Diageo PLC — Audit Report / Information 2012

Jun 30, 2012

Diageo Investment Corporation Financial statements 30 June 2012 $\overline{\mathfrak{M}}$

Diageo Investment Corporation Financial statements 30 June 2012

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CONTENTS

PAGES

Independent auditor's report to the members of Diageo Investment Corporation	3
Statement of comprehensive income		5
Statement of financial position		6
Statement of changes in equity
Statement of cash flows		8
Notes to the company financial statements		9

$\overline{e}$ .

Independent auditor's report to Diageo Investment Corporation

We have audited the non-statutory accounts of Diageo Investment Corporation Limited for the period ended 30 June 2012 set out on pages 5 to 26. These non-statutory accounts have been prepared in connection with the Company's wish to have audited financial statements and on the basis of the financial reporting framework of International Financial Reporting Standards (IFRSs) as adopted by the EU.

Our report has been prepared for the Company solely in connection with their wish to have audited financial statements. It has been released to the Company on the basis that our report shall not be copied, referred to or disclosed, in whole (save for the Company's own internal purposes) or in part, without our prior written consent.

Our report was designed to meet the agreed requirements of the Company determined by the Company's needs at the time. Our report should not therefore be regarded as suitable to be used or relied on by any party wishing to acquire rights against us other than the Company for any purpose or in any context. Any party other than the Company who obtains access to our report or a copy and chooses to rely on our report (or any part of it) will do so at its own risk. To the fullest extent permitted by law, KPMG Audit Plc will accept no responsibility or liability in respect of our report to any other party.

Respective responsibilities of directors and auditor

As explained more fully in the Directors' Responsibilities Statement set out on page 4, the directors are responsible for the preparation of the non-statutory accounts, which are intended by them to give a true and fair view. Our responsibility is to audit, and express an opinion on, the non-statutory accounts in accordance with the terms of our engagement letter dated 31 January 2012 and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board's (APB's) Ethical Standards for Auditors.

Scope of the audit of the non-statutory accounts

An audit involves obtaining evidence about the amounts and disclosures in the non-statutory accounts sufficient to give reasonable assurance that the non-statutory accounts are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the entity's circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the non-statutory accounts

Opinion on non-statutory accounts

In our opinion the non-statutory accounts:

• give a true and fair view of the state of the Company's affairs as at 30 June 2012 and of its loss for the period then ended; and
• have been properly prepared in accordance with IFRSs as adopted by the EU.

KPNG Audit Plc

KPMG Audit Plc Chartered Accountants 15 Canada Square London E14 5GL

13 December 2012

Statement of directors' responsibilities

The directors of Diageo Investment Corporation Limited ('the directors') have accepted responsibility for the preparation of these non-statutory accounts for the period ended 30 June 2012 which are intended by them to give a true and fair view of the state of affairs of the Company and of the profit or loss for that period. They have decided to prepare the non-statutory accounts in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union (EU).

In preparing these non-statutory accounts, the directors have:

• selected suitable accounting policies and applied them consistently; $\bullet$
• made judgements and estimates that are reasonable and prudent; $\bullet$
• stated whether they have been prepared in accordance with IFRSs as adopted by the EU; $\bullet$
• prepared the non-statutory accounts on the going concern basis as they believe that the $\bullet$ Company will continue in business.

The directors have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities.

Diageo Investment Corporation
Financial statements 30 June 2012

STATEMENT OF COMPREHENSIVE INCOME

	Notes	Year ended 30 June 2012 USD million	Year ended 30 June 2011 USD million
Interest receivable	$\overline{c}$	115	100
Interest payable	$\overline{\mathbf{c}}$	(155)	(124)
Net interest payable		(40)	(24)
Operating expense	$\boldsymbol{l}$	(19)	(3)
Loss before taxation		(59)	(27)
Taxation	$\mathfrak{Z}$	20	11
Loss for the year		(39)	(16)
Total comprehensive expense for the year		(39)	(16)

The accompanying notes are an integral part of these financial statements.

