programs for students in School and Higher Education and in testing and software services that help educators to personalize the learning process, 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.

	•	~~developing our fast-growing contracting businesses, which provide testing and other services~~Efficiency: We’ve invested to ~~corporations and government agencies;~~

	•	~~building the international reach of the~~~~Financial Times~~ ~~— both in print~~become a leaner, more efficient company, through ~~its four editions worldwide and online through FT.com — and enhancing the market positions of our network of national business newspapers around the world; and~~

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


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

	•	~~to capitalize on the growth prospects~~savings in our ~~markets~~individual businesses and onthrough a strong centralized operations structure. Over the past three years, we have increased our ~~leaner operations~~operating profit margins from 10.8% to ~~improve profits,~~15.0% and reduced average working capital as a percentage of sales in Pearson Education and Penguin from 29.4% to 25.6%, freeing up cash ~~flows and returns on invested capital.~~


United ~~Kingdom/ Republic of Ireland~~	32	%
~~Continental Europe, Africa and Middle East~~Kingdom	31	%
~~Americas~~Europe, Middle East and Africa	29	%
US	30	%
Asia	810	%


	•	50% interest in The Economist Group, publisher of one of the world’s leading weekly business and current affairs magazines.

	•	50% interest in FTSE International, a joint venture with the London Stock Exchange, which publishes a wide range of global indices, including the FTSE index.

	•	50% interest in~~FT Deutschland,~~ ~~launched in February 2000, in partnership with Gruner + Jahr.~~~~FT Deutschland~~ ~~is a German language newspaper with a fully integrated online business news, analysis and data service. Its circulation grew by 6% in 2005 to 102,000 copies.~~ 15 A 50% interest in The Economist Group, which publishes the world’s leading weekly business and current affairs magazine. Its circulation increased by 10% to 1,038,519 for the January to June 2005 period. ~~A 50% interest in FTSE International, a joint venture with the London Stock Exchange, which publishes a wide range of global indices, including the important FTSE index.~~ ~~A 33% interest in~~~~Vedomosti,~~ ~~a leading Russian business newspaper and a partnership venture with Dow Jones and IMH Media Ltd.~~ ~~A 50% interest in~~Business DayandFinancial Mail, publishers of one of South Africa’s leading financial ~~newspaper~~newspapers and ~~magazine.~~magazines.

	•	33% interest inVedomosti,a leading Russian business newspaper.


