Financial assets and financial liabilities measured and held at fair value are classified into one of three categories, known as hierarchy levels, which are defined according to the inputs used to measure fair value as follows:
Level 1: Fair value is determined using observable inputs that reflect unadjusted quoted market prices for identical assets and liabilities; Level 2: Fair value is determined using significant inputs that may be directly observable inputs or unobservable inputs that are corroborated
by market data; and
Level 3: Fair value is determined using significant unobservable inputs that are not corroborated by market data and may be used with internally developed methodologies that result in management’s best estimate of fair value.
2014 2013
31 December Level 1£m Level 2£m Level 3£m Total£m Level 1 £m Level 2 £m Level 3£m Total£m
Financial assets
Derivative financial instruments:
Energy derivatives 4 688 12 704 27 450 115 592
Interest rate derivatives – 158 – 158 – 95 – 95
Foreign exchange derivatives – 68 – 68 – 113 – 113
Treasury gilts designated at fair value through profit or loss 129 – – 129 126 – – 126
Debt instruments 59 – 3 62 52 – 3 55
Equity instruments (i) 24 59 – 83 23 – 7 30
Total financial assets at fair value 216 973 15 1,204 228 658 125 1,011
Financial liabilities
Derivative financial instruments:
Energy derivatives (320) (1,268) (321) (1,909) (24) (648) (81) (753)
Interest rate derivatives – (32) – (32) – (48) – (48)
Foreign exchange derivatives – (212) – (212) – (136) – (136)
Total financial liabilities at fair value (320) (1,512) (321) (2,153) (24) (832) (81) (937)
(i) Level 2 equity instruments relate to shares acquired in Enercare Inc., as detailed per note 12(c).
£31 million of net assets were transferred out of Level 1 into Level 2 during the year (2013: nil) as a result of the reassessment of derivatives held within the Hess Energy Marketing business acquired in 2013. There were no other significant transfers between Level 1 and Level 2 during the year (2013: nil).
Centrica plc Annual Report and Accounts 2014
NOTES TO THE FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
S4. Other equity
Revaluation reserve
During 2005, the revaluation to fair value of the Group’s existing interest in the Humber power station was recorded as a revaluation reserve adjustment following the acquisition by the Group of the remaining 40% in its owner, Centrica SHB Limited. During the year an impairment charge was made against the Humber power station (see note 7), of which £13 million was recognised in the Group Statement of Comprehensive Income through the revaluation reserve (together with an offsetting £3 million deferred tax movement).
Own shares reserve
The own shares reserve reflects the cost of shares in the Company held in the Centrica employee share ownership trusts to meet the future requirements of the Group’s share-based payment plans.
Treasury shares reserve
Treasury shares are acquired equity instruments of the Company. During 2014, the Group purchased £420 million of its own shares on the market under the share repurchase programme (2013: £500 million). The Group subsequently cancelled 154.3 million treasury shares with a nominal value of £10 million (see ‘Capital redemption reserve’) during the year (2013: no shares cancelled). The repurchase cost of £549 million has been transferred to retained earnings.
Share-based payments reserve
The share-based payments reserve reflects the obligation to deliver shares to employees under the Group’s share schemes in return for services provided.
Foreign currency translation reserve
The foreign currency translation reserve comprises exchange adjustments on the translation of the Group’s foreign operations. Historically the Group has hedged its net investments in these foreign operations and the opening balance of the foreign currency translation reserve includes exchange translation adjustments on borrowings and derivatives classified as net investment hedges under the requirements of IAS 39. Note S5 provides further detail on historical net investment hedges.
Cash flow hedging reserve
The cash flow hedging reserve comprises fair value movements on instruments designated as cash flow hedges under the requirements of IAS 39. Amounts are transferred from the cash flow hedging reserve to the Group Income Statement or Group Balance Sheet as and when the hedged item affects the Group Income Statement or Group Balance Sheet which is, for the most part, on receipt or payment of amounts denominated in foreign currencies and settlement of interest on debt instruments. Note S5 provides further detail on cash flow hedging.
S5. Hedge accounting
For the purposes of hedge accounting, hedges are classified either as fair value hedges, cash flow hedges or, in previous periods, hedges of net investments in foreign operations.
The fair values of derivatives and primary financial instruments in hedge accounting relationships at 31 December were as follows:
2014 2013
31 December Assets£m Liabilities £m Assets£m Liabilities £m
Fair value hedges 155 (1) 95 (16)
Cash flow hedges 13 (88) 7 (48)
The Group’s accounting policies in relation to derivatives qualifying for hedge accounting under IAS 39 are described below.
Fair value hedges
A derivative is designated as a hedging instrument and its relationship to a recognised asset or liability is classified as a fair value hedge when it hedges the exposure to changes in the fair value of that recognised asset or liability. The Group’s fair value hedges consist of interest rate swaps used to protect against changes in the fair value of fixed-rate, long-term debt due to movements in market interest rates. Any gain or loss from re-measuring the hedging instrument to fair value is recognised immediately in the Group Income Statement. Any gain or loss on the hedged item attributable to the hedged risk is adjusted against the carrying amount of the hedged item and recognised in the Group Income Statement within net finance cost. The Group discontinues fair value hedge accounting if the hedging instrument expires or is sold, terminated or exercised, the hedge no longer qualifies for hedge accounting or the Group revokes the designation. Any adjustment to the carrying amount of a hedged financial instrument for which the effective interest method is used is amortised to the Group Income Statement. Amortisation may begin as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged.
Gains or losses arising on fair value hedges net of gains or losses arising on hedged items attributable to the hedged risk for the years ended 31 December 2014 and 31 December 2013 were immaterial.