STATEMENT OF FINANCIAL POSITION

		30 June	30 June
	Notes	2012	2011
		USD	USD
		million	million
Non-current assets
Other financial assets	$\overline{7}$	87	22
Deferred tax assets	10	37	20
		124	42
Current assets
Notes receivable from related parties	$\overline{4}$	5,587	4,384
Interest receivable	$\overline{4}$
Other financial assets	$\overline{7}$		2
Cash and cash equivalents	5		1
		5,587	4,388
Total assets		5,711	4,430
Current liabilities
Notes payable to related parties	6	3,581	3,507
Borrowings and bank overdrafts	6
Interest payable	9	20	301
			23
Non-current liabilities		3,601	3,831
Borrowings
Other financial liabilities	6	2,259	758
Corporate tax payable	$\overline{7}$	51	3
	9	$\sqrt{2}$	L
		2,312	762
Total liabilities		5,913	4,593
Net liabilities
		(202)	(163)
Equity
Capital		75	75
Retained deficit		(277)	(238)
Total equity		(202)	(163)

The accompanying notes are integral part of these financial statements.

These financial statements on pages 5 to 26 were approved by the board of directors on 10 December 2012 and were signed on its behalf by:

Monika Pais Rounde

Director

Diageo Investment Corporation Financial statements 30 June 2012

STATEMENT OF CHANGES IN EQUITY ATTRIBUTABLE TO SHAREHOLDERS OF THE COMPANY

	Capital	Retained earnings	Total equity
	USD million	USD million	USD million
Balance at 1 July 2010	75	(222)	(147)
Total comprehensive income		(16)	(16)
Balance at 30 June 2011	75	(238)	(163)
Total comprehensive income		(39)	(39)
Balance at 30 June 2012	75	(277)	(202)

The accompanying notes are an integral part of these financial statements.

STATEMENT OF CASH FLOWS

	Year ended 30 June 2012 USD million	Year ended 30 June 2011 USD million
Cash flows from operating activities
Loss for the year	(39)	(16)
Taxation	(20)
Net interest expense excluding fair value movements	41	(11)
Operating profit excluding fair value movements	(18)	24 (3)
Fair value movements in interest rate derivative contracts in a hedge relationship	(20)	(1)
Fair value movements in external borrowings in a hedge relationship	21
Fair value movements in other interest rate instruments	$\overline{4}$	14
Amortization of notes, debentures and financial instruments Non cash movements	(6)	(13)
	(1)
Cash utilised by operations	(19)	(3)
Interest received	45
Interest paid	(87)	66 (89)
Income taxes settled	4	2
Cash received from monetization of interest rate instruments		17
Net cash outflow from operating activities	(57)	(7)
Cash flows from investing activities
Net cash flows from investing activities - UK and other
related parties	(1, 179)	(365)
Net cash outflow from investing activities	(1, 179)	(365)
Cash flows from financing activities
Net cash flows from financing activities - Parent and US
related parties Net increase in loans	50	387
Net cash inflow from financing activities	1,185
	1,235	387
Net increase/(decrease) in net cash and cash equivalents	(1)	14
Net cash and cash equivalents at the beginning of the year		(13)
Net cash and cash equivalents at the end of the year
Net cash and cash equivalents consist of:
Cash and cash equivalents		1

The accompanying notes are an integral part of these financial statements.

DESCRIPTION OF THE COMPANY AND ITS BUSINESS

Diageo Investment Corporation ('the Company') is incorporated in the United States ('US') under the laws of the state of Delaware and is a wholly owned subsidiary of Diageo Inc. The ultimate parent company is Diageo plc, a company incorporated in England and Wales.

The Company manages the daily cash and borrowing requirements of its US affiliates and acts as their principal financing agent. The Company's US affiliates are primarily engaged in the alcoholic beverage business, and include Diageo Americas Supply, Inc., Diageo Americas Inc., Diageo Chateau and Estate Wines, and Diageo Guinness USA.

The Company's sources of funds are external borrowings, and loans from US and UK affiliates including its parent. The results of operations of the Company and the development of its business are influenced to a considerable extent by its US affiliates financing requirements.

At 30 June 2012 the Company's total liabilities exceeded its total assets by \$202 million. Accordingly, the Company might not ordinarily be able to meet its liabilities as they fall due. However, Diageo Holdings Netherlands BV (intermediate parent company) has confirmed its intention to provide such support as is necessary to enable the Company to meet its liabilities as they fall due. In addition, the Stock Subscription Agreement set out in Note 11 adds appropriate resource to provide such support as is necessary.

ACCOUNTING POLICIES

Basis of preparation

These financial statements are prepared in accordance with IFRSs as endorsed and adopted for use in the EU. References to IFRS hereafter should be construed as references to IFRS as adopted by the EU.

Functional and presentational currency

These financial statements are presented in US dollars (\$), which is the Company's functional currency.

All financial information presented in US dollars has been rounded to the nearest (million).

