4 Use of estimates

The application of generally accepted accounting principles for the preparation of financial statements and interim reports involves management making accounting estimates based on complex and/or subjective judgements, estimates based on past experience and assumptions regarded as reasonable and realistic on the basis of the information known at the time of the estimate.

The use of these accounting estimates has an influence on the book value of the assets and liabilities and on the information about potential assets and liabilities at the reporting date, as well as the amount of revenues and costs in the reference period. The actual results may differ from the estimated results owing to the uncertainty that characterises the assumptions and the conditions on which the estimates are based.

Details are given below about the critical accounting estimates involved in the process of preparing the financial statements and interim reports, since they involve a high degree of recourse to subjective judgements, assumptions and estimates regarding matters that are by nature uncertain. Any change in the conditions forming the basis of the judgements, assumptions and estimates used could have a significant impact on subsequent results.

Impairment losses

Property, plant and equipment and intangible assets are impaired when events or changes in circumstances give cause to believe that the book value is not recoverable. The events which may give rise to an impairment of assets include changes in business plans, changes in market prices or reduced use of plants. The decision on whether to apply an impairment and the quantification of any such impairment depend on the assessments of management concerning complex and highly uncertain factors, such as future price trends, the impact of inflation and technological improvements on production costs, production profiles and conditions of supply and demand on a global or regional scale.

The impairment is determined by comparing the book value with the related recoverable value, represented by the greater of fair value less costs to sell and value in use, determined by discounting the expected cash flows deriving from the use of the asset. The expected cash flows are quantified in light of the information available at the time of the estimate, on the basis of subjective judgements regarding future trends in variables – such as prices, costs, the rate of growth of demand, production profiles – and are discounted using a rate that takes account of the risk inherent in the asset concerned.

Goodwill and other intangible assets with an indefinite useful life are not subject to amortisation; the recoverability of their book value is verified at least once a year and in any case whenever any event occurs leading to an assumption of impairment. With reference to goodwill, the verification is carried out at the level of the smallest aggregate (cash-generating unit) to which the goodwill can be reasonably and consistently attributed; this unit represents the basis on which management assesses, directly or indirectly, the return on investment. When the book value of the cash-generating unit, including the goodwill attributed to it, exceeds the recoverable value⁹, the difference is subject to impairment, which is attributed by priority to the goodwill up to its amount; any surplus in the impairment with respect to the goodwill is attributed pro rata to the book value of the assets which constitute the cash-generating unit.

Site dismantlement and restoration

Snam incurs significant liabilities associated with obligations of removal and dismantlement of plants or parts of plants. Estimating future dismantlement and restoration costs is a complex process and requires the assessment and judgement of the Company’s management in placing a value on the liabilities which will be incurred many years in the future for complying with dismantlement and restoration obligations, which often cannot be completely defined by laws, administrative regulations or contractual clauses. In addition, these obligations are affected by constant changes in technology and in dismantlement and restoration costs, as well as the constant growth of political and public awareness regarding matters of health and protection of the environment.

The criticality of estimates of dismantlement and restoration costs also depends on the accounting method used for these costs, whose current value is initially capitalised, along with the cost of the asset to which they relate, offset against the provision for risks and charges. Subsequently, the value of the provision for risks and charges is increased to reflect the passing of time and any changes in estimates as a result of changes in expected cash flows, the timing of their realisation and the discount rates applied. The determination of the discount rate to be used both in the initial valuation of the charge and in subsequent valuations is the result of a complex process which involves subjective judgements on the part of the Company’s management.

Business combinations

Business combinations are recognised by allocating the difference between the acquisition cost and the net book value to the assets and liabilities of the acquired company. For the majority of assets and liabilities, the difference is allocated by recognising the assets and liabilities at their fair value. The unattributed portion, if positive, is recognised as goodwill; if negative, it is attributed to the income statement. In the attribution process, Snam draws on the available information and, for the most significant business combinations, on external valuations.

Environmental liabilities

Snam is subject, in relation to its activities, to numerous laws and regulations on the protection of the environment at European, national, regional and local level, including the laws which implement international conventions and protocols relating to the activities carried out. With reference to this legislation, when it is probable that the existence and amount of a large liability can be reliably estimated, provisions are made for the associated costs.

While the Company does not currently believe that there will be any particularly significant negative effects on its financial statements due to non-compliance with environmental legislation, including taking account of the interventions already made, it cannot be ruled out that Snam might incur substantial additional costs or responsibilities, since it is currently impossible to foresee the effects of future developments, in view of factors such as: (i) the potential for contaminations emerging; (ii) the refurbishment in progress and to be followed and the other possible effects arising from the application of Environmental Minister Decree 471/1999; (iii) the possible effects of new laws and regulations for environmental protection; (iv) the effects of any technological innovations for environmental cleansing; and (v) the possibility of disputes and the difficulty of determining the possible consequences, including in relation to the liability of other parties and to possible compensation payments.

Provisions for employee benefits

Defined-benefit plans are valued on the basis of uncertain events and actuarial assumptions which include, inter alia, the discount rates, the expected returns on the assets servicing the plans, the level of future remuneration, the retirement age and future trends in the healthcare expenses covered.

The principal assumptions used for the quantification of post-employment benefits are determined as follows: (i) the discount and inflation rates representing the base rates at which the obligation to employees might actually be fulfilled are based on the rates which accrue on high-quality bonds (government bonds) and on inflation expectations; (ii) the level of future remuneration is determined on the basis of elements such as inflation expectations, productivity, career advancement and seniority; (iii) the future cost of healthcare services is determined on the basis of elements such as present and past trends in healthcare costs, including assumptions regarding the inflationary growth of costs, and changes in the health of the participating employees; (iv) the demographic assumptions reflect the best estimates of trends in variables such as mortality, turnover, invalidity and others in relation to the population of the participating employees; and (v) the return on the assets servicing the plans is determined on the basis of the weighted average of the expected future yields, differentiated by class of investment (fixed income, equity, money market).

The differences between the actual and expected costs and between the actual and expected returns on the assets servicing the plan are verified in the normal manner and are defined as actuarial gains or losses. The actuarial gains and losses are recognised pro rata in the income statement for the remaining average working life of the employees who take part in the plan, if and insofar as their net value not recognised at the end of the previous period exceeds the greater of 10% of the current value of the liabilities relating to the plan and 10% of the fair value of the assets servicing the plan (“corridor method”).

Actuarial assumptions are also used for determining obligations relating to long-term benefits; to this end, the effects arising from changes to the actuarial assumptions or the characteristics of the benefit are recognised entirely on the income statement.

Provisions

In addition to recognising environmental liabilities and obligations to remove property, plant and equipment and restore sites, and liabilities relating to employee benefits, Snam makes provisions relating mainly to legal and tax disputes.

The estimate of the provisions for these purposes is the result of a complex process involving subjective judgements on the part of the Company’s management.