Exceptional items and specific IAS 39 mark to market movements
The consolidated financial statements have been prepared using the historical cost convention, modified for certain items carried at fair value, as stated in the Group’s accounting policies.
In order to allow a better understanding of the financial information presented, and specifically the Group’s underlying business performance, the Group presents its income statement in three columns such that it identifies (i) results excluding exceptional items and specific IAS 39 mark to market movements, (ii) the effect
of exceptional items and specific IAS 39 mark to market movements and (iii) results for the year. For the purposes of clarity, in the explanation of the basis of preparation applied in the consolidated financial statements, these columns are described as the ‘left hand column’, the ‘middle column’ and the ‘right hand
column’ respectively.
Those items that the Group separately presents as exceptional are items which, in the judgement of the Directors, need to be disclosed separately by virtue of their size or incidence in order to obtain a proper understanding of the financial information. The Group discloses exceptional items in the middle column. The Group enters into derivative contracts to economically hedge certain of its physical and financial exposures. In relation to commodities trading, the Group considers economic hedges to be those which are asset backed, i.e. where the Group is either forward selling electricity from its own generation capacity or forward buying fuel for its own generation capacity. In respect of interest rate swaps and other treasury related derivatives, the Group considers economic hedges to be those which hedge existing assets, liabilities and firm commitments.
Some of these economic hedges achieve own use treatment under IAS 39 and are accounted for on an accruals basis. Some are accounted for as cash flow hedges under IAS 39 with fair value gains and losses recorded in other comprehensive income and accumulated in the hedging reserve. Where derivative contracts do not achieve
own use treatment and the Group could not, or has not sought to, apply cash flow hedge accounting, IAS 39 requires the derivative contract to be measured at fair value (marked to market) with fair value gains and losses recognised in the income statement. The Group separately presents these mark to market movements on economic hedges, in the middle column, to assist the reader’s understanding of underlying business performance and to provide a more meaningful presentation.
For economic hedges, where fair value gains and losses are recorded in the income statement, in the period in which the economically hedged transaction settles, the settlement amount of the derivative, being the cumulative fair value gains and losses recognised in the current and prior periods, is presented in the left hand column so that the transaction is measured at its contracted price (i.e. the spot price less the fair value gain or loss on the derivative contract at that date).
As the cumulative mark to market movements have already been recognised in the middle column in the current and prior periods, an equal but opposite amount is presented in the middle column so that cumulatively the amount recognised in the middle column in respect of such economic hedges is zero.
By presenting fair value gains and losses in this manner, the left hand column is not affected by mark to market movements and therefore reflects the underlying business performance at contracted prices.
The amortisation of derivatives, which are acquired with a fair value other than zero, is always recorded in the left hand column. This is achieved by presenting an equal but opposite amount in the middle column, such that specific IAS 39 mark to market movements presented in the middle column are shown net of the amortisation during the period.
Ineffectiveness in qualifying cash flow hedges under IAS 39 can arise from business combinations, where the fair value of the derivatives at acquisition is not equal to zero, or as a result of the difference between the contractual profile of the economic hedge and the profile of transactions defined as the hedged item. IAS 39 requires ineffectiveness in qualifying cash flow hedges to be recorded in the income statement, and therefore the Group records this ineffectiveness in the middle column when it relates to an economic hedge.
Mark to market movements of the fair value of embedded derivatives in convertible bonds, which relate to conversion features where the functional currency of the parent company and other factors preclude the conversion feature being treated as equity in the consolidated financial statements, are treated as specific IAS 39
mark to market movements and as such are presented in the middle column. The Directors consider the fair value gains and losses of these embedded derivatives should be appropriately disclosed within specific IAS 39 mark to market movements, in the middle column, so as to separately identify a non-cash movement which, if the conversion option is exercised, will ultimately be extinguished by the issue of equity.
Mark to market movements relating to proprietary trading activities, the revaluation of assets held for trading and amortisation of derivatives which are acquired with a fair value other than zero comprise part of the Group’s underlying business performance and are appropriately, in the judgement of the Directors, included within the left hand column.
The right hand column presents the results for the year, showing all gains and losses recorded in the consolidated income statement.
To the extent that exceptional items are separately identified in the income statement, they are also separately identified in the statement of cash flows under the respective heading to which they relate.