Financial assets

Notes receivable from related parties Notes receivable from related parties are recorded at cost (which is equal to fair value at inception), less any related allowance for impaired notes receivable on an individual basis. As of 30 June 2012, there was no impairment of any notes from parent and affiliates. Interest is recognized on an accrual basis.

Other receivables are financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are recognized initially at fair value plus any directly attributable transaction costs. Subsequent to initial recognition other receivables are measured at amortized cost using the effective interest method, less any impairment losses.

Cash and cash equivalents Cash and cash equivalents comprise cash in hand and deposits which are readily convertible to known amounts of cash and which are subject to insignificant risk of changes in value and have an original maturity of three months or less at acquisition, including money market deposits, commercial paper and investments.

ACCOUNTING POLICIES (continued)

Financial liabilities

Borrowings and Notes payable to related parties Borrowings and Notes payable to related parties are initially measured at cost (which is equal to fair value at inception), and are subsequently measured at amortised cost using the effective interest rate method. Any difference between the proceeds, net of transaction costs, and the settlement or redemption of borrowings is recognised over the term of the borrowings using the effective interest rate method.

Other payables Other payables are non-interest bearing and are stated at their nominal value.

Derivative financial instruments

Derivative financial instruments are carried at fair value that is calculated using a discounted cash flow technique based on market data applied consistently for similar types of instruments. Gains and losses on derivatives that do not qualify for hedge accounting treatment are taken to the income statement as they arise.

The purpose of hedge accounting is to mitigate the impact of potential volatility in the income statement due to changes in interest rates by matching the impact of the hedged item and the hedging instrument in the income statement. To qualify for hedge accounting, the hedging relationship must meet several conditions with respect to documentation, hedge effectiveness and reliability of measurement. At the inception of the transaction, the Company documents, the relationship between hedged items and hedging instruments, as well as its risk management objective and strategy for undertaking the hedge transaction. This process includes linking all derivatives designated as hedges to specific assets and liabilities. The Company also documents its assessment, at hedge inception and at least on a quarterly basis, as to whether the derivatives that are used in hedging transactions have been, and are likely to continue to be, effective in offsetting changes in fair value of hedged items.

The Company designates derivatives which qualify for hedge accounting as a hedge of the fair value of a recognised asset or liability.

Fair value hedges are used to manage the interest rate risks to which the fair value of certain assets and liabilities are exposed. Changes in the fair value of derivatives that are fair value hedges are recognised in the income statement, along with any changes in the relevant fair value of the underlying hedged asset or liability. If such a hedge relationship is de-designated, fair value movements on the derivative continue to be taken to the income statement while any fair value adjustments made to the underlying hedged item to that date are amortised through the income statement over its remaining life using the effective interest rate method.

Taxation

Current tax is based on taxable profit for the year. This requires an estimation of the current tax liability together with an assessment of the temporary differences which arise as a consequence of different accounting and tax treatments.

Full provision for deferred tax is made for temporary differences between the carrying value of assets and liabilities in the financial statements and their tax bases. The amount of deferred tax reflects the expected recoverable amount and is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted by the balance sheet date.

Diageo Investment Corporation Financial statements 30 June 2012

ACCOUNTING POLICIES (continued)

Taxation (continued)

Deferred tax assets are not recognised where it is more likely than not that the asset will not be realised in the future. No deferred tax liability is provided in respect of any future remittance of earnings of foreign subsidiaries where the group is able to control the remittance of earnings and it is probable that such earnings will not be remitted in the foreseeable future, or where no liability would arise on the remittance.

Tax benefits are not recognised unless it is probable that the tax positions are sustainable. Once considered to be probable, management reviews each material tax benefit to assess whether a provision should be taken against full recognition of the benefit on the basis of potential settlement through negotiation and/or litigation. Any interest and penalties on tax liabilities are provided for in the tax charge.

Management estimates and judgements

The preparation of financial statements in accordance with IFRSs requires management to make judgements, estimates and assumptions that affect the application accounting policies and the reported amounts of assets and liabilities at the balance sheet date and reported profit for the year. The directors base these on a combination of past experience and any other evidence that is relevant to the particular circumstance. The actual outcome could differ from those estimates.

Of the Company's accounting policies, the directors consider that policies in relation to fair valuation (see note 8 (h)) and taxation (see previous paragraph) are particularly subject to estimates and the exercise of judgement.