	•	The School market is primarily driven by an extensive backlist and frontlist of titles, including some of the very best new fiction and non-fiction, literary prize winners and commercial bestsellers. Our titles range from history and science to essential reference. We are also one of the pre-eminent classics publishers and publish some of the most highly prized and enduring brands in children’s publishing, featuring popular characters such as Spot, Peter Rabbit and Madeline, as well as the books of Roald Dahl. We rank in the top three consumer publishers, based upon sales, in all major English speaking and related markets — the United States, the United Kingdom, Australia, New Zealand, Canada, India and South Africa. Penguin publishes under many imprints including, in the adult market, Allen Lane, Avery, Berkley Books, Dorling Kindersley, Dutton, Hamish Hamilton, Michael Joseph, Plume, Putnam, Riverhead and Viking. Our leading children’s imprints include Puffin, Ladybird, Warne and Grosset & Dunlap. In 2005, Penguin’s US imprints placed 129 titles on~~The New York Times~~ bestseller list. In the United Kingdom, 54 Penguin titles featured on the Nielsen Bookscan top ten 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 2005, Penguin had sales of £804 million, representing 20% of Pearson’s total sales (21% in 2004). Revenues are balanced between frontlist and backlist titles. The Penguin Group earns over 95% of its revenues from the sale of hard cover and paperback books. The balance comes from audio books and from the sale and licensing of intellectual property rights, such as the Beatrix Potter series of fictional characters, and acting as a book distributor for a number of smaller publishing houses. We sell directly to bookshops and through wholesalers. Retail bookshops normally maintain relationships with both publishers and wholesalers and use the channel that best serves the specific requirements of an order. We also sell online through third parties such as Amazon.com. The Penguin Group’s gateway internet site, Penguin.com, provides access to its focused websites in the United States, Canada, United Kingdom and Australia. Websites have also been developed to target certain niche audiences. For example, Penguinclassics.com has an entire online service for the classics, with anthologies, original essays, interviews and discussions and links to other classics sites. ~~Competition~~ ~~All of Pearson’s businesses operate in highly competitive environments.~~ Pearson Education competes with other publishers and creators of educational materials and services. These companies include some small niche players and some large international companies, such as McGraw-Hill, Reed Elsevier, Houghton Mifflin and Thomson. Competition is based on the ability to deliver quality products and services that address the specified curriculum needs and appeal to the school boards, educators and government officials making purchasing decisions. ~~The FT Group’s newspapers and magazines compete with newspapers and other information sources, such as~~~~The Wall Street Journal,~~ ~~by offering timely and expert journalism. It competes for advertisers with~~ 16 ~~other forms of media based on the ability to offer an effective means for advertisers to reach their target audience. The efficiency of its cost base is also a competitive factor.~~ The Penguin Group competes with other publishers of fiction and non-fiction books. Principal competitors include Random House, HarperCollins, and Hachette Livre. Publishers compete by developing a portfolio of books by established authors and by seeking out and promoting talented new writers. ~~Intellectual Property~~ ~~Our principal intellectual property assets consist of our trademarks and other rights in our brand names, particularly the~~~~Financial Times~~ and the various imprints of Penguin and Pearson Education, as well as all copyrights in our content and our patents held in the testing business in the name of Pearson NCS. We believe we have taken all appropriate available legal steps to protect our intellectual property in all relevant jurisdictions. ~~Raw Materials~~ Paper is the principal raw material used by each of Pearson Education, the FT Group and the Penguin Group. We purchase most of our paper through our central purchasing department located in the United States. We have not experienced and do not anticipate difficulty in obtaining adequate supplies of paper for our operations, with sourcing available from numerous suppliers. While local prices fluctuate depending upon local market conditions, we have not experienced extensive volatility in fulfilling paper requirements. In the event of a sharp increase in paper prices, we have a number of alternatives to minimize the impact on our operating margins, including modifying the grades of paper used in production. ~~Government Regulation~~ The manufacture of certain of our products in various markets is subject to governmental regulation relating to the discharge of materials into the environment. Our operations are also subject to the risks and uncertainties attendant to doing business in numerous countries. Some of the countriesadoption cycle in which ~~we conduct these operations maintain controls on the repatriation of earnings~~major state education boards ‘adopt’ programs and ~~capital and restrict the means available~~provide funding to usschools for hedging potential currency fluctuation risks. The operations that are affected by these controls, however, are not material to us. Accordingly, these controls have not significantly affected our international operations. Regulatory authorities may have enforcement powers that could have an impact on us. We believe, however, that we have taken and continue to take measures to comply with all applicable laws and governmental regulations in the jurisdictions where we operate so that the risk of these sanctions does not represent a material threat to us. ~~Licenses, Patents and Contracts~~ We are not dependent upon any particular licenses, patents or new manufacturing processes that are material to our business or profitability. Likewise, we are not materially dependent upon any contracts with suppliers or customers, including contracts of an industrial, commercial or financial nature. ~~Recent Developments~~ ~~On January 9, 2006 Pearson announced~~ the purchase of ~~1,130,739 shares~~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 ~~Interactive Data from an individual shareholder~~line with the release of new editions or new technology offerings. The Company renews its pre-publication assets to meet the typical demand for ~~$21.67 per share in cash. This purchase brings Pearson’s total holding in Interactive Data~~new editions of, or revisions to, ~~almost 62%.~~ ~~On January 23, 2006 Pearson announced~~educational programs. Analysis of historical data shows that the ~~acquisition~~average life cycle of ~~Promissor, a leading professional testing business from Houghton Mifflin Company for $42m in cash.~~ ~~On April 25, 2006 Pearson announced~~Higher Education content is 5 years. Again the ~~acquisition of National Evaluation Systems, Inc, a leading teacher certification testing company in~~operating cycle mirrors the ~~US.~~market cycle.


