CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED 31 DECEMBER 2012 AND 31 DECEMBER 2011
Consolidated Income Statement and Statement of Comprehensive Income (expressed in millions of USD) Consolidated Income Statement Note 31 December 2012 31 December 2011 Gross Proceeds 6 60,450 60,199 Less: export duties (17,137) (16,951) Sales and other operating revenues 6 43,313 43,248 Earnings from equity-accounted investments 10 352 89 Gain on disposals of businesses 5 128 341 Other operating income 32 - Taxes other than income tax 18 (12,257) (11,849) Operating expenses (5,543) (5,696) Purchases of oil, oil products and other products (5,887) (5,674) Transportation expenses (4,112) (4,090) Depreciation, depletion and amortisation 11, 12 (2,306) (1,989) Selling, distribution and administrative expenses (1,824) (1,625) Loss on disposals and impairment of assets 11 (478) (260) Exploration expenses (292) (145) Operating profit 11,126 12,350 Exchange loss, net (99) (4) Finance cost (158) (289) Interest income and net other financial income/(expense) 16 65 Profit before income taxes 10,885 12,122 Income tax expense 16 (2,412) (2,689) Profit for the period 8,473 9,433 Less: profit attributable to noncontrolling interest (889) (740) Profit attributable to Group shareholders 7,584 8,693 Consolidated Statement of Comprehensive Income 31 December 2012 31 December 2011 Note Profit for the period 8,473 9,433 Other comprehensive income/(loss): Currency translation differences in relation to Group subsidiaries 116 (103) Currency translation differences in relation to equityaccounted investments 10 138 (128) Other comprehensive income/(loss) 254 (231) Less: other comprehensive (income)/loss attributable to noncontrolling interest (6) 8 Other comprehensive income/(loss) attributable to Group shareholders 248 (223) Total comprehensive income 8,727 9,202 Less: total comprehensive income attributable to noncontrolling interest (895) (732) Total comprehensive income attributable to Group shareholders 7,832 8,470 The accompanying notes are an integral part of these consolidated financial statements 3
Consolidated Statement of Financial Position (expressed in millions of USD) Note 31 December 2012 31 December 2011 1 January 2011 Assets Current assets Cash and cash equivalents 7 4,632 1,164 1,844 Restricted cash 7 2 48 8 Bank deposits with maturity more than 3 months 7-100 600 Income tax receivable 245 90 111 Trade and other receivables, net 8 4,564 5,113 3,353 Inventories 9 1,522 1,623 1,295 Other current assets 109 187 702 11,074 8,325 7,913 Non-current assets Loans and advances issued 10 541 490 1,171 Equity-accounted investments 10 3,565 3,237 2,545 Property, plant and equipment 11 25,973 22,348 19,402 Intangible assets 12 1,112 970 818 Deferred income tax assets 16 413 440 291 Other long-term assets 13 613 194 268 32,217 27,679 24,495 Total assets 43,291 36,004 32,408 Liabilities and equity Current liabilities Short-term debt and current portion of long-term debt 14 1,646 1,120 1,189 Accounts payable and accrued liabilities 15 4,395 3,452 3,052 Income tax payable 82 142 157 Other taxes payable 18 1,806 1,326 1,098 7,929 6,040 5,496 Non-current liabilities Long-term debt 14 6,248 7,072 6,142 Decommissioning, environmental and other provisions 17 1,033 711 591 Deferred income tax liabilities 16 3,278 2,904 2,389 Other non-current liabilities 205 - - 10,764 10,687 9,122 Total liabilities 18,693 16,727 14,618 Equity Ordinary share capital (authorised, issued and fully paid 54,000 shares, USD 1.0 par value) 19 - - - Additional paid-in capital 2,850 2,978 2,973 Retained earnings 19,602 14,816 13,614 Cumulative currency translation adjustment 25 (223) - Total Group shareholders equity 22,477 17,571 16,587 Noncontrolling interest 2,121 1,706 1,203 Total equity 24,598 19,277 17,790 Total liabilities and equity 43,291 36,004 32,408 Approved for issue and signed on behalf of the Group Management Board: Jonathan Muir Chief Financial Officer 5 March 2013 The accompanying notes are an integral part of these consolidated financial statements 4
Consolidated Statement of Changes in Equity (expressed in millions of USD) Equity attributable to Group shareholders Ordinary share capital Additional paid-in capital Retained earnings Cumulative currency translation adjustment Total Noncontrolling interest Total equity At 1 January 2011-2,973 13,614-16,587 1,203 17,790 Total comprehensive income - - 8,693 (223) 8,470 732 9,202 Dividends - - (7,491) - (7,491) (213) (7,704) Transactions with non-controlling interest shareholders (Note 5) - 5 - - 5 (16) (11) At 31 December 2011-2,978 14,816 (223) 17,571 1,706 19,277 Total comprehensive income - - 7,584 248 7,832 895 8,727 Dividends - - (2,798) - (2,798) (406) (3,204) Transactions with non-controlling interest shareholders (Note 5) - (128) - - (128) (74) (202) At 31 December 2012-2,850 19,602 25 22,477 2,121 24,598 The accompanying notes are an integral part of these consolidated financial statements 5
Consolidated Statement of Cash Flows (expressed in millions of USD) 31 December 2012 31 December 2011 Note Operating activities Profit before income taxes 10,885 12,122 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, depletion and amortisation 2,306 1,989 Finance cost 158 289 Interest income (74) (92) Loss on disposals and impairment of assets 11 478 260 Gain on disposals of businesses 5 (128) (341) Earnings from equity-accounted investments 10 (352) (89) Dry hole expenses 60 67 Exchange loss from investing and financing activities 58 - Net change in environmental provision 213 176 Other non-cash adjustments, net 47 28 Changes in operational working capital, excluding cash and cash equivalents: Restricted cash 46 (41) Trade and other receivables 683 (1,643) Inventories 46 (339) Accounts payable and accrued liabilities 447 172 Taxes payable 301 243 Other 99-5 Dividends received from equity-accounted investments 10 179 291 Interest received 50 75 Income taxes paid (2,264) (2,315) Net cash provided by operating activities 13,238 10,847 Investing activities Capital expenditures (5,366) (4,475) Interest capitalised paid (286) (202) Grants used for capital expenditures (468) (515) Grants received 468 515 Purchase of intangible assets 12 (89) (90) Acquisitions of and contributions to equity-accounted investments 5 - (259) Acquisitions of subsidiaries, net of cash acquired 5 (190) 10 Acquisitions of jointly controlled assets 5 (324) (396) Cash