Cash flow hedges
A derivative is classified as a cash flow hedge when it hedges exposure to variability in cash flows that is attributable to a particular risk either associated with a recognised asset, liability or a highly probable forecast transaction. The Group’s cash flow hedges consist primarily of: forward foreign exchange contracts used to protect against the variability of functional currency denominated cash flows associated with
non-functional currency denominated highly probable forecast transactions;
NOTES TO THE FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
S5. Hedge accounting
interest rate swaps used to protect against the variability in cash flows associated with floating-rate borrowings due to movements in market interest rates; and
cross-currency interest rate swaps and forward foreign exchange contracts used to protect against the variability in cash flows associated with borrowings denominated in non-functional currencies.
The portion of the gain or loss on the hedging instrument which is effective is recognised directly in equity while any ineffectiveness is recognised in the Group Income Statement. The gains or losses that are initially recognised in the cash flow hedging reserve in the Group Statement of Comprehensive Income are transferred to the Group Income Statement in the same period in which the highly probable forecast transaction affects income. Where the hedged item is the cost of a non-financial asset or liability, the amounts taken to equity are transferred to the initial carrying amount of the non- financial asset or liability on its recognition. Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised without replacement or rollover, no longer qualifies for hedge accounting or the Group revokes the designation. At that point in time, any cumulative gain or loss on the hedging instrument recognised in equity remains in equity until the highly probable forecast transaction occurs. If the transaction is no longer expected to occur, the cumulative gain or loss recognised in equity is recognised in the Group Income Statement.
Note S4 details movements in the cash flow hedging reserve. The ineffective portion of gains and losses on cash flow hedging is immaterial and is recognised immediately in the Group Income Statement.
Net investment hedges
Historically the Group engaged in net investment hedging (NIH) whereby it would obtain foreign currency debt issued in the same currency as its net investment in a foreign operation. Such hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the effective portion of the hedge is recognised in equity; any gain or loss on the ineffective portion of the hedge is recognised in the Group Income Statement. In 2009 the Group ceased to NIH, however the opening balance of the foreign currency translation reserve includes cumulative exchange translation adjustments on borrowings and derivatives classified as a NIH under the requirements of IAS 39. These balances will be recycled to the Group Income Statement on disposal of the relevant foreign operation.
S6. Fair value of financial instruments
The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Group has documented internal policies for determining fair value, including methodologies used to establish valuation adjustments required for credit risk.
(a) Fair value hierarchy
Financial assets and financial liabilities measured and held at fair value are classified into one of three categories, known as hierarchy levels, which are defined according to the inputs used to measure fair value as follows:
Level 1: Fair value is determined using observable inputs that reflect unadjusted quoted market prices for identical assets and liabilities; Level 2: Fair value is determined using significant inputs that may be directly observable inputs or unobservable inputs that are corroborated
by market data; and
Level 3: Fair value is determined using significant unobservable inputs that are not corroborated by market data and may be used with internally developed methodologies that result in management’s best estimate of fair value.
2014 2013
31 December Level 1£m Level 2£m Level 3£m Total£m Level 1 £m Level 2 £m Level 3£m Total£m
Financial assets
Derivative financial instruments:
Energy derivatives 4 688 12 704 27 450 115 592
Interest rate derivatives – 158 – 158 – 95 – 95
Foreign exchange derivatives – 68 – 68 – 113 – 113
Treasury gilts designated at fair value through profit or loss 129 – – 129 126 – – 126
Debt instruments 59 – 3 62 52 – 3 55
Equity instruments (i) 24 59 – 83 23 – 7 30
Total financial assets at fair value 216 973 15 1,204 228 658 125 1,011
Financial liabilities
Derivative financial instruments:
Energy derivatives (320) (1,268) (321) (1,909) (24) (648) (81) (753)
Interest rate derivatives – (32) – (32) – (48) – (48)
Foreign exchange derivatives – (212) – (212) – (136) – (136)
Total financial liabilities at fair value (320) (1,512) (321) (2,153) (24) (832) (81) (937)
(i) Level 2 equity instruments relate to shares acquired in Enercare Inc., as detailed per note 12(c).
£31 million of net assets were transferred out of Level 1 into Level 2 during the year (2013: nil) as a result of the reassessment of derivatives held within the Hess Energy Marketing business acquired in 2013. There were no other significant transfers between Level 1 and Level 2 during the year (2013: nil).
Centrica plc Annual Report and Accounts 2014
NOTES TO THE FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
S6. Fair value of financial instruments
The reconciliation of the Level 3 fair value measurements during the year is as follows:
2014 2013
Financial assets
£m Financial liabilities£m Financial assets £m Financial liabilities£m
Level 3 financial instruments
1 January 125 (81) 147 (157)
Total realised and unrealised (losses)/gains:
Recognised in Group Income Statement (69) 18 – (60)
Purchases, sales, issuances and settlements (net) (2) (260) 44 (53)
Transfers between Level 2 and Level 3 (i) (45) 3 (63) 188
Foreign exchange movements 6 (1) (3) 1
31 December 15 (321) 125 (81)
Total (losses)/gains for the year for Level 3 financial
instruments held at the end of the reporting year (ii) (61) (233) 3 (50)
(i) Transfers in 2013 primarily arose due to the extension of the active period of the UK gas and power markets. Transfers between levels are deemed to occur at the beginning of the reporting period.
(ii) £61 million losses (2013: £3 million gains) for the year for Level 3 financial assets held at the end of the reporting year were recognised within certain re-measurements and no gains or losses (2013: nil) were recognised in other comprehensive income. £233 million losses (2013: £50 million losses) for the year for Level 3 financial liabilities held at the end of the reporting year were recognised within certain re-measurements and no gains or losses (2013: nil) were recognised in other comprehensive income.