BP 2005 Annual Report Download - page 37

The treatment of gains and losses arising from revaluing derivatives
designated as hedging instruments depends on the nature of the
hedging relationship, as follows:
Fair value hedges For fair value hedges, the carrying amount of the
hedged item is adjusted for gains and losses attributable to the risk
being hedged; the derivative is remeasured at fair value and gains and
losses from both are taken to profit or loss. For hedged items carried
at amortized cost, the adjustment is amortized through the income
statement such that it is fully amortized by maturity. When an
unrecognized firm commitment is designated as a hedged item,
this gives rise to an asset or liability in the balance sheet, representing
the cumulative change in the fair value of the firm commitment
attributable to the hedged risk.
The group discontinues fair value hedge accounting if the hedging
instrument expires or is sold, terminated or exercised, the hedge no
longer meets the criteria for hedge accounting or the group revokes
the designation.
Cash flow hedges For cash flow hedges, the effective portion of the
gain or loss on the hedging instrument is recognized directly in equity,
while the ineffective portion is recognized in profit or loss. Amounts
taken to equity are transferred to the income statement when the
hedged transaction affects profit or loss, such as when a forecast
sale or purchase occurs. Where the hedged item is the cost of a non-
financial asset or liability, the amounts taken to equity are transferred
to the initial carrying amount of the non-financial asset or liability.
If the hedging instrument expires or is sold, terminated or exercised
without replacement or rollover, the hedged transaction ceases to be
highly probable, or if its designation as a hedge is revoked, amounts
previously recognized in equity remain in equity until the forecast
transaction occurs and are transferred to the income statement or to
the initial carrying amount of a non-financial asset or liability as above.
If a forecast transaction is no longer expected to occur, amounts
previously recognized in equity are transferred to profit or loss.
Hedges of the net investment in a foreign entity For hedges of the
net investment in a foreign entity, the effective portion of the gain or
loss on the hedging instrument is recognized directly in equity, while
the ineffective portion is recognized in profit or loss.
Amounts taken to equity are transferred to the income statement
when the foreign entity is sold.
Embedded derivatives Derivatives embedded in other financial
instruments or other host contracts are treated as separate derivatives
when their risks and characteristics are not closely related to those
of host contracts and the host contracts are not carried at fair value.
Contracts are assessed for embedded derivatives when the group
becomes a party to them, including at the date of a business
combination. These embedded derivatives are measured at fair value
at each period end. Any gains or losses arising from changes in fair
value are taken directly to net profit or loss for the period.
PROVISIONS
Provisions are recognized when the group has a present obligation
(legal or constructive) as a result of a past event, it is probable that an
outflow of resources embodying economic benefits will be required
to settle the obligation and a reliable estimate can be made of the
amount of the obligation. Where the group expects some or all of a
provision to be reimbursed, for example, under an insurance contract,
the reimbursement is recognized as a separate asset, but only when
the reimbursement is virtually certain. The expense relating to any
provision is presented in the income statement net of any
reimbursement. If the effect of the time value of money is material,
provisions are determined by discounting the expected future cash
flows at a pre-tax rate that reflects current market assessments of
the time value of money and, where appropriate, the risks specific to
the liability. Where discounting is used, the increase in the provision
due to the passage of time is recognized as other finance expense.
Any change in the amount recognized for environmental and litigation
and other provisions arising through changes in discount rates is
included within other finance expense.
A contingent liability is disclosed where the existence of an
obligation will only be confirmed by future events or where the
amount of the obligation cannot be measured with reasonable
reliability. Contingent assets are not recognized, but are disclosed
where an inflow of economic benefits is probable.
ENVIRONMENTAL LIABILITIES
Environmental expenditures that relate to current or future revenues
are expensed or capitalized as appropriate. Expenditures that relate to
an existing condition caused by past operations and do not contribute
to current or future earnings are expensed.
Liabilities for environmental costs are recognized when
environmental assessments or clean-ups are probable and the
associated costs can be reasonably estimated. Generally, the timing
of these provisions coincides with the commitment to a formal plan
of action or, if earlier, on divestment or on closure of inactive sites.
The amount recognized is the best estimate of the expenditure
required. Where the liability will not be settled for a number of years,
the amount recognized is the present value of the estimated
future expenditure.
DECOMMISSIONING
Liabilities for decommissioning costs are recognized when the group
has an obligation to dismantle and remove a facility or an item of plant
and to restore the site on which it is located, and when a reasonable
estimate of that liability can be made. Where an obligation exists for
a new facility, such as oil and natural gas production or transportation
facilities, this will be on construction or installation. An obligation for
decommissioning may also crystallize during the period of operation
of a facility through a change in legislation or through a decision to
terminate operations. The amount recognized is the present value of
the estimated future expenditure determined in accordance with local
conditions and requirements.
A corresponding item of property, plant and equipment of an
amount equivalent to the provision is also created. This is
subsequently depreciated as part of the capital costs of the facility
or item of plant.
Any change in the present value of the estimated expenditure is
reflected as an adjustment to the provision and the corresponding
property, plant and equipment.
EMPLOYEE BENEFITS
Wages, salaries, bonuses, social security contributions, paid annual
leave and sick leave are accrued in the period in which the associated
services are rendered by employees of the group. Deferred bonus
arrangements that have a vesting date more than 12 months after the
period end are valued on an actuarial basis using the projected unit
credit method and amortized on a straight-line basis over the service
period until the award vests. The accounting policy for pensions and
other post-retirement benefits is described below.
BP Annual Report and Accounts 2005 35