flows from sales of subsidiaries, net of cash disposed 5 314 955 Net change in bank deposits with maturity more than 3 months 7 100 500 Loans and advances issued 10 (298) (364) Loans collected 38 50 Net cash used for investing activities (6,101) (4,271) Financing activities Proceeds from issuance of long-term debt 14 675 2,025 Costs associated with issuance of debt 14 (9) (11) Proceeds from issuance of short-term debt 14 190 - Repayment of long-term debt 14 (1,130) (1,104) Interest paid net of the amounts capitalised (176) (249) Dividends paid to noncontrolling interest shareholders (258) (369) Dividends paid to Group shareholders (2,798) (7,493) Acquisition of non-controlling interest 5 (188) - Net cash used for financing activities (3,694) (7,201) Effect of exchange rate changes on cash and cash equivalents 25 (55) Net change in cash and cash equivalents 3,468 (680) Cash and cash equivalents at the beginning of period 7 1,164 1,844 Cash and cash equivalents at the end of period 7 4,632 1,164 The accompanying notes are an integral part of these consolidated financial statements 6
Note 1. Organisation TNK-BP International Limited ( TNK-BP International or the Company ) and its subsidiaries (jointly referred to as the Group ) conduct exploration and development activities and produce oil and gas, operate petroleum refineries and market oil and petroleum products in the Russian Federation and a number of other countries including Brazil, Venezuela, Vietnam and Ukraine. Effective 29 August 2003, Alfa Group, Access Industries, and Renova Group (jointly referred to as AAR ) and BP plc. ( BP ) formed TNK-BP Limited ( TNK-BP or the Parent ), a British Virgin Islands company, to hold their respective interests in their Russian and Ukrainian oil and gas assets. TNK-BP International is a wholly owned subsidiary of TNK-BP Limited. TNK-BP International Ltd is a limited liability company registered and domiciled in the British Virgin Islands. The address of its registered office is Craigmuir Chambers, P.O. Box 71, Road Town, Tortola, British Virgin Islands. Note 2. Basis of Presentation The consolidated financial statements of the Group have been prepared in accordance with International Financial Reporting Standards. Previously, the Group prepared its annual consolidated financial statements in accordance with Generally Accepted Accounting Principles of the United States of America ( US GAAP ). These consolidated financial statements should be read in conjunction with the Group s 2011 annual consolidated financial statements, which were prepared in accordance with US GAAP, and in consideration of the IFRS disclosures included in Note 2a to these consolidated financial statements. The preparation of these consolidated financial statements resulted in selected changes to the Group's accounting policies as compared to those disclosed in the Group s consolidated financial statements for the year ended 31 December 2011 issued under US GAAP. A summary of the significant changes to the Group s accounting policies is disclosed in Note 2a along with reconciliations of the Group s selected consolidated financial statements data prepared under US GAAP to IFRS; of the equity as of 1 January 2011 and 31 December 2011, and of the total comprehensive income for the year ended 31 December 2011. A summary of the Group s significant accounting policies under IFRS is presented in Note 3. These policies have been retrospectively and consistently applied except where specific exceptions required and exemptions permitted an alternative treatment upon transition to IFRS in accordance with IFRS 1 First-time Adoption of International Financial Reporting Standards as disclosed in Note 2a. The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the group s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 4. These consolidated financial statements have been prepared on a historical cost basis, except for derivative financial instruments that have been measured at fair value. The Group s subsidiaries registered in the Russian Federation maintain their accounting records in accordance with the Regulations on Accounting and Reporting in the Russian Federation. Subsidiaries outside the Russian Federation maintain their accounting records in accordance with local regulations. The accompanying consolidated financial statements have been prepared from these accounting records and adjusted as necessary in order to comply with IFRS. The consolidated financial statements are presented in United States dollars ( US dollars or USD ) and all values are rounded to the nearest million (USD million) except when otherwise indicated. 7
Note 2a. Transition to IFRS As discussed above, starting in 2012, the Group prepares consolidated financial statements in accordance with IFRS. The accounting policies set out in Note 3 have been applied in preparing the consolidated financial statements as of and for the year ended 31 December 2012, the comparative information presented in these consolidated financial statements as of 31 December 2011 and for the year ended 31 December 2011, and in the preparation of an opening IFRS consolidated statement of financial position as of 1 January 2011 (the Group s date of transition to IFRS). In preparing its opening IFRS statement of financial position, the Group has adjusted amounts reported previously in its consolidated financial statements prepared in accordance with US GAAP. The Group has applied IFRS 1 First time adoption of International Financial Reporting Standards, in preparing these consolidated financial statements. An explanation of how the transition from US GAAP to IFRS has affected the Group s financial position, financial performance and cash flows is set out in the tables and notes that accompany the tables in the following pages. Subject to certain exceptions, IFRS 1 requires retrospective application of the version of standards and interpretations effective as of 31 December 2012, the date of the Group s first annual IFRS consolidated financial statements. In preparing these consolidated financial statements, the Group has applied the relevant mandatory exceptions and certain optional exemptions from full retrospective application of IFRS, as detailed below. Exceptions from retrospective application, which are mandatory under IFRS 1, are: Estimates under IFRS at 1 January 2011 are consistent with estimates made for the same date under US GAAP. Hedge