LEGAL ISSUES
As previously reported, John Crane, Inc. (John Crane), a subsidiary of the Company, is one of many co-defendants in numerous law suits pending in the United States in which plaintiffs are claiming damages arising from exposure to, or use of, products containing asbestos. The John Crane products generally referred to in these cases are ones in which the asbestos fibres were encapsulated in such a manner that, according to tests conducted on behalf of John Crane, the products were safe. John Crane ceased manufacturing products containing asbestos in 1985.

John Crane has resisted every case in which it has been named and will continue its robust defence of all asbestos-related claims based upon this 'safe product' defence. In addition, John Crane has access to insurance cover which, while it is kept under review, is judged sufficient to meet all material costs of defending these claims for the foreseeable future.

As a result of its defence policy, John Crane has been dismissed before trial from cases involving approximately 95,000 claims over the last 25 years. John Crane is currently a defendant in cases involving approximately 180,000 claims. Despite these large numbers of claims, John Crane has had final judgements against it, after losing appeals, in only 39 cases, amounting to awards of some US$26m over the 25-year period. These awards, the related interest and all material defence costs have been met in full by insurance.

No provision relating to this litigation has been made in these accounts.

FINANCIAL CONTROLS
While our decentralised organisation delegates day-to-day control to local management, we have comprehensive systems in place, with regular reporting to the Board.

The Company has continuous, formalised business risk management processes operated at each business unit.

The internal audit department reviews all key business units over a rolling three-year cycle and its findings are reported to the Audit Committee. All acquisitions are reviewed within 12 months of acquisition, to verify compliance with the Group's procedures.

Further information regarding the Group's procedures to maintain strict internal controls over all aspects of risk, including financial risk, are set out in the Corporate Governance section of the Directors' Report.

INTERNATIONAL FINANCIAL REPORTING STANDARDS
From August 2005 onwards, in common with all listed companies in the European Union, Smiths will be required to prepare its consolidated accounts in accordance with International Financial Reporting Standards (IFRS). As a result the Financial Statements for 2004/05 will be the last prepared under UK Generally Accepted Accounting Principles (UK GAAP).

For some months now, we have been planning for the transition from UK GAAP to IFRS. We are currently in the process of interpreting the accounting standards that will apply from August 2005 onwards, setting the future accounting policies in accordance with IFRS and identifying the detailed accounting and disclosure requirements that will necessitate changes to our financial information systems.

We are not, as yet, in a position to quantify the effect of the differences between IFRS and UK GAAP on the Group's results or financial position. Based on our work to date, we believe that the significant differences will arise in the areas below:

Research and development costs
Expenditure on self-funded research and development is of the order of £140m per annum. Such expenditure is prudently expensed as incurred, a policy which we believe conforms with industry practice. IFRS requires development expenditure meeting certain recognition criteria to be capitalised on the balance sheet and amortised over its useful life. This standard is to be applied retrospectively; hence the intangible asset will include amounts expensed in previous years.

Derivatives and hedge accounting
A significant element of trading is denominated in US dollars and other foreign currencies. In order to protect ourselves from the associated currency volatility, we take levels of forward cover.

We also use derivatives to protect the Company from the impact of changes in interest rates. Currently, gains or losses arising on these derivatives are taken to the Profit and Loss Account in the same period as the underlying transaction.

IFRS requires all hedges to be strictly designated against specific transactions and the hedge effectiveness tested. All such instruments are required to be revalued to market values at the balance sheet date. If the hedging criteria are not achieved, then the change in value is taken to the Profit and Loss Account immediately.

Meeting the strict hedge criteria for all contracts may not be practicable, resulting in potential volatility in the reported Profit and Loss Account and Balance Sheet.

Goodwill
Generally, the carrying amount of goodwill recognised under UK GAAP on past acquisitions will not be revisited under IFRS. However, in comparison to UK GAAP, where goodwill is amortised over its useful life, under IFRS goodwill will not be amortised but, rather, will be subject to an annual impairment review which may introduce significant volatility in the Profit and Loss Account.

Other areas being considered, which could have a significant impact on the Company's results include share options, pensions, acquisitions and deferred tax.

Outside the European Union many other countries will require or permit companies to report under IFRS. Efforts to achieve convergence between IFRS and US GAAP are welcome.