BP 2011 Annual Report Download - page 188

186 BP Annual Report and Form 20-F 2011186 BP Annual Report and Form 20-F 2011
Notes on financial statements
1. Significant accounting policies continued
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.
Hedge relationships are formally designated and documented at
inception, 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 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 within other comprehensive income,
while the ineffective portion is recognized in profit or loss. Amounts taken
to other comprehensive income 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 recognized within other comprehensive
income 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 within other comprehensive income 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 reclassified to the income statement.
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 the income statement.
Provisions, contingencies and reimbursement assets
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.
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
risk-free 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 within finance costs. Provisions are split
between amounts expected to be settled within 12 months of the balance
sheet date (current) and amounts expected to be settled later (non-current).
Contingent liabilities are possible obligations whose existence will only be
confirmed by future events not wholly within the control of the group, or
present obligations where it is not probable that an outflow of resources
will be required or the amount of the obligation cannot be measured with
sufficient reliability.
Contingent liabilities are not recognized in the financial statements
but are disclosed unless the possibility of an outflow of economic resources
is considered remote.
Where the group makes contributions into a separately administered
fund for restoration, environmental or other obligations, which it does
not control, and the group’s right to the assets in the fund is restricted,
the obligation to contribute to the fund is recognized as a liability where
it is probable that such additional contributions will be made. The group
recognizes a reimbursement asset separately, being the lower of the
amount of the associated restoration, environmental or other provision and
the group’s share of the fair value of the net assets of the fund available to
contributors.