Marks and Spencer 2006 Annual Report Download - page 58

56 Marks and Spencer Group plc
Notes to the financial statements continued
1 ACCOUNTING POLICIES continued
D Non-equity shares
Under IAS 32, the Group’s non-equity B shares in the Group
are held as a current liability and the dividend paid is
included within the interest charge for the year.
E Bank borrowings
Interest-bearing bank loans and overdrafts are recorded
at the proceeds received, net of direct issue costs. Finance
charges, including premiums payable on settlement or
redemption and direct issue costs, are accounted for on
an effective interest method and are added to the carrying
amount of the instrument to the extent that they are not
settled in the period in which they arise.
F Loan notes
Long-term loans are held at amortised cost unless the loan
is hedged by a derivative financial instrument in which case
hedge accounting treatment will apply.
G Trade payables
Trade payables are stated at their nominal value.
H Equity instruments
Equity instruments issued by the Company are recorded at
the proceeds received, net of direct issue costs.
Derivative financial instruments and hedging activities
The Group primarily uses interest rate swaps and forward
foreign currency contracts to manage its exposures to fluctuating
interest and foreign exchange rates. These instruments are initially
recognised at fair value and are subsequently remeasured at
their fair value on the trade date. The method of recognising the
resulting gain or loss is dependent on whether the derivative is
designated as a hedging instrument and the nature of the item
being hedged. The Group designates derivatives as either:
• a hedge of a highly probable forecast transaction or change
in the cash flows of a recognised asset or liability (a cash
flow hedge); or
• a hedge of the exposure to change in the fair value of a
recognised asset or liability (a fair value hedge).
Underlying the definition of fair value is the presumption that the
Group is a going concern without any intention of materially
curtailing the scale of its operations.
For a majority of the Group’s derivative instruments, the fair
value will be determined by the Group applying discounted cash
flow analysis using quoted market rates as an input into the
valuation model.
In determining the fair value of a derivative, the appropriate
quoted market price for an asset held is the bid price, and for
a liability issued is the offer price.
At inception of a hedging relationship, the hedging instrument
and the hedged item are documented and prospective
effectiveness testing is performed. During the life of the hedging
relationship, effectiveness testing is continued to ensure the
instrument remains an effective hedge of the transaction.
In order to qualify for hedge accounting, the following conditions
must be met:
• formal designation and documentation at inception of the
hedging relationship, detailing the risk management objective
and strategy for undertaking the hedge;
• the hedge is expected to be highly effective in achieving
offsetting changes in fair value or cash flows attributable
to the hedged risk;
• for a cash flow hedge, a forecast transaction that is the
subject of the hedge must be highly probable;
• the effectiveness of the hedge can be reliably measured; and
• the hedge is assessed on an ongoing basis and determined
actually to have been highly effective throughout its life.
Derivatives classified as cash flow hedges
Changes in the fair value of derivative financial instruments that
are designated and effective as hedges of future cash flows are
recognised directly in equity and any ineffective portion is
recognised immediately in the income statement. If the firm
commitment or forecasted transaction that is the subject of
a cash flow hedge results in the recognition of an asset or a
liability, then, at the time the asset or liability is recognised, 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 hedges that do not
result in the recognition of an asset or a liability, amounts
deferred in equity are recognised in the income statement in the
same period in which the hedged items affect net profit or loss.
Derivatives classified as fair value hedges
For an effective hedge of an exposure to changes in the fair
value, the hedged item is adjusted for changes in fair value
attributable to the risk being hedged with the corresponding
entry in profit or loss. Gains or losses from remeasuring the
derivative, or for non-derivatives the foreign currency component
of its carrying amount, are recognised in profit or loss.
Changes in the fair value of derivative financial instruments that
do not qualify for hedge accounting are recognised in the
income statement as they arise.
Hedge accounting is discontinued when the hedging instrument
expires or is sold, terminated or exercised, or no longer qualifies
for hedge accounting. At that time, any cumulative gain or loss
on the hedging instrument recognised in equity is retained in
equity until the forecasted transaction occurs. If a hedged
transaction is no longer expected to occur, the net cumulative
gain or loss recognised in equity is transferred to net profit or
loss for the period.
The Group does not use derivatives to hedge balance sheet
and profit and loss account translation exposures. Where
appropriate, borrowings are arranged in local currencies
to provide a natural hedge against overseas assets.
Critical accounting estimates and judgements
The preparation of consolidated financial statements under