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Accounting Principles for the Consolidated Accounts

Basic information

Wärtsilä Corporation is a Finnish listed company organised under the laws of Finland and domiciled in Helsinki.

Wärtsilä is a global leader in complete lifecycle power solutions for the marine and energy markets. By emphasising technological innovation and total efficiency, Wärtsilä maximises the environmental and economic performance of the vessels and power plants of its customers.

In 2010, Wärtsilä's net sales totalled EUR 4.6 billion with approximately 17,500 employees. The company has operations in 160 locations in 70 countries around the world.

Basis of preparation

The consolidated annual financial statements are prepared in accordance with the International Financial Reporting Standards (IFRS) by applying IAS and IFRS standards, and their SIC and IFRIC interpretations, which were in force as at 31 December 2010. International Financial Reporting Standards refer to the standards, and their interpretations, approved for application in the EU in accordance with the procedures stipulated in the EU's regulation (EC) No. 1606/2002 and embodied in Finnish accounting legislation and the statutes enacted under it. The notes to the consolidated financial statements also comply with Finnish accounting principles and corporate legislation.

Reporting is based on the historical cost convention. Exceptions are financial assets available for sale, financial assets and liabilities designated at fair value through the statement of income, derivative contracts, items hedged at fair value, and share-based transactions made with cash and measured at fair value. The figures are in millions of euros.

Since 1 January 2010 the Group has applied the following updated standards, amendments and interpretations which have effect on the consolidated financial statements:

  • Revised IFRS 3 Business Combinations. Changes have an impact on the amount recognised as goodwill and gain or loss resulting from the sale of business. The revised standard also has an impact in the items recognised in the statement of income both when the business combination is carried out and in the subsequent periods during which additional purchase price is paid or additional acquisitions are made.
  • Amendment to IAS 27 Consolidated and Separate Financial Statements. According to the amendment the effects, arising from changes in subsidiary ownership, are recognised directly in Group's equity when the parent company remains in control. When the Group loses the control in a subsidiary, the remaining investment is recognised at fair value through the statement of income. The same is applicable to investments in associates (IAS 28) and joint ventures (IAS 31). As a consequence of the amendment in the standard, potential losses of a subsidiary can be allocated to non-controlling interests even if the loss amount exceeds the investment made by the non-controlling interest.

Since 1 January 2010 the Group has applied the following updated standards, amendments and interpretations which have no significant impact on the consolidated financial statements:

  • Amendment to IAS 39 Financial Instruments: Recognition and Measurement - Eligible Hedged Items
  • IFRIC 18 Transfers of Assets from Customers
  • Amendments to IFRIC 9 Reassessment of Embedded Derivatives and IAS 39 Financial Instruments: Recognition and Measurement - Embedded Derivatives

Use of estimates

The preparation of the financial statements in accordance with IFRS requires management to make estimates and assumptions that affect the valuation of the reported assets and liabilities and other information, such as contingent liabilities and the recognition of income and expenses in the statement of income. Although these estimates are based on management's best knowledge of current events and actions, actual results may differ from the estimates. The most important items, which require management estimates and which may include uncertainty, include the following:

Sales revenue is typically recognised when the product or service has been delivered, its value has been determined and it is probable that the receivable will be collected. These estimates affect the amount of sales revenue recognised. Revenue from long-term projects, and long-term operations and maintenance agreements is recognised according to their percentage of completion when the profit on the project or agreement can be reliably determined. The degree of completion and the profit are based on management's estimates as to the realisation of the project or agreement. These estimates are reviewed regularly. Recognised sales revenue and profit recorded are adjusted during the project when assumptions concerning the outcome of the entire project are updated. Changes in assumptions relate to changes in the project's or agreement's schedule, scope of supply, technology, costs and any other relevant factors.

Warranty provisions are recorded on the recognition of sales revenue. The provision is based on accumulated experience of the level of warranty needed to manage future and current cost claims. Products can contain new and complex technology that can affect warranty estimates with the result that such provisions are not always sufficient.

The Group is a defendant in several court cases arising from its business operations. A provision is recorded when an unfavourable result is probable and the loss can be determined with reasonable certainty. The final result can differ from these estimates.