accounting exception. The Group does not apply hedge accounting. Other exceptions were not applicable because there were no significant differences as to management application of US GAAP in these areas. The Group has applied the following optional exemptions: IFRS 3, Business Combinations, has not been applied to acquisitions of subsidiaries or of interests in associates and joint ventures that occurred before 1 January 2011, the Group s date of transition. The Group has elected to set the previously accumulated currency translation adjustments to zero at 1 January 2011. The Group has elected to apply the exemption from full retrospective application of decommissioning provisions as allowed under IFRS 1. As such, the Group has remeasured the provisions as of 1 January 2011 under IAS 37 Provisions, contingent liabilities and contingent assets, estimated the amount to be included in the cost of the related asset by discounting the liability to the date at which the liability first arose using best estimates of the historical risk-adjusted discount rates, and recalculated the accumulated depreciation, depletion and amortisation under IFRS. The following reconciliations provide a quantification of the effect of the transition to IFRS. 8
Total Equity Reconciliation Ref 31 December 2011 1 January 2011 Total equity under US GAAP 20,755 18,863 Effects of transition to IFRS: Impairment of assets (i) (261) (216) Replacement accounting (ii) (534) (456) IFRS transition of equity-accounted investees (iii) (278) (81) Interest capitalisation (iv) (18) (18) Measurement of long-term provisions (v) 22 26 Deferred taxes (vi) (409) (328) Total equity under IFRS 19,277 17,790 Total Comprehensive Income Reconciliation Ref 31 December 2011 Total comprehensive income under US GAAP 9,608 Effects of transition to IFRS: Impairment of assets (i) (45) Replacement accounting (ii) (78) IFRS transition of equity-accounted investees (iii) (197) Measurement of long-term provisions (v) (5) Deferred taxes (vi) (81) Total comprehensive income under IFRS 9,202 9
Consolidated Statement of Financial Position Reconciliation as of 1 January 2011 US GAAP Impairment Replacement accounting Equityaccounted investees Deferred Taxes Reclasses and other adjustments Current assets Cash and cash equivalents 1,844 - - - - - 1,844 Restricted cash 8 - - - - - 8 Bank deposits with maturity more than 3 months 600 - - - - - 600 Income tax receivable - - - - - 111 111 Trade and other receivables, net 3,464 - - - - (111) 3,353 Inventories 1,295 - - - - - 1,295 Other current assets 790 - - - - (88) 702 8,001 - - - - (88) 7,913 Non-current assets Loans and advances issued 29 - - - - 1,142 1,171 Equity-accounted investments 3,665 - - (81) - (1,039) 2,545 Property, plant and equipment 19,712 (138) (456) - - 284 19,402 Intangible assets 896 (78) - - - - 818 Deferred income tax assets 163 - - - - 128 291 Other long-term assets 660 - - - - (392) 268 IFRS 25,125 (216) (456) (81) - 123 24,495 Total assets 33,126 (216) (456) (81) - 35 32,408 Liabilities and equity Current liabilities Current portion of long-term debt 1,051 - - - - 138 1,189 Accounts payable and accrued liabilities 3,171 - - - - (119) 3,052 Income tax payable - - - - - 157 157 Other taxes payable 1,228 - - - - (130) 1,098 5,450 - - - - 46 5,496 Non-current liabilities Long-term debt 6,078 - - - - 64 6,142 Decommissioning, environmental and other provisions 374 - - - - 217 591 Deferred income tax liabilities 2,049 - - - 328 12 2,389 Other non-current liabilities 312 - - - - (312) - 8,813 - - - 328 (19) 9,122 Total liabilities 14,263 - - - 328 27 14,618 Equity Ordinary share capital - - - - - - - Additional paid-in capital 2,940 - - - - 33 2,973 Retained earnings 14,747 (216) (456) (81) (328) (52) 13,614 Cumulative currency translation adjustment (82) - - - - 82 - Total Group shareholders equity 17,605 (216) (456) (81) (328) 63 16,587 Noncontrolling interest 1,258 - - - - (55) 1,203 Total equity 18,863 (216) (456) (81) (328) 8 17,790 Total liabilities and equity 33,126 (216) (456) (81) - 35 32,408 10
Consolidated Statement of Financial Position Reconciliation as of 31 December 2011 US GAAP Impairment Replacement accounting Equityaccounted investees Deferred Taxes Reclasses and other adjustments Current assets Cash and cash equivalents 1,164 - - - - - 1,164 Restricted cash 48 - - - - - 48 Bank deposits with maturity more than 3 months 100 - - - - - 100 Income tax receivable - - - - - 90 90 Trade and other receivables, net 5,276 - - - - (163) 5,113 Inventories 1,623 - - - - - 1,623 Other current assets 289 - - - - (102) 187 8,500 - - - - (175) 8,325 Non-current assets Loans and advances issued 24 - - - - 466 490 Equity-accounted investments 3,715 - - (278) - (200) 3,237 Property, plant and equipment 22,731 (183) (534) - - 334 22,348 Intangible assets 1,095 (78) - - - (47) 970 Deferred income tax assets 272 - - - - 168 440 Other long-term assets 735 - - - - (541) 194 IFRS 28,572 (261) (534) (278) - 180 27,679 Total assets 37,072 (261) (534) (278) - 5 36,004 Liabilities and equity Current liabilities Current portion of long-term debt 998 - - - - 122 1,120 Accounts payable and accrued liabilities 3,558 - - - - (106) 3,452 Income tax payable - - - - - 142 142 Other taxes payable 1,471 - - - - (145) 1,326 6,027 - - - - 13 6,040 Non-current liabilities Long-term debt 7,049 - - - - 23 7,072 Decommissioning, environmental and other provisions 370 - - - - 341 711 Deferred income tax liabilities 2,475 - - - 409 20 2,904 Other non-current liabilities 396 - - - (396) - 10,290 - - - 409 (12) 10,687 Total liabilities 16,317 - - - 409 1 16,727 Equity Ordinary share capital - - - - - - - Additional paid-in capital 2,945 - - - - 33 2,978 Retained earnings 16,235 (261) (534) (167) (409) (48) 14,816 Cumulative currency translation adjustment (202) - - (111) - 90 (223) Total Group shareholders equity 18,978 (261) (534) (278) (409) 75 17,571 Noncontrolling interest 1,777 - - - - (71) 1,706 Total equity 20,755 (261) (534) (278) (409) 4 19,277 Total liabilities and equity 37,072 (261) (534) (278) - 5 36,004 11
