BP 2007 Annual Report Download - page 107

BP ANNUAL REPORT AND ACCOUNTS 2007 105
1 Significant accounting policies continued
At the inception of a hedge relationship the group formally designates and documents the hedge relationship for which the group wishes to claim
hedge accounting, together with the risk management objective and strategy for undertaking the hedge. The documentation includes identification of
the hedging instrument, the hedged item or transaction, the nature of the risk being hedged, and how the entity will assess the hedging instrument
effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows attributable to the hedged item. Such hedges are
expected at inception to be highly effective in achieving offsetting changes in fair value or cash flows.
Hedges meeting the criteria for hedge accounting are accounted for as follows:
Fair value hedges
The change in fair value of a hedging derivative is recognized in profit or loss. The change in the fair value of the hedged item attributable to the risk
being hedged is recorded as part of the carrying value of the hedged item and is also recognized in profit or loss.
The group applies fair value hedge accounting for hedging fixed interest rate risk on borrowings. The gain or loss relating to the effective portion
of the interest rate swap is recognized in the income statement within finance costs, offsetting the amortization of the interest on the underlying
borrowings.
If the criteria for hedge accounting are no longer met, or if the group revokes the designation, the adjustment to the carrying amount of a hedged
item for which the effective interest rate method is used is amortized to profit or loss over the period to maturity.
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.
The gain or loss relating to the effective portion of interest rate swaps hedging variable rate borrowings is recognized in the income statement within
finance costs.
Where the hedged item is the cost of a non-financial asset or liability, such as a forecast transaction for the purchase of property, plant and
equipment, 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.
Hedges of a net investment in a foreign operation
For hedges of a net investment in a foreign operation, 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
operation is sold or partially disposed.
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 the host contract. Contracts are assessed for embedded derivatives when the group becomes a party to them,
including at the date of a business combination. Embedded derivatives are measured at fair value at each balance sheet date. Any gains or losses
arising from changes in fair value are taken directly to profit or loss.
Provisions and contingencies
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 appropriate, the future cash flow estimates are adjusted to reflect risks specific to the liability. 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. Where discounting is used, the increase in the provision due to the passage of time
is recognized as 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 expenditures and 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
reliably estimated. Generally, the timing of recognition 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 reliable 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.