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ICI » Topics » Critical accounting policies and estimates

This excerpt taken from the ICI 20-F filed Apr 1, 2005.

Critical accounting policies and estimates

The Group’s main accounting policies affecting its results of operations and financial condition are set forth under the heading “Accounting policies”, which appears on pages 58 and 59 under Item 18 “Financial Statements” of this Annual Report on Form 20-F. Judgements and assumptions have been required by management in applying the Group’s accounting policies in many areas. Actual results may differ from the estimates calculated using these judgements and assumptions. The following policies are considered to be the Group’s critical accounting policies under UK GAAP as the judgements and assumptions made could have a significant impact on its results of operations and financial condition.

Disposal provisions
As at December 31, 2004, the Group had disposal provisions of £310m. These disposal provisions have arisen as a result of the reshaping of the Group’s portfolio of businesses and include amounts relating to long-term residual obligations such as legacy management, pension administration, environmental costs and direct disposal costs such as termination costs, transaction costs and separation costs. The initial determination of the size of these provisions, and the subsequent timing and amounts of the expenditure in relation to these provisions, is inherently difficult to estimate and is based on best management judgement at the time. The provisions are regularly reviewed in the light of the most current information available.

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Restructuring provisions
As at December 31, 2004, the Group had restructuring provisions of £73m, principally in respect of the restructuring programmes announced during 2003. The provisions are established in accordance with FRS No. 12, but include judgements on the costs of severance of the affected employees and of plant closure and other costs. In addition, management judgement is required in determining the asset impairments related to the programme. The provisions will be reviewed in future years.

Retirement benefits
A triennial valuation of the ICI UK Pension Fund was conducted at March 31, 2003, both for funding purposes and for accounting purposes (in accordance with SSAP 24). The accounting valuation, which was based on assumptions determined with advice from the Company’s actuary, identified a deficit of £344m, compared with a deficit of £4m at the previous valuation at March 31, 2000. The charge to the profit and loss account increased from £42m in 2003 to £52m in 2004 mainly due to the full year effect. The size of the deficit is sensitive to the market value of the Fund’s investments and to actuarial assumptions, which include price inflation, pension and salary increases, the discount rate used in assessing accrued liabilities, demographic assumptions and the level of contributions by the Company. As there is a degree of inter-dependency between some of the assumptions, it would be impractical and potentially misleading to give any approximate impact on the annual Group operating profit of a change in any one assumption in isolation.

Forward share purchase arrangements
Included within exceptional items in 2003 was a charge of £57m as a provision against shares of the Company, which ICI is committed to buy under forward purchase agreements. The provision is based on the estimated net realisable value of the shares having regard to the period over which the related options are exercisable. The provision is unchanged in 2004 and will be kept under review in the light of the trends in the Company’s share price.

Contingent liabilities
The Group is exposed to a variety of events which might result in liabilities arising. No provision has been made for these contingent liabilities since either the obligations have been evaluated as “possible” and their existence will be confirmed by uncertain future events, or they have not been recognised, as either a transfer of economic benefits is not “probable” or the amount cannot be measured with sufficient reliability. Details of the Group’s contingent liabilities are set out in “Notes relating to the accounts – Note 39 – Commitments and contingent liabilities”, which appears on pages 107 and 108 under Item 18 “Financial Statements” of this Annual Report on Form 20-F.

Taxation
Provisions for tax contingencies require management to make judgements and estimates in relation to tax issues and exposures. Amounts provided are based on management’s interpretation of country specific tax law and the likelihood of settlement. Tax benefits are not recognised unless the tax positions are probable of being sustained. In arriving at this position, management reviews each material tax benefit to assess whether a provision should be taken against full recognition of the benefit on the basis of potential settlement through negotiation and/or litigation. All such provisions are included in creditors due within one year.

The material tax provisions are discussed below:

Over the past eight years, the Group has established a portfolio of specialty chemicals and coatings businesses through a number of acquisitions and disposals. Since 1997, the Group has bought and sold businesses valued in excess of £12bn. As a result of this reshaping and of disposals, a number of potential tax exposures have arisen. The Group had a provision of £84m at December 31, 2004 for these exposures. In addition, the Group faces a number of potential transfer pricing issues in jurisdictions around the world. The issues are often complex and can require many years to resolve. The total provision included in the financial statements to cover the various worldwide exposures to transfer pricing issues was £71m at December 31, 2004.

 

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Additionally, the Group considers its goodwill accounting policy to be critical under US GAAP:

Goodwill
The Group had capitalised goodwill under US GAAP of £2,827m at December 31, 2004. Goodwill is required to be tested for impairment at least annually (the fourth quarter for the Group) or more frequently if changes in circumstances or the occurrence of events indicated potential impairment exists. The Company uses the present value of future cash flows to determine implied fair value. In calculating the fair value, significant management judgement is required in forecasting cash flows of the reporting unit, in estimating terminal growth values and in selecting an appropriate discount rate. If alternative management judgements were adopted then different impairment outcomes could result. No further impairment resulted from the annual impairment test. The headroom in the annual impairment test for the Quest reporting unit was £74m (total US GAAP goodwill of £547m at December 31, 2004); a 1% increase in the discount rate applied would have resulted in an impairment.