Consolidated Income Statement Reconciliation for the year ended 31 December 2011 US GAAP Impairment Replacement accounting Equityaccounted investees Deferred Taxes Reclasses and other adjustments Gross Proceeds 60,199 - - - - - 60,199 Less: export duties - - - - (16,951) (16,951) Sales and other operating revenues 60,199 - - - - (16,951) 43,248 Earnings from equityaccounted investments 175 - (86) - - 89 Gain on disposals of businesses 341 - - - - - 341 Export duties (16,951) - - - - 16,951 - Taxes other than income tax (11,849) - - - - - (11,849) Operating expenses (5,710) - - - - 14 (5,696) Purchases of oil, oil products and other products (5,674) - - - - - (5,674) Transportation expenses (4,090) - - - - - (4,090) Depreciation, depletion and amortisation (2,085) 18 51 - - 27 (1,989) Selling, distribution and administrative expenses (1,625) - - - - - (1,625) Loss on disposal and impairment of assets (69) (63) (128) - - - (260) Exploration expenses (145) - - - - - (145) Operating profit 12,517 (45) (77) (86) - 41 12,350 Exchange gain/(loss), net 63 - - - (67) - (4) Finance costs (242) - - - - (47) (289) Interest income and net other financial income/(expense) 65 - - - - - 65 Profit before income taxes 12,403 (45) (77) (86) (67) (6) 12,122 Income tax expense (2,675) 10 16 - (40) - (2,689) Profit for the period 9,728 (35) (61) (86) (107) (6) 9,433 Less: profit attributable to noncontrolling interest (747) (3) - - - 10 (740) Profit attributable to Group shareholders 8,981 (38) (61) (86) (107) 4 8,693 IFRS 12
Cash Flow Data Reconciliation 31 December 2011 IFRS adjustment US GAAP (ref (viii)) IFRS Net cash provided by operating activities (viii) 10,525 322 10,847 Net cash used for investing activities (4,198) (73) (4,271) Net cash used for financing activities (viii) (6,952) (249) (7,201) The following discussion explains significant differences between the Group s previous US GAAP accounting policies and those applied by the Group under IFRS. The IFRS policies have been retrospectively and consistently applied except where specific IFRS 1 optional exemptions and mandatory exceptions permitted an alternative treatment upon transition to IFRS for first-time adopters. The descriptive note captions below correspond to the adjustments presented in the preceding reconciliations. (i) Impairment of assets Under US GAAP, impairment was recognised if the carrying amount of a cash generating unit ( CGU ) exceeded the undiscounted cash flows expected to be generated by that CGU. Impairment was measured as the amount by which the carrying value exceeded the fair value of the CGU. Fair value was determined based on the discounted cash flows expected to be generated by the CGUs. Impairments recognised previously were never reversed. Under IFRS, impairment is recognised if the carrying value exceeds the recoverable amount for a CGU which is determined based on the discounted cash flows expected to be generated by the CGU. If the carrying value of the CGU exceeds the recoverable amount, the cash-generating unit is written down with an impairment recognised in the consolidated income statement. Impairments recognised under IFRS are reversed when and to the extent there has been a subsequent increase in the recoverable amount. Impairment reversals are recognised in the consolidated income statement and the carrying amount of the cash-generating unit is increased to its revised recoverable amount. As of 1 January 2011, the Group recognised a pre-tax impairment of USD 216 million for the Ukrainian downstream business. The impairment recognised was based on the difference between the net book value of the assets and their recoverable amount at 1 January 2011. The recoverable amount was determined based on discounted future cash flows using forecast prices and costs expected to be generated by the retail and refining CGU s of the Ukrainian business unit. As of 31 December 2011, the Group recognised a pre-tax impairment of USD 63 million related to a greenfield project of Vanyoganneft, a Group upstream subsidiary. The impairment recognised was based on the difference between the net book value of the assets and their recoverable amount at 31 December 2011. The recoverable amount was determined based on discounted future cash flows of proved and probable reserves using forecast prices and costs expected to be generated by the project. Under US GAAP, the above assets were included in Refining, Marketing and Distribution, and Exploration and Production segments, respectively, and were not impaired as of 1 January 2011 and 31 December 2011. (ii) Replacement accounting Under US GAAP, oil and gas assets were accounted for and depleted on a field-by-field basis (or for group of fields) using the unit of production ( UOP ) method. No gain or loss was recognised on retirement or disposal of an individual well or an item of equipment. When the last well on an individual property (group of properties) ceased to produce, the entire property (group of properties) was abandoned and the resulting gain or loss was recognised. Under IFRS, if a part of an item is replaced and the new part is capitalised, then the replaced part should be written-off with the resulting gain or loss recognised in the consolidated income statement. This requirement should be complied with irrespective of whether the replaced part was depreciated separately. The application of this requirement resulted in a USD 456 million decrease to property, plant and equipment and a corresponding pre-tax decrease to retained earnings in the consolidated statements of financial position as of 1 January 2011, and a pre-tax charge to the 2011 consolidated income statement of USD 77 million. Subsequent 13
IFRS replacement accounting effects are recognised in loss on disposals and impairment of assets in the consolidated income statement for the relevant period. (iii) IFRS transition of equity-accounted investees Under US GAAP, the Group accounted for its equity investees based on their US GAAP financial statements. Upon transition to IFRS, the financial information of the equity-accounted investees was also restated under IFRS. As a result, the Group recognised a USD 81 million and USD 278 million reduction in the carrying value of investments with a corresponding decrease to the Group s equity under IFRS as of 1 January 2011 and 31 December 2011 respectively. Under IFRS, the Group separately presents loans and advances issued to equity-accounted investees or in relation to the acquisition of equity-accounted investees, which were included in the carrying value of equityaccounted investments under US GAAP. As a result, the Group reclassified USD 1,000 million and USD 158 million from equity-accounted investments to loans and advances issued as of 1 January 2011 and 31 December 