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Note 2 Critical accounting estimates and judgements
Use of estimates
The preparation of Consolidated financial statements conforming to IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the dates of the Financial statements and the reported amounts of revenues and expenses during the period. The estimates are based on historical experience and various other assumptions that are believed to be reasonable, though actual results and timing could differ from the estimates. Management believes that the accounting policies below represent those matters requiring the exercise of judgement where a different opinion could result in the greatest changes to reported results.
Intangible assets and property, plant and equipment
For material intangible assets and property, plant and equipment in an acquisition, an external advisor makes a fair valuation of the acquired intangible assets and property, plant and equipment and assists in determining their remaining useful lives. Management believes that the assigned values and useful lives, as well as the underlying assumptions, are reasonable, though different assumptions and assigned lives could have a significant impact on the reported amounts.
The carrying amounts of Intangible assets and property, plant and equipment are reviewed at each reporting date or whenever events or changes in circumstances indicate that the carrying amount of an asset may be impaired. The recoverable amount of an asset is estimated as the higher of fair value less cost of disposal and the value in use, with an impairment charge being recognised whenever the carrying amount exceeds the recoverable amount. The value in use is calculated using a discounted cash flow model which is most sensitive to the discount rate as well as the expected future cash flows. The key assumptions used in the impairment testing, including sensitivity analysis, are explained further in Note 10 Depreciation, amortisation and impairment charges.
Goodwill is tested by Cash Generating Unit (CGU) or by group of CGUs at least on an annual basis and any impairment is measured using the discounted cash flow valuation method. This method uses future projections of cash flows from each of the reporting units in a CGU or group of CGUs and includes, among other estimates, projections of future product pricing, production levels, product costs, market supply and demand, projected maintenance capital expenditures and an assumption of the weighted average cost of capital. A pre-tax discount rate used for the net present value calculation of projected cash flows reflects the weighted average cost of capital.
The group has evaluated the most sensitive estimates which when changed could have a material effect on the fair value of the assets or goodwill and therefore could lead to an impairment. These estimates are expected sales prices of the products, expected inflation rate of the product costs and discount rate. The key assumptions used in the impairment testing, including sensitivity analysis, are explained further in Note 10 Depreciation, amortisation and impairment charges.
Control assessment of joint operations and associates
Note 1 Accounting principles describes Veracel and Montes del Plata as joint operations. In both companies Stora Enso’s ownership is 50%. The interpretations as joint operations are based on shareholders’ agreements which give Stora Enso rights to share of the returns and make the group liable indirectly for the liabilities, as our ability to pay for the pulp is used to finance the debts. Joint operations are consolidated with the proportionate line-by-line method.
The forest holding companies Bergvik Skog Ab and Tornator Oyj are equity accounted investments. Stora Enso does not control the companies alone or jointly with other parties and thus retains its significant minority interest as equity accounted investments. Equity accounted investments are accounted for using the equity method. These companies are presented in Note 13 Equity accounted investments.
Fair value of financial instruments
Where the fair value of financial assets and liabilities cannot be derived directly from publicly quoted market prices, other valuation techniques such as discounted cash flow models, transaction multiples, the Black and Scholes model and the Gordon model are employed. The key judgements include future cash flows, credit risk, volatility and changes in assumptions about these factors which could affect the reported fair value of the financial instruments. Investments in debt and equity securities of unlisted entities, such as Pohjolan Voima Oy (PVO), represent a significant portion of the group’s assets and require significant management judgement, as explained in more detail in Notes 14 Available-for-sale investments and 24 Financial risk management.
Tax assets and liabilities are reviewed on a periodic basis and balances are adjusted as appropriate. Management considers that adequate provision has been made for future tax consequences based upon current facts, circumstances and tax law. However, should any tax positions be challenged and not prevail, different outcomes could result and have a significant impact on the amounts reported in the consolidated financial statements.
The determination of the group pension obligation and expense is subject to the selection of certain assumptions used by actuaries in calculating such amounts, including, among others, the discount rate, the expected rate of return on plan assets, the annual rate of increase in future compensation levels and estimated lifespans. Amounts charged in the Income statement are determined by independent actuaries, however, where actual results differ from the initial estimates, together with the effect of any change in assumptions or other factors, these differences are recorded directly in equity, as disclosed in the Statement of comprehensive income. See Note 20 Post-employment benefits for detailed information on the assumptions used in the pension liability calculations.
The group has biological assets in equity accounted investment companies, joint operation companies and in subsidiaries. Biological assets, in the form of standing trees, are accounted for under IAS 41, which requires that the assets be measured at fair value less costs to sell. Fair value is determined using discounted cash flows from continuous operations based on sustainable forest management plans taking into account the growth potential of one cycle. These discounted cash flows require estimates of growth, harvest, sales price and costs, and changes in these premises are included in the Consolidated income statement, for directly owned interests and for joint operations, on the line for Change in Net Value of Biological assets. For those assets shown in the Consolidated statement of financial position of equity accounted investments changes are included on the line for Share of results of equity accounted investments. It is therefore important that the management of the group, joint operation companies and the equity accounted investments make appropriate estimates of future price levels and trends for sales and costs, and undertakes regular surveys of the forest to establish the volumes of wood available for cutting and their current growth rates. See Note 12 Biological assets for more detailed information.
The group has made provisions for known environmental liabilities where legal or constructive obligation exists, based on management’s best estimate of the remediation costs. There is uncertainty regarding the timing and amount of these costs and therefore the final liability could differ significantly from the original estimate.