Vodafone 2011 Annual Report Download - page 91

Vodafone Group Plc Annual Report 2011 89
Financials
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 (legal or
constructive) as a result of a past event, it is probable that the Group will be
required to settle that obligation and a reliable estimate can be made of the
amount of the obligation. Provisions are measured at the directors’ best
estimate of the expenditure required to settle the obligation at the reporting
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 is equal to the closing price of
the Vodafone’s shares on the date of grant, adjusted for the present value of
future dividend entitlements where appropriate.
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 amount due on 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 issuance 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 remeasured 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,
or the Company chooses to end the hedging relationship.
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 comprehensive income. 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.
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.
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 non-controlling interests, adjacent to
non-controlling interests in the net assets of consolidated subsidiaries.