Unilever 2005 Annual Report Download - page 24

Report of the Directors
Unilever Annual Report and Accounts 2005 21
Financial review
(continued)
Financial instruments
From 1 January 2005, we account for financial instruments in
accordance with IAS 32 and 39. Financial instruments are
classified according to the purpose for which the instruments
were acquired. This gives rise to the following categories: held-to-
maturity investments, loans and receivables, available-for-sale
financial assets and financial assets at fair value through profit or
loss. Please refer to note 1 on page 83 for a description of each
of these categories.
Based on IAS 32 and 39, we report derivative financial
instruments at fair value. Changes in fair values are booked
through profit or loss unless the derivatives are designated and
effective as hedge of future cash flows, in which case the changes
are recognised directly in equity. At the time the hedged cash
flow results in the recognition of an asset or a liability, the
associated gains or losses on the derivative that had previously
been recognised in equity are included in the initial measurement
of the asset or liability. For hedged items that do not result in the
recognition of an asset or liability, amounts deferred in equity are
recognised in the income statement in the same period in which
the hedged item affects net profit or loss.
Changes in fair value of net investment hedges in relation to
foreign subsidiaries are recognised directly in equity.
The most important change associated with the implementation
of IAS 32 relates to the treatment of our preference share capital.
Under the new accounting rules we treat the preference shares as
third-party borrowings and the dividends are reported as interest
costs through profit or loss.
Retirement benefits
We account for pensions and similar obligations in accordance
with IAS 19 ’Employee Benefits’. Under this standard, the assets
and liabilities of the plans are recognised at fair values in the
balance sheet.
Pension accounting requires certain assumptions to be made in
order to value our obligations and to determine the charges to be
made to the income statement. These figures are particularly
sensitive to assumptions for discount rates, inflation rates and
expected long-term rates of return on assets. The following table
sets out these assumptions, as at 31 December 2005, in respect
of the four largest Unilever pension plans. Further details of
assumptions made are given in note 22 on pages 115 and 116.
%%%%
Nether- United
UK lands States Germany
Discount rate 4.7 4.0 5.5 4.0
Inflation 2.7 1.8 2.4 1.8
Expected long-term rate of return:
Equities 7.6 7.0 8.0 7.0
Bonds 4.5 3.7 4.8 3.7
Property 6.1 5.5 6.5 5.5
Others 6.7 3.7 4.2 3.7
These assumptions are set by reference to market conditions at
the valuation date. Actual experience may differ from the
assumptions made. The effects of such differences are recognised
through the statement of recognised income and expense.
Demographic assumptions, such as mortality rates, are set having
regard to the latest trends in life expectancy, plan experience and
other relevant data. The assumptions are reviewed and updated
as necessary as part of the periodic actuarial valuation of the
pension plans. Mortality assumptions for the four largest plans are
given in more detail in note 22 on page 116.
Share-based compensation
In accordance with IFRS 2 we include a non-cash charge against
operating profit to reflect the fair value to the employee of share
options and awards granted. In determining the additional
charge, we apply a valuation based on modified Black-Scholes or
multinomial models spread over the vesting period. The fair value
so calculated depends on certain assumptions which are described
in note 31 on page 132. The assumptions made in respect of
share price volatility and expected dividend yields are particularly
subjective. Unilever considers these and all other assumptions to
be appropriate, but significant changes in assumptions could
materially affect the charge recorded.
Provisions
Provision is made, among other reasons, for environmental and
legal matters and for employee termination costs where a legal
or constructive obligation exists at the balance sheet date and
a reliable estimate can be made of the likely outcome.
Advertising and promotion costs
Expenditure on items such as consumer promotions and trade
advertising is charged against profit in the year in which it is
incurred. At each balance sheet date, we are required to estimate
the part of expenditure incurred but not yet invoiced based on
our knowledge of customer, consumer and promotional activity.
Deferred tax
Full provision is made for deferred taxation, as required under
IAS 12, at the rates of tax prevailing at the year end unless future
rates have been enacted, as detailed in note 1 on page 84.
Deferred tax assets are regularly reviewed for recoverability, and a
valuation allowance is established to the extent that recoverability
is not considered likely.
Reporting currency and exchange rates
Foreign currency amounts for results and cash flows are translated
from underlying local currencies into euros using annual average
exchange rates; balance sheet amounts are translated at year-end
rates except for the ordinary capital of the two parent companies.
These are translated at the rate prescribed by the Equalisation
Agreement of £1 = Fl.12, and then to euros at the official rate of
€1.00 = Fl.2.20371 (see Corporate Governance on page 41).