BP 2006 Annual Report Download - page 106

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1 Significant accounting policies continued
Cash and cash equivalents
Cash and cash equivalents comprise cash in hand; current balances with banks and similar institutions; and short-term highly liquid investments thatare
readily convertible to known amounts of cash, are subject to insignificant risk of changes in value and have a maturity of three months or less from the
date of acquisition.
For the purpose of the group cash flow statement, cash and cash equivalents consist of cash and cash equivalents as defined above, net of
outstanding bank overdrafts.
Trade and other payables
Trade and other payables are carried at payment or settlement amounts. Where the time value of money is material, payables are carried at amortized
cost.
Interest-bearing loans and borrowings
All loans and borrowings are initially recognized at fair value, being the fair value of the proceeds received net of issue costs associated with the
borrowing.
After initial recognition, interest-bearing loans and borrowings are subsequently measured at amortized cost using the effective interest method.
Amortized cost is calculated by taking into account any issue costs, and any discount or premium on settlement.
Gains and losses arising on the repurchase, settlement or cancellation of liabilities are recognized respectively in interest and other revenues and
other finance expense.
Leases
Finance leases, which transfer to the group substantially all the risks and benefits incidental to ownership of the leased item, are capitalized at the
inception of the lease at the fair value of the leased property or, if lower, at the present value of the minimum lease payments. Lease payments are
apportioned between the finance charges and reduction of the lease liability so as to achieve a constant rate of interest on the remaining balance of the
liability. Finance charges are charged directly against income.
Capitalized leased assets are depreciated over the shorter of the estimated useful life of the asset or the lease term.
Operating lease payments are recognized as an expense in the income statement on a straight-line basis over the lease term.
Derivative financial instruments
The group uses derivative financial instruments to manage certain exposures to fluctuations in foreign currency exchange rates, interest rates and
commodity prices as well as for trading purposes. From 1 January 2005, such derivative financial instruments are initially recognized at fair value on the
date on which a derivative contract is entered into and are subsequently remeasured at fair value. Derivatives are carried as assets when the fair valueis
positive and as liabilities when the fair value is negative.
Contracts to buy or sell a non-financial item that can be settled net in cash or another financial instrument, or by exchanging financial instruments, as
if the contracts were financial instruments, with the exception of contracts that were entered into and continue to be held for the purpose of the receipt
or delivery of a non-financial item in accordance with the group’s expected purchase, sale or usage requirements, are accounted for as financial
instruments.
For those derivatives designated as hedges and for which hedge accounting is desired, the hedging relationship is documented at its inception. This
documentation identifies the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how effectiveness will be
measured throughout its duration. Such hedges are expected at inception to be highly effective.
For the purpose of hedge accounting, hedges are classified as:
– Fair value hedges when hedging the exposure to changes in the fair value of a recognized asset or liability.
– Cash flow hedges when hedging exposure to variability in cash flows that is either attributable to a particular risk associated with a recognized asset
or liability or a highly probable forecast transaction, including intragroup transactions.
– Hedges of the net investment in a foreign entity.
Any gains or losses arising from changes in the fair value of all other derivatives, which are classified as held for trading, are taken to the income
statement. These may arise from derivatives for which hedge accounting is not applied because they are either not designated or not effective as
hedging instruments or from derivatives that are acquired for trading purposes.
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 portionis
recognized in profit or loss. Amounts taken to equity are transferred to the income statement when the hedged transaction affects profit or loss. 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, 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.