		~~Percentage~~
		~~Interest/ Voting~~
~~Name~~	~~Country of Incorporation/ Residence~~	~~Power~~

~~Pearson Education~~
~~Pearson Education Inc~~	~~United States (Delaware)~~		~~100%~~
~~Pearson Education Ltd~~	~~England and Wales~~		~~100%~~
~~NCS Pearson Inc~~	~~United States (Minnesota)~~		~~100%~~
~~FT Group~~
~~The Financial Times Limited~~	~~England and Wales~~		~~100%~~
~~Financial Times Business Ltd~~	~~England and Wales~~		~~100%~~
~~Interactive Data Corporation~~	~~United States (Delaware)~~		~~61%~~
~~Les Echos SA~~	~~France~~		~~100%~~
~~The Penguin Group~~
~~Penguin Group (USA) Inc~~	~~United States (Delaware)~~		~~100%~~
~~The Penguin Publishing Co Ltd~~	~~England and Wales~~		~~100%~~
~~Dorling Kindersley Holdings Ltd~~	~~England and Wales~~		~~100%~~


	Fees payable from
	July 1, 2007 (£)

Non-executive director fee		60,000
Chairmanship of audit committee		20,000
Chairmanship of personnel committee		15,000
Membership of audit committee		10,000
Membership of personnel committee		5,000
Senior independent director		15,000


	Salaries/Fees		Bonus(1)		Other(2)		Total

	£’000		£’000		£’000		£’000
Chairman
Dennis Stevenson (retired 1 October 2005)		281		—		—		281
Glen Moreno (appointed 1 October 2005)		106		—		—		106
Executive directors
Marjorie Scardino		710		1,038		62		1,810
David Bell		395		560		17		972
Rona Fairhead		420		608		16		1,044
Peter Jovanovich		41		—		373		414
John Makinson		475		564		211		1,250

Senior management as a group		2,428		2,770		679		5,877


	Salaries/		Annual
	Fees		incentive		Allowances(1)		Benefits(2)		Total(3)
	£000		£000		£000		£000		£000

Chairman
Glen Moreno		450		—		—		—		450
Executive directors
Marjorie Scardino		900		1,341		52		39		2,332
David Bell		442		650		—		19		1,111
Rona Fairhead		487		693		—		27		1,207
Robin Freestone		405		597		—		15		1,017
John Makinson		507		743		169		29		1,448

Senior management as a group		3,191		4,024		221		129		7,565


(1)	~~For~~	Allowances for Marjorie Scardino David Bell and Rona Fairhead, annual incentives were based on the financial performance of Pearson plc. In the case of John Makinson, 70% of his annual incentive was based on the performance of Penguin Group and 20% on the financial performance of Pearson plc. In the case of David Bell, Rona Fairhead and John Makinson, 10% of their annual incentives was based on performance against personal objectives.


~~(2)~~	~~Other emoluments~~ include ~~company car and healthcare benefits. In the case of Marjorie Scardino, these include £39,245~~£41,760 in respect of housing costs and a ~~cash~~ US payroll supplement of ~~£8,372.~~£10,446. John Makinson is entitled to a location and market premium in relation to the management of the business of the Penguin Group in the ~~US. He~~US and received ~~£186,279 in cash~~£168,545 for ~~2005.~~2007.

(2)		Benefits include company car, car allowance, health care and, for Marjorie Scardino, pension planning and financial advice. Marjorie Scardino, Rona Fairhead, David Bell and John Makinson have the use of a chauffeur. ~~In accordance with~~

(3)		No amounts as compensation for loss of office and no expense allowances chargeable to UK income tax were paid during the ~~agreement dated 28 January 2005 referred to on page 26 of this report, Peter Jovanovich received short-and long-term disability payments in cash for the period 1 February 2005 to 31 December 2005.~~year.


(1)	Shares under option are designated as:aexecutive;bworldwide save for shares;cpremium priced; anddlong-term incentive; and*where options are exercisable.


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

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

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


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


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

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


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

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

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


As at March 31, 2006	Ordinary Shares(1)		Restricted Shares(2)

Glen Moreno		100,000		—
Marjorie Scardino		184,889		1,336,015
David Bell		103,158		587,829
Terry Burns		5,717		—
Patrick Cescau		—		—
Rona Fairhead		43,209		637,936
Susan Fuhrman		2,681		—
John Makinson		149,466		642,756
Reuben Mark		16,908		—
Vernon Sankey		5,563		—
Rana Talwar		14,561		—


	Ordinary		Restricted
As at March 31, 2008	shares(1)		shares(2)

Glen Moreno		180,000		—
Marjorie Scardino		400,886		1,825,384
David Arculus		10,545		—
David Bell		172,896		631,408
Terry Burns		8,792		—
Patrick Cescau		3,079		—
Rona Fairhead		123,460		742,896
Robin Freestone		7,930		278,143
Susan Fuhrman		5,726		—
Ken Hydon		7,494		—
John Makinson		306,592		696,012
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.


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