NEW STANDARDS

The IASB has recently issued a number of new accounting standards that may impact the Company. None of these standards have yet been endorsed by the EU and are likely to be effective for annual periods beginning on or after 1 January 2013 which for the Company will mean the financial year ending 30 June 2014 unless a decision is made to early adopt. A summary of the principal impacts of the standards is as follows:

IFRS 9 - Financial instruments removes the multiple classification and measurement models for financial assets in IAS 39 and introduces a model that has only two classification categories: amortised cost and fair value. Classification is driven by the business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. The accounting and presentation for financial liabilities and for derecognising financial instruments has been relocated from IAS 39 without significant change. The Company is currently assessing the impact this standard would have on the results and net assets of the Company.

IFRS 13 - Fair value measurement explains how to measure fair value and aims to enhance fair value disclosures. The standard does not change the measurement of fair value but codifies it in one place. The Company is currently assessing the impact this standard would have on the presentation of its results.

NOTES TO THE FINANCIAL STATEMENTS

1. OPERATING COSTS

	Year ended 30 June 2012 USD million	Year ended 30 June 2011 USD million
Guarantee fee expense (a) Administrative expenses (b)	(17)	(2)
	(19)	(3)

• (a) Guarantee fee expense: Notes and debentures issued by the Company are guaranteed by Diageo plc. The guarantee fee payable by the Company to Diageo Plc was increased to 2% from 1 July $2011(2011 - 0.25\%)$ .
• (b) Administrative expenses include administration fee of \$2 million (2011 \$1 million) paid to Diageo Finance Plc, and fees in respect of statutory audit services provided by the auditor of \$99,000 (2011 - \$108,000).

2. NET INTEREST EXPENSE

	Year ended 30 June 2012 USD million	Year ended 30 June 2011 USD million
Interest receivable on notes receivable from related parties Interest receivable on internal derivatives Interest receivable on external derivatives Fair value gain on interest rate instruments with external parties	26 16	38 22 6
Fair value gain on interest rate instruments with related parties Fair value adjustment on borrowings Amortization of bonds Total interest income	65 6 115	10 10 13 100
Interest payable on notes payable to related parties Interest payable on internal derivatives Interest payable on notes and debentures Fair value loss on interest rate instruments with external parties Fair value loss on interest rate instruments with related parties Fair value adjustment on borrowings Discount and fee amortization on notes and debentures Total interest expense	(9) (11) (64) (1) (48) (22) (155)	(4) (4) (81) (5) (19) (10) (1) (124)
Net interest expense	(40)	(24)

Diageo Investment Corporation Financial statements 30 June 2012

NOTES TO THE FINANCIAL STATEMENTS (continued)

3. TAXATION

	Year ended 30 June 2012 USD million	Year ended 30 June 2011 USD million
(a) Analysis of taxation credit for the year
Current tax	(1)
Deferred tax
Origination and reversal of temporary differences	(1)
Tax loss carry forward	22
	21	11
Taxation	20	11
(b) Factors affecting tax credit for the year
Loss before taxation	(59)	(27)
Taxable items		17
Taxable loss	(59)	(10)
Taxation on loss at US corporation tax rate of 37.61% $(2011 - 37.5%)$	22	4
Change in audit provision	(1)
Change in unrecognised temporary differences	(1)	7
Tax credit for the year	20	11

The net deferred tax assets on other temporary differences is primarily related to current year net operating losses and mark to market differences and will likely be realized in the future.

4. NOTES AND OTHER RECEIVABLES

Notes receivable from related parties	30 June 2012 USD million 5.587	30 June 2011 USD million 4.384
Prepayments and accrued income
	5,587	4.386

All amounts fall due within one year. There are no overdue balances.

Notes receivables from related parties include interest receivable at 30 June 2012 and at 30 June 2011 on the underlying notes which is capitalized into the underlying receivable. The due dates for these notes receivable range from on demand to three months with annual interest rates from 0.19% to 2.74% for the year ended 30 June 2012 (0.19% to 3.1% for the year ended 30 June 2011).

Notes receivable from related parties represent transactions with companies in the Diageo group with which the Company has a long term financing relationship. These financing relationships are expected to continue for the foreseeable future. For the purposes of financial statement classification, amounts owed by related parties that do not have a specified repayment date are regarded as short term and consequently are considered to have a fair value which is not materially different to the book value.

5. CASH AND CASH EQUIVALENTS

The Company has entered into a joint and several guarantee with certain other Diageo plc US group undertakings such that any balance on the Company's bank accounts within the cash pool may be offset against the bank balances or overdrafts of those companies included in the cash pool.

