BP 2007 Annual Report Download - page 60

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per barrel and $5.50 per mmBtu). These long-term planning assumptions
are subject to periodic review and modification. The estimated future
level of production is based on assumptions about future commodity
prices, lifting and development costs, field decline rates, market demand
and supply, economic regulatory climates and other factors.
The future cash flows are adjusted for risks specific to the asset
where appropriate and are discounted using a pre-tax discount rate of
11% (2006 10%). This discount rate is derived from the group’s post-tax
weighted average cost of capital and is adjusted where applicable to take
into account country-specific risk.
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
$11.0 billion on its balance sheet, principally relating to the Atlantic
Richfield and Burmah Castrol acquisitions. In testing goodwill for
impairment, the group uses a similar approach to that described above.
The cash-generating units for impairment testing in this case are one
level below business segments. As noted above, 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.
Deferred taxation
The group has carry-forward tax losses in certain taxing jurisdictions that
are available to offset against future taxable income. However, deferred
tax assets are recognized only to the extent that it is considered more
likely than not that suitable taxable income will arise. Management
judgement is exercised in assessing whether this is the case. For further
information see Financial statements – Note 20 on page 128 and Note 44
on page 165.
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 asset removal obligations facing BP relate to the
removal and disposal of oil and natural gas platforms and pipelines
around the world. The estimated discounted costs of dismantling and
removing these facilities are accrued on the installation of those 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 removal events are many
years in the future and the precise requirements that will have to be met
when the removal event actually occurs are uncertain. Asset removal
technologies and costs are constantly changing, as well as political,
environmental, safety and public expectations. Consequently, the timing
and amounts of future cash flows are subject to significant uncertainty.
Changes in the expected future costs are reflected in both the provision
and the asset.
Decommissioning provisions associated with downstream and
petrochemicals facilities are generally not provided for, as such potential
obligations cannot be measured, given their indeterminate settlement
dates. The group performs periodic reviews of its downstream and
petrochemicals long-lived assets for any changes in facts and
circumstances that might require the recognition of a decommissioning
provision.
The timing and amount of future expenditures are reviewed annually,
together with the interest rate used in discounting the cash flows. The
interest rate used to determine the balance sheet obligation at the end of
2007 was 2%, unchanged from the end of 2006. The interest rate
represents the real rate (i.e. adjusted for inflation) on long-dated
government bonds.
Other provisions and liabilities are recognized in the period when it
becomes probable that there will be a future outflow of funds resulting
from past operations or events and the amount of cash outflow can be
reliably estimated. The timing of recognition requires the application of
judgement to existing facts and circumstances, which can be subject to
change. Since the actual cash outflows can take place many years in the
future, the carrying amounts of provisions and liabilities are reviewed
regularly and adjusted to take account of changing facts and
circumstances.
A change in estimate of a recognized provision or liability would result
in a charge or credit to net income in the period in which the change
occurs (with the exception of decommissioning costs as described
above).
Provisions for environmental clean-up and remediation costs are based
on current legal and constructive requirements, technology, price levels
and expected plans for remediation. Actual costs and cash outflows can
differ from estimates because of changes in laws and regulations, public
expectations, prices, discovery and analysis of site conditions and
changes in clean-up technology.
The provision for environmental liabilities is reviewed at least annually.
The interest rate used to determine the balance sheet obligation at
31 December 2007 was 2%, the same rate as at the previous balance
sheet date.
As further described in Financial statements – Note 44 on page 165,
the group is subject to claims and actions. The facts and circumstances
relating to particular cases are evaluated regularly in determining whether
it is ‘probable’ that there will be a future outflow of funds and, once
established, whether a provision relating to a specific litigation should be
adjusted. Accordingly, significant management judgement relating to
contingent liabilities is required, since the outcome of litigation is difficult
to predict.
Pensions and other post-retirement benefits
Accounting for pensions and other post-retirement benefits involves
judgement about uncertain events, including estimated retirement dates,
salary levels at retirement, mortality rates, rates of return on plan assets,
determination of discount rates for measuring plan obligations, healthcare
cost trend rates and rates of utilization of healthcare services by retirees.
These assumptions are based on the environment in each country.
Determination of the projected benefit obligations for the group’s defined
benefit pension and post-retirement plans is important to the recorded
amounts for such obligations on the balance sheet and to the amount of
benefit expense in the income statement. The assumptions used may
vary from year to year, which will affect future results of operations. Any
differences between these assumptions and the actual outcome also
affect future results of operations.
Pension and other post-retirement benefit assumptions are reviewed
by management in December each year. These assumptions are used to
determine the projected benefit obligation at the year end and hence the
surpluses and deficits recorded on the group’s balance sheet, and
pension and post-retirement benefit expense for the following year.
The pension and other post-retirement benefit assumptions at
31 December 2007, 2006 and 2005 are provided in Financial statements
–Note38onpage152.
The assumed rate of investment return, discount rate and the US
healthcare cost trend rate have a significant effect on the amounts
reported. A sensitivity analysis of the impact of changes in these
assumptions on the benefit expense and obligation is provided in
Financial statements – Note 38 on page 152.
In addition to the financial assumptions, we regularly review the
demographic and mortality assumptions. Mortality assumptions reflect
best practice in the countries in which we provide pensions and have
been chosen with regard to the latest available published tables adjusted
where appropriate to reflect the experience of the group and an
extrapolation of past longevity improvements into the future. BP’s most
substantial pension liabilities are in the UK, US and Germany and the
mortality assumptions for these countries are detailed in Financial
statements–Note38onpage152.