BP 2012 Annual Report Download - page 174

For oil and natural gas properties, the expected future cash flows are
estimated using management’s best estimate of future oil and natural gas
prices and reserves volumes. Prices for oil and natural gas used for future
cash flow calculations are based on market prices for the first five years
and the group’s long-term price assumptions thereafter. As at
31 December 2012, the group’s long-term price assumptions were $90
per barrel for Brent and $6.50/mmBtu for Henry Hub (2011 $90 per barrel
and $6.50/mmBtu). These long-term price assumptions are subject to
periodic review and modification. The estimated future level of production
is based on assumptions about future commodity prices, production and
development costs, field decline rates, current fiscal regimes and other
factors.
The future cash flows are adjusted for risks specific to the cash-generating
unit and are discounted using a pre-tax discount rate. The discount rate is
derived from the group’s post-tax weighted average cost of capital and is
adjusted where applicable to take into account any specific risks relating
to the country where the cash-generating unit is located, although other
rates may be used if appropriate to the specific circumstances. In 2012
the rates ranged from 12% to 14% nominal (2011 12% to 14% nominal).
The discount rates applied in assessments of impairment are reassessed
each year.
Irrespective of whether there is any indication of impairment, BP is
required to test annually for impairment of goodwill acquired in a business
combination. The group carries goodwill of approximately $11.9 billion on
its balance sheet (2011 $12.1 billion), principally relating to the Atlantic
Richfield, Burmah Castrol, Devon Energy and Reliance transactions. In
testing goodwill for impairment, the group uses a similar approach to that
described above for asset impairment. If there are low oil prices or natural
gas prices or refining margins or marketing margins for an extended
period, the group may need to recognize significant goodwill impairment
charges.
Refer to Oil and natural gas accounting above for a discussion on the
recoverability of intangible exploration and appraisal expenditure.
Details of impairment charges recognized in the income statement are
provided in Financial statements – Note 5 and details on the carrying
amounts of assets are shown in Financial statements – Note 21, Note 22
and Note 23.
Judgements are also required in assessing the recoverability of overdue
trade receivables and determining whether a provision against the future
recoverability of those receivables is required. Factors considered include
the credit rating of the counterparty, the amount and timing of anticipated
future payments and any possible actions that can be taken to mitigate
the risk of non-payment.
Business combinations
Accounting for business combinations using the acquisition method
requires the determination of the fair value of the consideration
transferred, together with the fair value of the identifiable assets acquired
and liabilities assumed at the acquisition date. Goodwill is measured as
being the excess of the aggregate of the consideration transferred, the
amount recognized for any minority interest and the acquisition-date fair
values of any previously held interest in the acquiree over the fair value of
the identifiable assets acquired and liabilities assumed at the acquisition
date.
Judgement is required in determining whether a transaction meets the
criteria to be treated as a business combination or not. Judgements and
estimates are also required in order to determine the fair values of the
assets acquired and the liabilities assumed, and the group uses all
available information, including external valuations and appraisals where
appropriate, to determine these fair values. If necessary, the group has up
to one year from the acquisition date to finalize the determinations of fair
value.
Details of the business combinations undertaken by the group in 2012 are
provided in Financial statements – Note 3 on page 198.
Taxation
The computation of the group’s income tax expense and liability involves
the interpretation of applicable tax laws and regulations in many
jurisdictions throughout the world. The resolution of tax positions taken by
the group, through negotiations with relevant tax authorities or through
litigation, can take several years to complete and in some cases it is
difficult to predict the ultimate outcome.
In addition, the group has carry-forward tax losses and tax credits in
certain taxing jurisdictions that are available to offset against future taxable
profit. However, deferred tax assets are recognized only to the extent that
it is probable that taxable profit will be available against which the unused
tax losses or tax credits can be utilized. Management judgement is
exercised in assessing whether this is the case.
To the extent that actual outcomes differ from management’s estimates,
income tax charges or credits, and changes in deferred tax assets or
liabilities, may arise in future periods. For more information see Financial
statements – Note 18 on page 212 and Note 43 on page 253.
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. In addition,
derivatives embedded within other financial instruments or other host
contracts are treated as separate derivatives when their risks and
characteristics are not closely related to those of the host contract.
Forward contracts to buy or sell equity investments, including
investments in associates and joint ventures, are also accounted for as
derivative financial instruments. All such derivatives 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 relating to
unquoted equity instruments are carried at cost where it is not possible to
reliably measure their fair value subsequent to initial recognition. Gains
and losses arising from changes in the fair value of derivatives that are not
designated as effective hedging instruments are recognized in the income
statement.
In some cases the fair values of derivatives are estimated using internal
models and other valuation methods due to the absence of quoted prices
or other observable, market-corroborated data. This applies to the group’s
longer-term, structured derivative products and complex options, to the
forward contracts to purchase shares in Rosneft, as well as to the majority
of the group’s natural gas embedded derivatives. The group’s embedded
derivatives arise primarily from long-term UK gas contracts that use pricing
formulae not related to gas prices, for example, oil product and power
prices. These contracts are valued using models with inputs that include
price curves for each of the different products that are built up from active
market pricing data and extrapolated to the expiry of the contracts using
the maximum available external pricing information. Additionally, where
limited data exists for certain products, prices are interpolated using
historic and long-term pricing relationships. Price volatility is also an input
for the models.
Changes in the key assumptions could have a material impact on the fair
value gains and losses on derivatives and embedded derivatives
recognized in the income statement. For more information see Financial
statements – Note 33 on page 228.
Details of the value-at-risk techniques used by the group to measure
market risk exposure arising from its derivative trading positions is
provided in Financial statements – Note 26 on page 220. An analysis of
the sensitivity of the fair value of the embedded derivatives to changes in
the key assumptions is provided in Financial statements – Note 26 on
page 220.
Provisions and contingencies
The group holds provisions for the future decommissioning of oil and
natural gas production facilities and pipelines at the end of their economic
lives. The largest decommissioning obligations facing BP relate to the
plugging and abandonment of wells and the removal and disposal of oil
and natural gas platforms and pipelines around the world. The estimated
discounted costs of performing this work are recognized as we drill the
wells and install the facilities, reflecting our legal obligations at that time. A
corresponding asset of an amount equivalent to the provision is also
created within property, plant and equipment. This asset is depreciated
over the expected life of the production facility or pipeline. Most of these
decommissioning events are many years in the future and the precise
requirements that will have to be met when the removal event actually
172 Additional disclosures
BP Annual Report and Form 20-F 2012