	30 June 2012 USD million	30 June 2011 USD million
Cash at bank

All cash balances are denominated in US dollars.

6. BORROWINGS AND BANK OVERDRAFTS

	Maturity	Currency	Year end interest rates %	30 June 2012 USD million	30 June 2011 USD million
External borrowings	2011	US dollars	9		300
Guaranteed debenture 2011 Fair value adjustment to borrowings
Borrowings due within one year and bank overdrafts					301
Guaranteed debenture 2022	2022	US dollars	2.875	991
Guaranteed debenture 2022	2022	US dollars	8	297	298
Guaranteed bond 2035	2035	US dollars	7.45	400	400
Guaranteed bond 2042	2042	US dollars	4.25	494
Fair value adjustment to borrowings				77	60
Borrowings due after one year				2,259	758
Total external borrowings				2,259	1,059
Related party borrowings
Notes payable to related parties	Various	US dollars	Various	3,581	3,507
Borrowings due within one year				3,581	3,507
Total related party borrowings				3,581	3,507

All bonds and debentures are guaranteed by Diageo plc.

The interest rates of external borrowings shown in the table above are those contracted on the underlying borrowings. The average coupon on external borrowings for the year was $4.7\%$ (2011 - $8\%$ ).

Borrowings are reported in the table above at amortised cost.

Notes payable to related parties include interest payable at 30 June 2012 and at 30 June 2011 on the underlying notes which is capitalized into the underlying borrowing. The due dates for these notes payable range from on demand to three months with annual interest rates from 0.19% to 0.58% at 30 June 2012 (0.01% to 0.54% at 30 June 2011).

Notes payable to related parties represent transactions with companies in the Diageo group with which the Company has a long term financing relationship. These financing relationships are expected to continue for the foreseeable future. For the purposes of financial statement classification, amounts owed to related parties that do not have a specified repayment date are regarded as short term and consequently are considered to have a fair value which is not materially different to the book value.

7. OTHER FINANCIAL ASSETS AND LIABILITIES

30 June 2012	Non-current assets USD million	Current assets USD million	Non-current liabilities USD million
Intra-group derivative assets/(liabilities)
Not designated in a hedge relationship	87		(51)
Total other financial assets/(liabilities)	87		(51)
30 June 2011 Intra-group derivative assets/(liabilities)
Designated in fair value hedge	10
Not designated in a hedge relationship	12
	22		(3)
External derivative assets/(liabilities)			(3)
Designated in fair value hedge
Total other financial assets/(liabilities)	22		(3)

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

The Company's funding, liquidity and exposure to foreign exchange rate risks are managed by the Diageo's treasury department. The treasury department uses a combination of derivative and conventional financial instruments to manage these underlying risks.

Derivative instruments are used for risk management purposes only within a framework of policies and guidelines authorized by the board of the Diageo group.

(a) Currency risk

The Company issues its financial statements in US dollars and conducts business in the same currency. As a result, it is not subject to foreign currency exchange risk.

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)

(b) Interest rate risk

The Company participates in the Diageo group's management of its exposure to interest rate risk. The Diageo group and the Company have an exposure to interest rate risk. The Company's primary exposure is to changes in US interest rates. Changes in interest rates affect the fair value of fixed rate borrowings and the amount of interest paid on variable rate borrowings.

The Diageo group seeks to manage its interest rate risk within limits approved by the Board of Diageo group by managing the proportion of interest cost subject to fixed and variable rates.

Diageo group's treasury function is responsible for managing the Diageo group's interest rate exposure and does this through the issuance of long-term fixed rate bonds, medium-term notes, floating-rate commercial paper, and by entering into derivative instruments such as interest rate swaps, forward starting interest rate swaps and cross currency interest rate swaps. Some of these instruments, predominantly those denominated in US dollars, have been transacted by the Company.

The Company's existing interest rate derivatives are legacy fair value hedges that have locked in positive market values. These instruments are no longer involved in hedge relationships and the fair value change is recognised in the income statement which is partially offset by the net interest earned on these derivatives.

(c) Liquidity risk

Liquidity risk is the risk that the Company will encounter difficulty in meeting the obligations associated with its financial liabilities that are settled by delivering cash or another financial asset. The Company's approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Company's reputation.

In order to maintain liquidity to ensure that sufficient funds are available for ongoing operation, the Company has access to group funding.