2011, respectively. (iv) Interest capitalisation Under US GAAP, the Group capitalised interest paid in respect of its equity investee NVGRES, which, under IFRS, should be expensed as incurred. As a result of applying the guidance of IAS 23, Borrowing Costs, the Group recorded a USD 18 million reduction in the carrying value of investments with a corresponding decrease in the Group s retained earnings under IFRS as of 1 January 2011 and 31 December 2011. (v) Measurement of long-term provisions Under US GAAP, environmental provisions were not discounted unless the timing and settlement amounts were fixed or determinable with certainty. Under IFRS, environmental remediation liabilities are recorded on a discounted basis considering the expected amount and timing of the cash payments. Further, different discount rates are applied under IFRS and US GAAP for asset retirement obligations ( ARO ). According to US GAAP, these liabilities are not remeasured to reflect current discount rates. Under IFRS, the asset retirement obligations are measured as the best estimate of the expenditure to be incurred using the period end discount rate. The Group was required to remeasure its asset retirement obligations and environmental provisions upon transition to IFRS and recognise the differences in Retained earnings. The application of this requirement resulted in a USD 26 million and USD 22 million decrease in Decommissioning and environmental provisions as of 1 January and 31 December 2011, respectively, and a corresponding pre-tax adjustment to Retained earnings. Subsequent IFRS remeasurements of decommissioning liabilities are recorded with a corresponding adjustment to Property, plant and equipment. (vi) Deferred taxes IFRS transition differences in the area of deferred taxes relate primarily to the different treatment of the impact of changes in exchange rates on long-term assets with tax values denominated in currencies different from the functional currency. In addition, there are tax effects in respect of US GAAP versus IFRS differences arising on transition as discussed above. Upon transition to IFRS, the Group recognised a USD 328 million and USD 409 million increase in Deferred income tax liabilities with a corresponding reduction in Retained earnings in the consolidated statements of financial position as of 1 January 2011 and 31 December 2011, respectively. (vii) Revenues According to the Group s accounting policy under US GAAP, duties remitted to governmental authorities on export from Russia of crude oil and petroleum products sold internationally were accounted for on a gross basis (included in revenues and costs). Under IFRS, taxes and duties arising on the sale of goods to third parties do not form part of revenue. Accordingly, export duties are presented netting the Group s Sales and other operating revenues under IFRS. 14
(viii) Adjustments to the statement of cash flows The transition from US GAAP to IFRS had no significant impact on the Group s cash flows except that, under IFRS, the amounts of interest paid net of interest capitalised are classified as financing cash flows. Under US GAAP, these payments were classified as operating cash flows. Note 3. Summary of significant accounting policies Foreign currency translation The local currencies of certain subsidiaries and equity investees of the Group are: the Russian Rouble ( RUR ), the Ukrainian Hryvna, the Vietnamese dong, the Brazilian real and Venezuelan bolivar. For the purposes of financial reporting under IFRS, transactions and balances have been remeasured into the functional currency of the subsidiary or the equity investee which, in the majority of cases, is the USD. Monetary assets and liabilities are remeasured at closing exchange rates and non-monetary items are measured at historic exchange rates and adjusted for any impairment. The consolidated income statement and statement of cash flows have been remeasured at the average exchange rates during the period or the actual rate on the transaction date. Exchange differences resulting from the use of these exchange rates have been included in the determination of profit for the period and are included in Exchange gain/(loss), net in the accompanying consolidated income statement. The results and financial position of all the Group entities that have a functional currency other than USD are translated into USD as follows: (a) assets and liabilities for each statement of financial position presented are translated at the closing rate at the date of that statement; (b) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the rate on the dates of the transactions); and (c) all resulting exchange differences are recognised as currency translation differences in Other comprehensive income. As of 31 December 2012, 31 December 2011 and 1 January 2011, exchange rates were 30.37, 32.20 and 30.35 RUR to the USD, respectively. Average exchange rates for the years ended 31 December 2012 and 2011 were 31.09 and 29.39 RUR to the USD, respectively. Marketing business subsidiaries functional currency change Pursuant to an updated assessment of economic and regulatory matters affecting the Group s Russian Marketing business, effective January 2011, management has changed the functional currency of the subsidiaries included in this business from the US dollar to the Russian rouble. Resulting from this change, as of 31 December 2011, the Group recorded a currency translation loss of USD 103 million in the consolidated statement of comprehensive income. Principles of consolidation The consolidated financial statements include the operations of the Group s subsidiaries which are entities in which the Group, directly or indirectly, has an interest of more than one half of the voting rights or otherwise has power to govern the financial and operating policies so as to obtain benefits. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are consolidated from the date on which control is transferred to the Group (acquisition date) and are deconsolidated from the date that control ceases. The financial statements of the subsidiaries are prepared for the same reporting period as the parent company, using consistent accounting policies. The acquisition method of accounting is used to account for the acquisition of subsidiaries other than those acquired from parties under common control. Identifiable assets acquired and liabilities and contingent liabilities 15