This excerpt taken from the ICI 6-K filed Mar 16, 2005.
Critical Accounting Policies and Estimates
The Group’s main accounting policies affecting its results of operations and financial condition are set out on pages 58 and 59. Judgements and assumptions have been required by management in applying the Group’s accounting policies in many areas. Actual results may differ from the estimates calculated using these judgements and assumptions. The following policies are considered to be the Group’s critical accounting policies under UK GAAP as the judgements and assumptions made could have a significant impact on its results of operations and financial condition.

Disposal provisions
As at 31 December 2004, the Group had divestment provisions of £310m. These disposal provisions have arisen as a result of the reshaping of the Group’s portfolio of businesses and include amounts relating to long term residual obligations such as legacy management, pension administration, environmental costs and direct disposal costs such as termination costs, transaction costs and separation costs. The initial determination of the size of these provisions, and the subsequent timing and amounts of the expenditure in relation to these provisions, is inherently difficult to estimate and is based on best management judgement at the time. The provisions are regularly reviewed in the light of the most current information available.

Restructuring provisions
As at 31 December 2004, the Group had restructuring provisions of £73m, principally in respect of the restructuring programmes announced during 2003. The provisions are established in accordance with FRS No. 12, but include judgements on the costs of severance of the affected employees and of plant closure and other costs. In addition, management judgement is required in determining the asset impairments related to the programme. The provisions will be reviewed in future years.

Retirement benefits
A triennial valuation of the ICI UK Pension Fund was conducted at 31 March 2003 both for funding purposes and for accounting purposes (in accordance with SSAP 24). The accounting valuation, which was based on assumptions determined with advice from the Company’s actuary, identified a deficit of £344m, compared with a deficit of £4m at the previous valuation at 31 March 2000. The charge to the profit and loss account increased from £42m in 2003 to £52m in 2004 mainly due to the full year effect. The size of the deficit is sensitive to the market value of the Fund’s investments and to actuarial assumptions, which include price inflation, pension and salary increases, the discount rate used in assessing accrued liabilities, demographic assumptions and the



ICI ANNUAL REPORT AND ACCOUNTS 2004

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OPERATING AND FINANCIAL REVIEW  
25

level of contributions by the Company. As there is a degree of inter-dependency between some of the assumptions, it would be impractical and potentially misleading to give any approximate impact on the annual Group operating profit of a change in any one assumption in isolation.

Forward share purchase arrangements
Included within exceptional items in 2003 was a charge of £57m as a provision against shares of the Company, which ICI is committed to buy under forward purchase agreements. The provision is based on the estimated net realisable value of the shares having regard to the period over which the related options are exercisable. The provision is unchanged in 2004 and will be kept under review in the light of trends in the Company’s share price.

Contingent liabilities
The Group is exposed to a variety of events which might result in liabilities arising. No provision has been made for these contingent liabilities since either the obligations have been evaluated as “possible” and their existence will be confirmed by uncertain future events, or they have not been recognised as either a transfer of economic benefits is not “probable”, or the amount cannot be measured with sufficient reliability. Details of the Group’s contingent liabilities are set out in note 39 to the consolidated financial statements.

Taxation
Provisions for tax contingencies require management to make judgements and estimates in relation to tax issues and exposures. Amounts provided are based on management’s interpretation of country specific tax law and the likelihood of settlement. Tax benefits are not recognised unless the tax positions are probable of being sustained. In arriving at this position, management reviews each material tax benefit to assess whether a provision should be taken against full recognition of the benefit on the basis of potential settlement through negotiation and/or litigation. All such provisions are included in creditors due within one year.

The material tax provisions are discussed below:

Over the past eight years, the Group has established a portfolio of specialty chemicals and coatings businesses through a number of acquisitions and disposals. Since 1997, the group has bought and sold businesses worth in excess of £12bn. As a result of this reshaping and of disposals, a number of potential tax exposures have arisen. The Group has a provision of £84m for these exposures. In addition, the Group faces a number of potential transfer pricing issues in jurisdictions around the world. The issues are often complex and can require many years to resolve. The total provision included in the financial statements to cover the various worldwide exposures to transfer pricing issues is £71m.

Additionally, the Group considers its goodwill accounting policy to be critical under US GAAP:

Goodwill
The Group has capitalised goodwill under US GAAP of £2,827m at 31 December 2004. Goodwill is required to be tested for impairment at least annually (the fourth quarter for the Group) or more frequently if changes in circumstances or the occurrence of events indicated potential impairment exists. The Company uses the present value of future cash flows to determine implied fair value. In calculating the implied fair value, significant management judgement is required in forecasting cash flows of the reporting unit, in estimating terminal growth values and in selecting an

appropriate discount rate. If alternative management judgements were adopted then different impairment outcomes could result. No impairment resulted from the annual impairment test in 2004. The headroom in the annual impairment test for the Quest reporting unit was £74m (total US GAAP goodwill of £547m at 31 December 2004); a 1% increase in the discount rate applied would have resulted in an impairment.

EXCERPTS ON THIS PAGE:

20-F
Apr 1, 2005
6-K
Mar 16, 2005

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