Maturity of cash flows on non-derivative financial liabilities

	Borrowings USD million	Interest on external borrowings USD million	Notes payable to related parties USD million	Total USD million
30 June 2012
Analysis by year of repayment:
After five years	(2,200)	(1, 343)		(3, 543)
From four to five years		(104)		(104)
From three to four years		(104)		(104)
From two to three years		(104)		(104)
From one to two years		(104)		(104)
Due after one year	(2,200)	(1, 759)		(3,959)
Due within one year		(104)	(3,581)	(3,685)
Total gross contractual cash flows	(2, 200)	(1, 863)	(3,581)	(7, 644)
Net carrying amount	(2, 259)	(20)	(3, 581)	(5,860)

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)

30 June 2011	Borrowings USD million	Interest on borrowings USD million	Notes payable to related parties USD. million	Total USD million
Analysis by year of repayment:
After five years	(700)	(722)		(1, 422)
From four to five years		(54)	$\blacksquare$	(54)
From three to four years		(54)		(54)
From two to three years		(54)		(54)
From one to two years		(54)		(54)
Due after one year	(700)	(938)		(1,638)
Due within one year	(300)	(67)	(3,507)	(3, 874)
Total gross contractual cash flows	(1,000)	(1,005)	(3,507)	(5,512)
Net carrying amount	(1,059)	(23)	(3,507)	(4, 589)

Maturity of cash flows on derivative financial liabilities

		2012		2011
	Inflow USD million	Outflow USD million	Inflow USD million	Outflow USD million
After five years
From four to five years
From three to four years		(9)
From two to three years		(11)		(3)
From one to two years		(11)		(5)
Due after one year		(43)	12	(9)
Due within one year		(11)		(6)
Total gross contractual cash flows		(54)	12	(15)

Maturity of cash flows on derivative financial assets

		2012		2011
	Inflow USD million	Outflow USD million	Inflow USD million	Outflow USD million
After five years	25			(27)
From four to five years	11
From three to four years	13
From two to three years	15		10
From one to two years	15		15
Due after one year	79		31	(27)
Due within one year	15	ă.	19
Total gross contractual cash flows	94		50	(27)

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)

Amounts are shown on an undiscounted basis. Where interest payments are on a floating rate basis, rates of each cash flow until maturity of the instruments are calculated based on the forward yield curve at the last business day of the years ended 30 June 2012 and 30 June 2011. Cash flows are presented on a net basis in accordance with the settlement arrangements of the instruments.

(d) Total financial assets and liabilities

The table below sets out the Company's accounting classification of each class of financial assets and liabilities, and their fair values.

		2012		2011
	Total carrying value	Fair value	Total carrying value	Fair value
	USD million	USD million	USD million	USD million
Cash and cash equivalents				1
Notes receivable from related parties	5,587	5,587	4,384	4,384
Interest receivable			2	$\overline{c}$
Financial assets at fair value through P&L	87	87	23	23
Financial assets	5,674	5,674	4,410	4,410
Borrowings not in a hedge relationship	(2,259)	(2, 589)	(1,059)	(1,229)
Notes payable to related parties	(3,581)	(3, 581)	(3,507)	(3,507)
Interest payable	(20)	(20)	(23)	(23)
Financial liabilities at fair value through P&L	(51)	(51)	(3)	(3)
Financial liabilities	(5, 911)	(5,241)	(4, 592)	(4, 762)

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)

All derivative financial instruments not in a hedge relationship are classified as trading derivatives with fair value changes recorded in the income statement. The Company does not use derivatives for speculative purposes. All transactions in derivative financial instruments are initially undertaken to manage the risks arising from underlying business activities.

The fair values of derivatives and financial instruments are estimated by discounting the future contractual cash flows using the appropriate yield curves at 30 June each year. As at 30 June 2012 and at 30 June 2011, the carrying values of cash and cash equivalents, bank overdrafts, notes receivables and notes payables, other assets and other liabilities were considered to approximate to fair values.

(e) Hedging instruments

The Company designates derivatives which qualify as hedges for accounting purposes as a hedge of the fair value of a recognised asset or liability (fair value hedge). The accounting treatment for hedges is disclosed in 'Accounting policies of the Company'.

The Company tests effectiveness on a prospective and retrospective basis. Methods for testing effectiveness include dollar offset, critical terms, regression analysis, hypothetical derivative method and volatility reduction.

Gain on fair value hedging instruments for the year was \$20 million $(2011 - $1$ million) and the loss on the hedged items attributable to the hedged risks was \$21 million $(2011 - $$ nil).