assumed in a business combination are measured at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. Goodwill is measured by deducting the net assets of the acquiree from the aggregate of the consideration transferred for the acquiree, the amount of non-controlling interest in the acquiree and fair value of an interest in the acquiree held immediately before the acquisition date. Any negative amount ( negative goodwill ) is recognised in the Group s consolidated income statement, after a management reassessment whether all the assets acquired and all liabilities and contingent liabilities assumed are identified and a review of the appropriateness of their measurement. Non-controlling interests Non-controlling interest is that part of the net results and of the equity of a subsidiary attributable to interests which are not owned, directly or indirectly, by the Group. Non-controlling interest forms a separate component of Group s equity. Losses within a subsidiary are attributed to the non-controlling interest even if that results in a deficit balance. In acquisitions of subsidiaries, the Group measures non-controlling interest on a transaction by transaction basis, either at: (a) fair value, or (b) the non-controlling interest's proportionate share of net assets of the acquiree. The Group treats transactions with non-controlling interests as transactions with equity owners of the Group. For purchases from non-controlling interests, the difference between any consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary is recorded in equity. Gains or losses on disposals to non-controlling interests are also recorded in equity. Transactions under common control Purchases of subsidiaries from parties under common control are accounted for using the predecessor values method. Under this method the consolidated financial statements of the combined entity are presented as if the businesses had been combined from the beginning of the earliest period presented or, if later, the date when the combining entities were first brought under common control. The assets and liabilities of the subsidiary transferred under common control are recognised at the predecessor entity s carrying amounts. The predecessor entity is considered to be the highest reporting entity in which the subsidiary s IFRS financial information was consolidated. Related goodwill inherent in the predecessor entity s original acquisitions is also recorded in the consolidated financial statements of the combined entity. Any difference between the carrying amount of net assets, including the predecessor entity's goodwill, and the consideration for the acquisition is accounted for in these consolidated financial statements as an adjustment to Additional Paid-in Capital within equity. Associates Associates are entities over which the Company has significant influence (directly or indirectly), but not control, generally accompanying a shareholding of between 20 and 50 percent of the voting rights. Investments in associates are accounted for using the equity method of accounting and are initially recognised at cost. Dividends received from associates reduce the carrying value of the investment in associates. Other postacquisition changes in the Group s share of net assets of an associate are recognised as follows: (i) the Group s share of profits or losses of associates is recorded in the consolidated income statement for the year as Earnings from equity-accounted investments, (ii) the Group s share of other comprehensive income is recognised in other comprehensive income and presented separately, (iii) all other changes in the Group s share of the carrying value of net assets of associates are recognised in the consolidated income statement within Earnings from equity-accounted investments. However, when the Group s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate. 16
Unrealised gains on transactions between the Group and its associates are eliminated to the extent of the Group s interest in the associates; unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Joint Ventures IFRS defines joint control as contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control (the venturers). A jointly controlled asset involves the joint control by the ventures of one or more assets contributed to, or acquired for the purpose of, the joint venture and dedicated for the purpose of the joint venture. These joint ventures do not involve the establishment of a corporation, partnership or other entity, or a financial structure that is separate from the venturers themselves. Each venturer has control over its share of future economic benefits through its share of the jointly controlled asset. The Group recognises in its consolidated financial statements its share of the jointly controlled assets, any liabilities that it has incurred, the expenses it incurs and the income that it earns from the sale or use of its share of the output from the joint venture. A jointly controlled operation involves the use of assets and other resources of the Group and other venturers rather than the establishment of a corporation, partnership or other entity. The Group recognises in its consolidated financial statements the assets that it controls and the liabilities that it incurs, the expenses it incurs and the share of income that it earns from the sale of goods or services by the joint venture. A jointly controlled entity is a corporation, partnership or other entity in which each participant holds an interest. A jointly controlled entity operates in the same way as other entities, controlling the assets of the joint venture, earning its own income and incurring its own liabilities and expenses. Interests in jointly controlled entities are accounted for using the equity method described above for associates. Disposals of subsidiaries, associates or joint ventures When the Group ceases to have control, joint control or significant influence, any retained interest in the entity is remeasured to its fair value, with the change in carrying amount recognised in the consolidated income statement. The fair value is the initial carrying amount for the purposes of subsequent accounting for the retained interest as an associate, joint venture or financial asset. In addition, any amounts previously recognised in other comprehensive income in respect of that entity are accounted for as if the Group had directly disposed of the related assets or liabilities. This may mean that amounts previously recognised in other comprehensive income are reclassified to the consolidated income statement. If the ownership interest in an associate / joint venture is reduced but significant influence / joint control is retained, only a proportionate share of the amounts previously recognised in other comprehensive income are reclassified to the consolidated income statement where appropriate. Non-current assets held for sale Non-current assets and disposal groups classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. Non-current assets and disposal groups are classified as held for sale if their carrying amounts will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and the asset or disposal group is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets. Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification as held for sale. Property, plant and equipment and intangible assets once classified as held for sale are not depreciated. The Group ceases to use the equity method of accounting on the date from which an interest in a jointly controlled entity or an interest in an associate becomes held for sale. 17
Property, plant and equipment Property, plant and equipment are carried at historical cost of acquisition or construction and adjusted for accumulated depreciation, depletion, amortisation and impairment. The Group follows the successful efforts method of accounting for its oil and gas properties and equipment whereby property acquisitions, successful exploratory wells, all development costs and support equipment and facilities are capitalised. The Group carries exploratory well costs as an asset when the well has found a sufficient quantity of reserves to justify its completion as a producing well and where the Group is making sufficient progress assessing the reserves and the economic and operating viability of the project. Exploratory well costs not meeting these criteria are charged to expense. Production costs, overheads and all exploration costs other than exploratory drilling and license acquisition costs are charged to expense as incurred. Acquisition costs of unproved properties are evaluated periodically and any impairment assessed is charged to expense. Depreciation, depletion and amortisation of capitalised costs of proved oil and gas properties and equipment is calculated using the unit-of-production method for each field based upon proved reserves for property acquisitions and proved developed reserves for other development costs, except in the case of significant asset components whose useful life differs from the lifetime of the field, in which case the straight-line method is applied. The proved reserves data used are estimated in accordance with the standards of reserves measurement applied by the U.S. Securities and Exchange Commission (the SEC ), on a life of field basis as management believes it will continue to be successful in the renewal of its oil and gas licenses. Property, plant and equipment which are not associated with exploration and production activities are carried at cost less accumulated depreciation. Depreciation of these assets is calculated on a straight-line basis as follows: Buildings and installations 5-33 years Machinery and equipment 5-15 years The Group capitalises borrowing costs necessarily incurred to finance expenditures for non-current assets during the construction and development period as part of the historical cost of acquiring the constructed assets. Capitalised interest costs are included in property, plant and equipment and are depreciated over the useful life of the related assets. Capital grants The Group recognises capital grants from local governments when there is reasonable assurance that the Group will comply with the conditions attached and that the grant will be received. The capital grants are accounted for as a reduction of the cost of the asset for which the grant is received. Advances for acquisition of property, plant and equipment In the ordinary course of business the Group makes prepayments for acquisition of items of property, plant and equipment and construction in progress. If the receipt of a prepaid item or service is expected in one year from the payment date, such advances are classified as current advances issued and are included in trade and other receivables, net. If not, advances are classified as long-term advances issued in other long-term assets. Intangible assets The Group's intangible assets primarily include intangible assets associated with land rights and permits, software licenses and road-use rights, and goodwill. The intangible assets associated with land rights and permits are amortised on a straight-line basis over 20 years. Software licenses are amortised on a straight-line basis over the related license period. The road-use rights are amortised on a straight-line basis over the expected lives of the related contracts. In 2011, the Group recognised an intangible asset associated with the rights and permits to construct and operate a pipeline transportation system in Vietnam. This asset will be amortised over 12 years in accordance with the period covered by the contract signed with the Vietnamese government. Amortised intangible assets are reviewed for impairment whenever events or changes in circumstances indicate 18
that the carrying amount of an asset may not be recoverable. The Group does not have intangible assets with indefinite lives other than goodwill. Impairment of non-financial assets other than goodwill Intangible assets and property, plant and equipment other than exploration and evaluation assets are assessed for possible impairment in accordance with IAS 36, Impairment of assets, which requires long-lived assets with recorded values that are not expected to be recovered through future cash flows to be written down to their recoverable amount which is the higher of fair value less costs to sell and value-in-use. Value-in-use is determined as the amount of estimated risk-adjusted discounted future cash flows. For this purpose, assets are grouped into cash generating units based on separately identifiable and largely independent cash inflows. Estimates of future cash flows used in the evaluation of impairment of assets are made using management s forecasts of commodity prices, market supply, demand and product margins and, in the case of oil and gas