138 BAE Systems Annual Report 2017 Independent Auditor’s report continued Our response 2.4. Tax accruals 2.5. Deferred tax assets Our audit procedures included: Refer to page 85 (Audit Committee report) and page 171 Refer to page 85 (Audit Committee report) and pages Historical comparison: Assessing the reasonableness (accounting policy and financial disclosures) 169 to 171(accounting policy and financial disclosures) of the directors’ assumptions by reference to past Tax accruals: £351m (2016 £365m) Deferred tax assets: £724m (2016 £1,251m) performance. Benchmarking assumptions: Assessing the Risk versus 2016: Risk versus 2016: reasonableness of the directors’ assumptions by reference to publicly-available information, such The risk: Dispute outcomes The risk: Subjective estimate as future defence expenditure. We also compared Accruals for tax contingencies require the directors The directors are required to estimate the valuation the directors’ assumptions to externally-derived to make judgements and estimates in relation to of deferred tax assets and to record those assets data (for example, bond yields and inflation tax risks. This is one of the key judgement areas to the extent their recovery is probable. This requires statistics) and internally-derived data to challenge that our audit is concentrated on due to the Group a significant element of judgement. other key inputs, such as projected economic operating in a number of tax jurisdictions, the The majority of the deferred tax asset balance growth and gearing leverage. complexities of local and international tax legislation, is in relation to the Group’s retirement benefit Comparing valuations: We compared the sum and the number of years which some matters can obligations. As a result of the reduction in the of the discounted cash flows to the Group’s take to resolve. valuation of the Group’s net share of the retirement market capitalisation to assess the reasonableness The tax matters are at various stages, from benefit obligations, the Group’s related deferred of those cash flows and challenged management’s the first identification of risks to discussions tax asset has also reduced: compared with last year, explanation in reconciling the two. with tax authorities and through to tax tribunal the period required for the Group to recover the Our sector experience: Our valuation specialists or court proceedings. amount of deferred tax is less. For this reason, we assisted in evaluating the reasonableness of Our response have determined that the audit risk has reduced assumptions and methodologies underlying the Our audit procedures included: from the prior year. discount rates adopted by the directors, including Our taxation expertise: Our tax specialists assisted Our response the discount rate applied in the valuation of the in assessing the Group’s tax positions, its exposure Our audit procedures included: Applied Intelligence CGU. to future cash outflows and the assumptions Assessing forecasts: We assessed and challenged Sensitivity analysis: We have run scenario-specific used by the directors to estimate the tax accruals. the directors’ judgement as to why it is deemed models, including changes to the discount rate, This included an inspection of the Group’s probable that the deferred tax assets recognised forecast cash flows and break-even analyses correspondence with the relevant tax authorities will be recovered, considering: to stress-test the valuations of CGUs’ recoverable and the Group’s external tax advisers. – the appropriateness and reliability of amounts. Benchmarking assumptions: We used our forecasts used by management to estimate Assessing transparency: We considered the knowledge and experience of the application of the recovery period; adequacy of the Group’s disclosure in respect the international and local legislation by the relevant – the timeframe of the pension deficit recovery of the sensitivities to changes in key assumptions authorities and courts in order to challenge the plan; and and the risks inherent in the valuation of goodwill. positions taken by the directors. In support of – the consistency of this judgement with other Results these positions, we separately met with certain assumptions and estimates made by the directors, We found the Group’s assessment of the key external tax advisers of the Group. In respect for example, those used to test impairment of recoverable amount of goodwill to be acceptable of certain matters, we compared the position taken assets, including goodwill. (2016 result: acceptable). by the directors with outcomes of similar cases. Assessing transparency: We have also considered Benchmarking assumptions: We considered the the adequacy of the Group’s tax disclosures. funding arrangements agreed with the Trustees of the UK pension schemes. We compared the Results views and estimates arrived at by the directors The results of our testing were satisfactory and (as described above) with advice received by the we found the resulting estimate of tax accruals Trustees in arriving at the funding arrangements to be acceptable (2016 result: acceptable). on the covenant provided by the Group over the deficit recovery periods. Tests of detail: We analysed the calculations used to determine the estimated recovery period and tested the accuracy of these calculations. Results As a result of our work, we found the level of deferred tax assets recognised to be acceptable (2016 result: acceptable).