(f) Credit risk

Credit risk refers to the risk that a counterparty will default on its contractual obligations resulting in financial loss to the Company. Credit risk arises from cash balances, derivative financial instruments and other receivables.

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)

(g) Market risk sensitivity analysis

The Company has used a sensitivity analysis technique that measures the estimated impacts on the profit for the year and other comprehensive income of an instantaneous increase or decrease of 0.5% (50 basis points) in market interest rates, for each class of financial instrument with all other variables remaining constant. The sensitivity analysis excludes the impact of market risks on taxation. This analysis is for illustrative purposes only.

The sensitivity analysis is based on the following:

• Financial instruments are valued at the balance sheet date using discounted cash flow techniques.
• Changes in interest rates affect the interest income or expense of variable interest financial $\sim$ . instruments.
• Changes in interest rates only affect interest income or expense in relation to financial and i instruments with fixed interest rates if these are recognised at their fair value.
• Changes in interest rates affect the fair value of derivative financial instruments designated as hedging instruments and all hedges are expected to be highly effective.
• Changes in the fair values of derivative financial instruments and other financial assets and liabilities are estimated by discounting the future cash flows to net present values using rates prevailing at the year end.

The amounts generated from the sensitivity analysis are estimates of the impact of market risk assuming that specified changes occur. Actual results in the future may differ materially from these results due to developments in the global financial markets which may cause fluctuations in interest and exchange rates to vary from the hypothetical amounts disclosed in the following table, which therefore should not be considered a projection of likely future events and losses.

As at 30 June 2012 and at 30 June 2011 hypothetical changes in other risk variables would not significantly affect the fair value of financial instruments at that date.

	0.5 % decrease in interest rates USD million	0.5 % increase in interest rates USD million
30 June 2012
Impact on income statement - gain/(loss)	(9)	9
Impact on other comprehensive income-gain/(loss)	(9)	9
30 June 2011
Impact on income statement - gain/(loss)	10	(9)
Impact on other comprehensive income-gain/(loss)	10	(9)

8. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)

(h) Fair value measurements

IFRS 7 requires enhanced disclosures about fair value measurements of financial instruments through the use of a three-level fair value hierarchy that prioritises the valuation techniques used in fair value calculations.

The levels can be broadly described as follows:

Level $1$ – use of unadjusted quoted prices in active markets for identical assets or liabilities;

Level $2$ – use of observable inputs other than quoted prices included within level 1, such as quoted prices for similar assets or liabilities in active markets; and

Level 3 - use of inputs not based on observable market data but reflecting management's own assumptions about pricing the asset or liability.

The Company maintains policies and procedures to value instruments using the most relevant data available. If there are multiple inputs available that fall into different levels of the hierarchy, the instrument is categorised on the basis of the lowest level input.

Derivatives and other financial liabilities

Interest rate swaps are valued in the market using discounted cash flow techniques. These techniques incorporate inputs at levels 1 and 2, such as interest rates. These market inputs are used in the discounted cash flow calculation incorporating the instrument's term, notional amount and discount rate, and taking credit risk into account. As significant inputs to the valuation are observable in the markets, these instruments are categorised as level 2 in the hierarchy.

Borrowings

External and related party borrowings are measured at amortised cost therefore fair value hierarchy disclosure is not applicable.

The Company's financial assets and liabilities measured at fair value at 30 June 2012 are categorised as follows:

	30 June 2012 Level 2 USD million	30 June 2011 Level 2 USD million
Assets
Derivative assets	87	23
Total assets	87	23
Liabilities
Derivative liabilities	(51)	(3)
Total liabilities	(51)	(3)

Diageo Investment Corporation Financial statements 30 June 2012

NOTES TO THE FINANCIAL STATEMENTS (continued)

9. OTHER PAYABLES

	30 June 2012			30 June 2011
	Due within one year USD million	Due after one year USD million	Due within one year USD million	Due after one year USD million
Interest payable	20	$\equiv$	23
Corporate tax payable		$\overline{2}$	÷
	20		23

The Company is included in consolidated federal and state income tax returns filed by its US parent, Diageo, Inc. Under Diageo, Inc.'s tax allocation policy the income tax benefit or provision is allocated to DIC as if the Company filed a separate return. Current and deferred taxes are recognized by each entity within the consolidated group, even if they are payable and recoverable by the parent entity and not the subsidiary itself. As part of the intercompany tax settlement process, Diageo, Inc. remunerates its subsidiaries for the benefit of their tax attributes including loss carry-forwards to the extent that the consolidated group utilizes the losses to offset income tax expense.

