Vodafone 2008 Annual Report Download - page 97

Capital market and bank borrowings
Interest bearing loans and overdrafts are initially measured at fair value (which
is equal to cost at inception), and are subsequently measured at amortised cost,
using the effective interest rate method, except where they are identified as a
hedged item in a fair value hedge. Any difference between the proceeds net of
transaction costs and the settlement or redemption of borrowings is recognised
over the term of the borrowing.
Equity instruments
Equity instruments issued by the Group are recorded at the proceeds received,
net of direct issue costs.
Derivative financial instruments and hedge accounting
The Group’s activities expose it to the financial risks of changes in foreign
exchange rates and interest rates.
The use of financial derivatives is governed by the Group’s policies approved by
the Board of directors, which provide written principles on the use of financial
derivatives consistent with the Group’s risk management strategy. Changes in
values of all derivatives of a financing nature are included within investment
income and financing costs in the income statement. The Group does not use
derivative financial instruments for speculative purposes.
Derivative financial instruments are initially measured at fair value on the contract
date and are subsequently re-measured to fair value at each reporting date.
The Group designates certain derivatives as either:
hedges of the change of fair value of recognised assets and liabilities
(“fair value hedges”); or
hedges of net investments in foreign operations.
Hedge accounting is discontinued when the hedging instrument expires or is sold,
terminated, or exercised, or no longer qualifies for hedge accounting.
Fair value hedges
The Group’s policy is to use derivative instruments (primarily interest rate swaps)
to convert a proportion of its fixed rate debt to floating rates in order to hedge the
interest rate risk arising, principally, from capital market borrowings. The Group
designates these as fair value hedges of interest rate risk with changes in fair value
of the hedging instrument recognised in the income statement for the period
together with the changes in the fair value of the hedged item due to the hedged
risk, to the extent the hedge is effective. The ineffective portion is recognised
immediately in the income statement.
Net investment hedges
Exchange differences arising from the translation of the net investment in foreign
operations are recognised directly in equity. Gains and losses on those hedging
instruments (which include bonds, commercial paper and foreign exchange
contracts) designated as hedges of the net investments in foreign operations
are recognised in equity to the extent that the hedging relationship is effective.
These amounts are included in exchange differences on translation of foreign
operations as stated in the statement of recognised income and expense.
Gains and losses relating to hedge ineffectiveness are recognised immediately
in the income statement for the period. Gains and losses accumulated in the
translation reserve are included in the income statement when the foreign
operation is disposed of. During the year ended 31 March 2006, the Group adopted
the Amendments to IAS 21, “The Effect of Changes in Foreign Exchange Rates”,
with effect from 1 April 2004, being the date of transition to IFRS for the Group.
Put option arrangements
The potential cash payments related to put options issued by the Group over the
equity of subsidiary companies are accounted for as financial liabilities when such
options may only be settled other than by exchange of a fixed amount of cash
or another financial asset for a fixed number of shares in the subsidiary.
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The amount that may become payable under the option on exercise is initially
recognised at fair value within borrowings with a corresponding charge directly to
equity. The charge to equity is recognised separately as written put options over
minority interests, adjacent to minority interests in the net assets of consolidated
subsidiaries. The Group recognises the cost of writing such put options, determined
as the excess of the fair value of the option over any consideration received,
as a financing cost.
Such options are subsequently measured at amortised cost, using the effective
interest rate method, in order to accrete the liability up to the amount payable
under the option at the date at which it first becomes exercisable. The charge
arising is recorded as a financing cost. In the event that the option expires
unexercised, the liability is derecognised with a corresponding adjustment
to equity.
Provisions
Provisions are recognised when the Group has a present obligation as a result
of a past event and it is probable that the Group will be required to settle
that obligation. Provisions are measured at the directors’ best estimate of the
expenditure required to settle the obligation at the balance sheet date and
are discounted to present value where the effect is material.
Share-based payments
The Group issues equity-settled share-based payments to certain employees.
Equity-settled share-based payments are measured at fair value (excluding the
effect of non market-based vesting conditions) at the date of grant. The fair
value determined at the grant date of the equity-settled share-based payments
is expensed on a straight-line basis over the vesting period, based on the Group’s
estimate of the shares that will eventually vest and adjusted for the effect of non
market-based vesting conditions.
Fair value is measured using a binomial pricing model, being a lattice-based
option valuation model, which is calibrated using a Black-Scholes framework.
The expected life used in the model has been adjusted, based on management’s
best estimate, for the effects of non-transferability, exercise restrictions and
behavioural considerations.
The Group uses historical data to estimate option exercise and employee
termination within the valuation model; separate groups of employees that
have similar historical exercise behaviour are considered separately for valuation
purposes. The expected life of options granted is derived from the output of
the option valuation model and represents the period of time that options are
expected to be outstanding. Expected volatilities are based on implied volatilities
as determined by a simple average of no less than three international banks,
excluding the highest and lowest numbers. The risk-free rates for periods within
the contractual life of the option are based on the UK gilt yield curve in effect
at the time of grant.
Some share awards have an attached market condition, based on Total
Shareholder Return (“TSR”), which is taken into account when calculating the
fair value of the share awards. The valuation for the TSR is based on Vodafone’s
ranking within the same group of companies, where possible, over the past five
years. The volatility of the ranking over a three year period is used to determine
the probable weighted percentage number of shares that could be expected
to vest and hence affect fair value.
The fair value of awards of non-vested shares to the Board of directors and
Executive Committee is equal to the closing price of the Vodafone’s shares on
the date of grant, as these awards are entitled to dividend equivalents during the
vesting period. Awards of non-vested shares to other employees are not entitled
to dividends during the vesting period and the fair value reflects a discount to the
closing share price of Vodafone’s shares on the date of grant equal to the present
value of expected dividends to be received over the vesting period.
Vodafone Group Plc Annual Report 2008 95