properties, expected production volumes. The latter takes into account assessments of field and reservoir performance and includes expectations about proved and unproved volumes, which are risk-weighted utilising geological, production, recovery and economic projections. Cash flow estimates are risk-adjusted to reflect local conditions as appropriate and discounted at a rate based on the Group s weighted average cost of capital. Impairments are reversed as applicable to the extent that the events or circumstances that triggered the original impairment have changed. Impairment of Goodwill Goodwill is tested for impairment annually (as at 30 November) and when circumstances indicate that the carrying value may be impaired. Impairment is determined for goodwill by assessing the recoverable amount of each cash-generating unit (or group of cash-generating units) to which the goodwill relates. Where the recoverable amount of the cash-generating unit is less than their carrying amount an impairment loss is recognised. Impairment losses relating to goodwill cannot be reversed in future periods. Financial assets All financial assets are recognised initially at fair value plus, in the case of investments not at fair value through profit or loss, directly attributable transaction costs. The Group s financial assets include cash and cash equivalents and short-term deposits, trade and other receivables, loans issued and derivative financial instruments. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. After initial measurement, such financial assets are subsequently measured at amortised cost using the effective interest rate method, less impairment. The accrued interest is included in interest income in the consolidated income statement. The losses arising from impairment are recognised as finance costs in the consolidated income statement. Cash and cash equivalents in the consolidated statement of financial position comprise cash at banks and at hand and short-term deposits with an original maturity of three months or less. The Group recognises derivatives as either assets or liabilities in the consolidated statement of financial position and measures those instruments at fair value. Changes in fair value are recorded as a gain or a loss through the Group s consolidated income statement of the current period. Impairment of financial assets The Group assesses at each reporting date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is deemed to be impaired if, and only if, there is objective evidence of impairment as a result of one or more events that has occurred after the initial recognition of the asset (an incurred loss event ) and that the loss event has an impact on the 19
estimated future cash flows of the financial asset or the group of financial assets that can be reliably estimated. Evidence of impairment may include indications that the debtor or a group of debtors is experiencing significant financial difficulty, default or delinquency in interest or principal payments, the probability that they will enter bankruptcy or other financial reorganisation and where observable data indicate that there is a measurable decrease in the estimated future cash flows, such as changes in arrears or economic conditions that correlate with defaults. The impairment loss of financial assets is recorded in interest income and net other financial income/(expense) in the consolidated income statement. Financial liabilities All financial liabilities are recognised initially at fair value and in the case of loans and borrowings, net of directly attributable transaction costs. The Group s financial liabilities include trade and other financial payables, loans and borrowings and derivative financial instruments. After initial recognition, interest bearing loans and borrowings are subsequently measured at amortised cost using the effective interest rate method. Gains and losses are recognised in the consolidated income statement when the liabilities are derecognised as well as through the effective interest rate method amortisation process. Borrowings are recognised initially at fair value, net of transaction costs incurred. Borrowings are subsequently carried at amortised cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognised in the consolidated income statement over the period of the borrowings using the effective interest method. The interest accrued is included in finance cost in the consolidated income statement. A financial liability is derecognised when the obligation under the liability is discharged or cancelled or expired. When an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the respective carrying amounts is recognised in the consolidated income statement. Inventories Inventories are stated at the lower of cost and net realisable value. Cost of producing and refining crude oil is accounted on a weighted average basis. This cost includes all costs incurred in the normal course of business in bringing each product to its present location and condition. The cost of purchased crude oil and refined products is the purchase cost, cost of refining, including the appropriate proportion of depreciation, depletion and amortisation (DD&A) and overheads based on normal capacity. Net realisable value of crude oil and refined products is based on estimated selling price in the ordinary course of business less any costs expected to be incurred to completion and disposal. 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 an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. Where the Group expects some or all of a provision to be reimbursed, for example, under an insurance contract, the reimbursement is recognised as a separate asset but only when the reimbursement is virtually certain. The expense relating to any provision is presented in the consolidated income statement net of any reimbursement. If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage of time is recognised as a finance cost. Decommissioning liabilities The Group recognises decommissioning liabilities for its upstream assets. The fair values of these liabilities are recorded as liabilities on a discounted basis, which is typically at the time the assets are installed. The costs associated with these liabilities are capitalised as part of the related assets and depleted as the reserves are produced. Over time, the liabilities are accreted for the change in present value. 20