Use of accounting estimates

The use of generally accepted accounting standards in preparing annual and interim financial statements means that management must make accounting estimates based on complex and/or subjective judgements, estimates based on past experience and assumptions considered reasonable and realistic based on information known at the time of the estimate.

The use of these accounting estimates influences the carrying value of assets and liabilities and disclosures about contingent assets and liabilities on the date of the annual financial statements, as well as the amount of revenues and expenses during the period in question. Actual results may differ from estimates due to the characteristic uncertainty of the assumptions and conditions on which estimates are based.

Set out below are the accounting estimates critical to the process of preparing the annual and interim financial statements since they involve great reliance on subjective judgments, assumptions and estimates on matters which by their very nature are uncertain. Changes to the conditions underlying the judgments, assumptions and estimates adopted may have a material effect on subsequent results.

Duration and residual value of assets under concession

The natural gas distribution business is carried out under concessions from local state-owned entities awarding the service. As for the duration of the concessions, Legislative Decree no. 164/00 (Letta Decree) has stipulated that all awards must be tendered for bids by the expiration of the so-called “transitory period” (for the Group no later than 31 December 2012) and that the new duration of concessions may not exceed 12 years. Upon the expiration of concessions, the outgoing operator, in view of the transfer of its own distribution networks, excluding assets assignable free of charge, is paid a defined indemnity based on industrial estimation criteria.

In terms of the estimates made by the directors in determining depreciation criteria, the net carrying value of the assets upon the expiration of the concession should not be greater than the aforesaid industrial value.

Impairment losses

Impairment losses on plant, property and equipment and intangible assets are recognised when events or changing circumstances lead to the belief that the carrying value on the financial statements is not recoverable. An impairment loss is determined by comparing the carrying value with the respective recoverable value, represented by whichever is greater between the fair value, net of any disposal expenses, and the usage value adjusted for the expected cash flows deriving from use of the asset. The expected cash flows are quantified in light of the information available at the time of the estimate based on subjective judgments on the trends with future variables – such as prices, expenses, demand growth rates, production profiles – and are discounted using a rate considering the inherent risk of the activity in question.

Site dismantling and restoration

Snam Rete Gas may incur future liabilities for obligations to remove and dismantle plants or parts thereof. Although such obligations are currently remote, in some cases where legal4 or constructive5 obligations exist, provisions are made for these costs.

Estimating future dismantlement and restoration costs is complex and requires assessment and judgment by corporate management in valuing liabilities to be incurred many years later to fulfil dismantlement and restoration obligations, often not completely set out in laws, administrative regulations, or contractual clauses. In addition, these obligations are affected by the continual updating of dismantlement and restoration techniques and costs, as well as continually changing political and public attitudes toward environmental protection.

Also critical to accounting estimates of dismantlement and restoration expenses is the accounting method used for those expenses for which the present value is initially capitalised together with the cost of the asset with crossentries to the provision for risks. The provision for risks is subsequently increased to reflect the passage of time, while the original amount of capitalised liability is amortised based on the asset’s useful life.

Determination of the discounting rate to be used for the initial and subsequent valuation of the expense is a complex procedure involving subjective judgments by management.

Environmental liabilities

Operations carried out by Snam Rete Gas must comply with many community, national, regional and local environmental protection laws. When it is likely that an expense liability exists on account of such laws and the amount can be estimated reliably, provisions are made for the respective costs.

Although the company does not currently believe that material negative effects on the financial statements will arise from non-compliance with environmental laws, especially considering the work already undertaken, it cannot be ruled out with certainty, however, that Snam Rete Gas could incur further potentially considerable costs or liability, since it is currently impossible to foresee the effects of future developments, taking into account the following factors, among others: (i) the possibility that contamination may emerge; (ii) possible effects deriving from the application of new environmental protection laws and regulations; (iii) the effects of any technological innovations for environmental remediation; and (iv) the possibility of litigation and the difficulty in determining the possible consequences, including in terms of the liability of other parties and possible compensation.

Provisions

Besides providing for obligations to remove property, plant and equipment and restore sites, Snam Rete Gas makes provisions primarily for employee benefits and legal and tax disputes. Estimates of the accruals to be made for these purposes are the result of a complex process involving management’s subjective opinions.

Employee benefits

Defined benefit plans are valued considering uncertain events and actuarial assumptions which include, among others, discount rates, expected returns on plan assets, future salary levels, retirement age and future trends with health expenses covered.

The main assumptions used to quantify post-employment benefits are determined as follows: (i) the discount and inflation rates representing the basic rates at which such obligations to employees could actually be performed are based on rates accruing on high-quality bonds (government bonds) and expected inflation; (ii) the level of future compensation is determined based on elements such as expected inflation, productivity, career advancement and seniority; (iii) the future cost of health benefits is determined based on such elements as present and past trends in health benefit costs, including assumptions on growing cost inflation, and changes to the health condition of beneficiaries; (iv) demographic assumptions reflect the best estimate of trends with variables, such as, for example, mortality, turnover and disability and other factors related to the beneficiaries; and (v) the returns on plan assets are determined based on the weighted average expected future yield by investment class (fixed income, equity, or cash).

Actuarial assumptions are adopted also for the determination of obligations for long-term benefits; for this purpose, the effects of changes to actuarial assumptions or to benefit characteristics are posted in full on the income statement.

(4) A legal obligation derives from a contract, law or other legal provision.
(5) A constructive obligation arises when a company generates an expectation for third parties that it will meet its commitments even when not required to do so by law.