BP 2008 Annual Report Download - page 113

BP Annual Report and Accounts 2008
Notes on financial statements
1. Significant accounting policies continued
Financial liabilities
Financial liabilities are classified as financial liabilities at fair value through
profit or loss; derivatives designated as hedging instruments in an
effective hedge; or as financial liabilities measured at amortized cost, as
appropriate. Financial liabilities include trade and other payables, accruals,
finance debt and derivative financial instruments. The group determines
the classification of its financial liabilities at initial recognition. The
measurement of financial liabilities depends on their classification,
as follows:
Financial liabilities at fair value through profit or loss
Derivatives, other than those designated as effective hedging
instruments, are classified as held for trading and are included in
this category. These liabilities are carried on the balance sheet at fair
value with gains or losses recognized in the income statement.
Derivatives designated as hedging instruments in an effective hedge
Such derivatives are carried on the balance sheet at fair value, the
treatment of gains and losses arising from revaluation are described
below in the accounting policy for Derivative financial instruments
and hedging activities.
Financial liabilities measured at amortized cost
All other financial liabilities are initially recognized at fair value. For
interest-bearing loans and borrowings this is the fair value of the
proceeds received net of issue costs associated with the borrowing.
After initial recognition, other financial liabilities 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 finance costs.
This category of financial liabilities includes trade and other
payables and finance debt.
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
commencement of the lease term at the fair value of the leased property
or, if lower, at the present value of the minimum lease payments. Finance
charges are allocated to each period so as to achieve a constant rate of
interest on the remaining balance of the liability and 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.
For both finance and operating leases, contingent rents are
recognized in the income statement in the period in which they
are incurred.
Derivative financial instruments and hedging activities
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. 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 value is 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.
Gains or losses arising from changes in the fair value of
derivatives that are not designated as effective hedging instruments
are recognized in the income statement.
For the purpose of hedge accounting, hedges are classified as:
• Fair value hedges when hedging 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.
• Hedges of a net investment in a foreign operation.
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.
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