Vodafone 2006 Annual Report Download - page 28

26 Vodafone Group Plc Annual Report 2006
Critical Accounting Estimates
The Group prepares its Consolidated Financial Statements in accordance with IFRS, the
application of which often requires judgements to be made by management when
formulating the Group’s financial position and results. Under IFRS, the directors are
required to adopt those accounting policies most appropriate to the Group’s
circumstances for the purpose of presenting fairly the Group’s financial position,
financial performance and cash flows. The Group also prepares a reconciliation of the
Group’s revenue, net profit and shareholders’ equity between IFRS and US GAAP.
In determining and applying accounting policies, judgement is often required in respect
of items where the choice of specific policy, accounting estimate or assumption to be
followed could materially affect the reported results or net asset position of the Group
should it later be determined that a different choice would be more appropriate.
Management considers the accounting estimates and assumptions discussed below to
be its critical accounting estimates and, accordingly, provides an explanation of each
below. Where it is considered that the Group’s US GAAP accounting policies differ
materially from the IFRS accounting policy, a separate explanation is provided.
The discussion below should also be read in conjunction with the Group’s disclosure of
significant IFRS accounting policies, which is provided in note 2 to the Consolidated
Financial Statements, “Significant accounting policies” and with the “Summary of
differences between IFRS and US GAAP” provided in note 38 to the Consolidated
Financial Statements.
Management has discussed its critical accounting estimates and associated disclosures
with the Company’s Audit Committee.
Impairment reviews
Asset recoverability is an area involving management judgement, requiring assessment
as to whether the carrying value of assets can be supported by the net present value of
future cash flows derived from such assets using cash flow projections which have been
discounted at an appropriate rate. In calculating the net present value of the future cash
flows, certain assumptions are required to be made in respect of highly uncertain
matters, as noted below.
IFRS requires management to undertake an annual test for impairment of indefinite
lived assets, and for finite lived assets, to test for impairment if events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Group management currently undertakes an annual impairment test covering goodwill
and other indefinite lived assets, and also reviews finite lived assets and investments in
associated undertakings at least annually to consider whether a full impairment review
is required. In the year to 31 March 2006, the Group has recognised impairment losses
amounting to £23,515 million relating to the Group’s mobile operations in Germany,
Italy and Sweden, of which £23,000 million was recognised following completion of the
annual impairment test.
US GAAP
Under US GAAP, the requirements for testing the recoverability of intangible assets and
property, plant and equipment differ from IFRS. US GAAP requires the carrying value of
such assets with finite lives to be compared to undiscounted future cash flows over the
remaining useful life of the primary asset of the asset group being tested for
impairment, to determine if the asset or asset group is recoverable. If the carrying value
exceeds the undiscounted cash flows, the carrying value is not recoverable and the asset
or asset group is written down to the net present value of future cash flows derived in a
manner similar to IFRS.
For purposes of goodwill impairment testing under US GAAP, the fair value of a reporting
unit including goodwill is compared to its carrying value. If the fair value of a reporting
unit is lower than its carrying value, the fair value of the goodwill within that reporting
unit is compared with its respective carrying value, with any excess carrying value
written off as an impairment. The fair value of the goodwill is the difference between the
fair value of the reporting unit and the fair value of the net assets of the reporting unit.
Following the issuance of EITF Topic D-108, “Use of the Residual Method to Value
Acquired Assets Other Than Goodwill”, in the year ended 31 March 2005, the Group, in
respect of the indefinite lived licences in Verizon Wireless, was required to perform a
transitional impairment test on indefinite lived intangible assets other than goodwill by
comparing the carrying amount with the fair value of the asset determined on a
standalone basis. In the year ended 31 March 2005, the cumulative effect on net loss of
adopting this standard was £6,177 million, net of taxes of £5,239 million.
Assumptions
There are a number of assumptions and estimates involved in calculating the net
present value of future cash flows from the Group’s businesses including management’s
expectations of:
•growth in EBITDA, calculated as adjusted operating profit before depreciation and
amortisation;
•timing and quantum of future capital expenditure;
•uncertainty of future technological developments;
•long term growth rates; and
•the selection of discount rates to reflect the risks involved.
The Group prepares and internally approves formal ten-year plans for its businesses and
uses these as the basis for its impairment reviews. Management uses the initial five years
of the plans, except in markets which are forecast to grow ahead of the long term growth
rate for the market. In such cases, further years will be used until the forecast growth
rate trends towards the long term growth rate, up to a maximum of ten years.
For mobile businesses, a long term growth rate into perpetuity has been determined as
the lower of:
•the nominal GDP rates for the country of operation, using forecast nominal GDP
rates from external sources; and
•the long term compound annual growth rate in EBITDA implied by the business
plan.
For non-mobile businesses, no growth is expected beyond management’s plans for the
initial five year period.
Changing the assumptions selected by management, in particular the discount rate and
growth rate assumptions used in the cash flow projections, could significantly affect the
Group’s results. The Group’s review includes the key assumptions related to sensitivity in
the cash flow projections.
The following changes to the assumptions used in the impairment review would have
(increased)/decreased the combined impairment loss recognised in the year ended
31 March 2006 in respect of the Group’s mobile operations in Germany and Italy:
Increase by 1/2% Decrease by 1/2%
£bn £bn
Discount rate (2.2) 2.4
Budgeted EBITDA(1) 0.3 (0.3)
Capital expenditure(2) (0.2) 0.2
Long term growth rate 2.9 (2.5)
Notes:
(1) Represents the compound annual growth rate for the initial five years of the Group’s approved financial plans.
(2) Represents capital expenditure as a percentage of revenue in the initial five years of the Group’s approved plans.
These assumption changes in isolation would not have resulted in an impairment loss
in any other of the Group’s continuing operations.
US GAAP
Under US GAAP, the assumptions and estimates involved in reviewing for impairment are
similar to IFRS, with the exception of the requirement to determine the primary asset of
an asset group. For asset groups represented by the Group’s operating companies, the
primary asset is determined as the 3G licence, except for operating companies where no
3G licence has been acquired, in which case the 2G licence is the primary asset. If the
primary asset of the Group’s mobile operations in Germany were the 2G rather than the
3G licence, the carrying value would exceed the undiscounted cash flows and result in a
significant impairment loss.
Business combinations
Goodwill only arises in business combinations. The amount of goodwill initially
recognised is dependent on the allocation of the purchase price to the fair value of the
identifiable assets acquired and the liabilities assumed. The determination of the fair
value of the assets and liabilities is based, to a considerable extent, on management’s
judgement.
Allocation of the purchase price affects the results of the Group as finite lived intangible
assets are amortised whereas indefinite lived intangible assets, including goodwill, are
not amortised, and could result in differing amortisation charges based on the allocation
to indefinite lived and finite lived intangible assets.
On the acquisition of mobile network operators, the identifiable intangible assets may
include licences, customer bases and brands. The fair value of these assets is