10. DEFERRED TAX ASSETS AND LIABILITIES

The amounts of deferred tax accounted for in the balance sheet comprises the following net deferred tax assets/(liabilities):

	Operating losses USD million	Fair value gains and losses USD million	Total USD million
At 1 July 2010	3	9	12
Credited to the income statement	$\overline{4}$		11
Amounts settled with related parties	(3)		(3)
At 30 June 2011	$\overline{\mathbf{4}}$	16	20
Credited to the income statement	22	(1)	21
Amounts settled with related parties	(4)		(4)
At 30 June 2012	22	15	37

The net deferred tax assets on other temporary differences is primarily related to current year net operating losses and mark to market differences and will likely be realized in the future.

11. SHARE CAPITAL AND RESERVES

		30 June 2012 USD million	30 June 2011 USD million
Capital

The Company entered into a subscription agreement, dated 14 August 1991, as amended and restated as of 1 September 1992, and 18 April 1995, with Diageo, Inc. pursuant to which Diageo, Inc. has agreed to subscribe, on demand by the Company, to common stock in an amount of up to \$2.5 billion. The agreement may not be terminated or modified in a manner materially prejudicial to the Company prior to 1 January 2040.

12. CONTINGENT LIABILITIES

There are no contingent liabilities and legal proceedings at the Company.

13. RELATED-PARTY TRANSACTIONS

The immediate parent undertaking of the Company is Diageo, Inc. a company incorporated and registered in the United States ('US').

The ultimate parent undertaking of the Company is Diageo plc which is the ultimate controlling party of Diageo group. Diageo plc is incorporated and registered in England. The consolidated financial statements of Diageo plc can be obtained from the registered office at Diageo, Lakeside Drive, Park Royal, London, NW10 7HO.

Transactions between the Company and its related parties are made on terms equivalent to those that prevail in arm's length transactions.

13. RELATED-PARTY TRANSACTIONS (continued)

The following transactions were carried out with related parties:

(a) Interest income from related parties and interest expense to related parties

	30 June 2012	30 June 2011
	USD million	USD million
Interest income in respect of notes receivable
Parent company	12	20
Fellow group undertakings - US	9	15
Fellow group undertakings - UK	5	3
	26	38
Interest income in respect of intra-group derivatives
Fellow group undertakings - UK	16	22
	16	22
Interest expense in respect of notes payable
Fellow group undertakings - US	(9)	(4)
	(9)	(4)
Interest expense in respect of intra-group derivatives
Fellow group undertakings - UK	(11)	(4)
	(11)	(4)
Total interest income from related parties	22	52

(b) Notes receivable from related parties and Notes payable to related parties

30 June 2012 USD million	30 June 2011 USD million
2,565	2,530
408	421
2,614	1,434
5,587	4,385
(167)
(3,411)	(3,507)
(3)	(1)
(3,581)	(3,508)
2,006	877

Diageo Investment Corporation Financial statements 30 June 2012

The above amounts include interest receivable and payable at 30 June 2012 on the underlying notes which is capitalized into the underlying receivable or payable. The due dates for these notes receivable and notes payable range from on demand to three months with annual interest rates from 0.19% to 2.74% at 30 June 2012 (0.01% to 3.1% at 30 June 2011).

Notes receivable from related parties and notes payable to related parties represent transactions with companies in the Diageo group with which the Company has a long term financing relationship. These financing relationships are expected to continue for the foreseeable future. For the purposes of financial statement classification, amounts owed by and to affiliates that do not have a specified repayment date are regarded as short term and consequently are considered to have a fair value which is not materially different to the book value.

(c) Intra-group derivatives

All intra-group derivatives are transacted with its fellow group undertaking, Diageo Capital Plc, incorporated in the United Kingdom. Detailed information about derivatives is disclosed under Notes 7 and 8.

(d) Guarantee fees

The notes and debentures are guaranteed by Diageo plc. As the result of this guarantee the Company paid Diageo plc \$17 million guarantee fees for the year ended 30 June 2012 (\$2 million for the year ended 30 June 2011). The guarantee fee payable by the Company to Diageo Plc was increased to 2% from 1 July 2011 (2011 - 0.25%).

15. POST BALANCE SHEET EVENTS

There were no events after the balance sheet date that had a material effect on the Company's financial position. Subsequent events have been evaluated through the date of issuance, 10 December 2012.