The recoverable amounts of property, plant and equipment, intangible assets and goodwill are determined for all cash-generating units annually or, if it is shown that the asset has lost value, where its value in use is determined. The value in use is determined using estimates of future market development such as growth and profitability as well as other significant factors. The most important factors underlying such estimates are growth, operating margin, useful life, future investment needs, and the discount interest rate. Changes in these assumptions can significantly affect future estimates.

Estimates of pension obligations in the case of defined benefit plans are based on actuarial estimates of factors including future salary increases, discount interest rates and income from reserve funds. Changes in these assumptions can significantly affect the company's pension obligations and pension costs.

Principles of consolidation

The consolidated financial statements include the parent company Wärtsilä Corporation and all subsidiaries in which the parent company directly or indirectly holds more than 50 per cent of the voting rights or in which Wärtsilä is otherwise in control, as well as the Group's associated companies (20 to 50 per cent voting rights and significant influence over the company but not control over its financial and operating policies). Associated companies and joint ventures are included in the consolidated financial statements using the equity method. If the Group's share of the associated company's or joint venture's losses exceeds its interest in the company, the carrying amount is written down to zero. After this losses are only reported if the Group has incurred obligations from the associated company or joint venture.

The Group's share of the associated company's or joint venture's profit for the financial period are shown as a separate item before the Group's operating result. The Group's share of the associated company's or joint venture's changes recorded in other comprehensive income are recorded in the Group's other comprehensive income.

Acquired or established subsidiaries, associated companies and joint ventures are included in the consolidated financial statements from the day the company was acquired or established, until ownership of the company legally terminates.

Acquired companies are accounted for using the purchase method of accounting. Accordingly the purchase price and the acquired company's identifiable assets, liabilities and contingent liabilities are measured at fair value on the date of acquisition. In the acquisition of non-controlling interests, if the Group already has control, the non-controlling interest is valued either at fair value or at the non-controlling interests' proportionate share of the identifiable net assets. The difference between the purchase price, possible equity belonging to the non-controlling interests and the acquired company's net identifiable assets, liabilities and contingent liabilities measured at fair value is goodwill. Goodwill is tested for impairment at least annually.

The purchase price includes the possible consideration paid, measured at fair value. The acquisition costs are expensed in the same reporting period in which they occur. For the acquisitions made before January 1, 2010, the accounting principles valid at the time of the acquisition have been applied.

All intra group transactions, dividend distributions, receivables and liabilities and unrealised margins are eliminated in the consolidated financial statements. In the statement of income, non-controlling interests have been separated from the income for the reporting period. In the Group's statement of financial position, non-controlling interests are shown as a separate item under equity.

Measurement of fair value of assets acquired in business combinations

In major business combinations, the Group has employed an external advisor when measuring the fair values of the property, plant and equipment and intangible assets acquired. In the case of property, plant and equipment, comparisons have been made with the market prices of corresponding assets, and the decrease in value resulting from the assets' age, degree of wear and other similar factors has been estimated. Measurement of the fair value of intangible assets is based on estimates of cash flows related to these assets.

Joint ventures

Joint ventures are companies in which the Group shares control with another party. The Group's holdings in joint ventures are consolidated by using the equity method. The Group's proportion of profit is shown in the statement of income on line Share of result in associates and joint ventures. Wärtsilä's proportion of retained earnings post acquisition is included in the equity.

Foreign subsidiaries

The statements of income and other comprehensive income of foreign subsidiaries are translated into euros at the quarterly average exchange rates. Statements of financial position are translated into euros at the exchange rates prevailing at the end of the reporting period. The translation of the profit of the period and other comprehensive income using different exchange rates in the statement of comprehensive income and the statement of financial position cause translation differences, which are recognised in equity and which are recorded in other comprehensive income as change. Translation differences of foreign subsidiaries' acquisition cost eliminations and post acquisition profits and losses are recognised in other comprehensive income and are presented as a separate item in equity. The goodwill generated in the acquisition of foreign entities and their fair value adjustments of assets and liabilities are considered as assets and liabilities of foreign entities, which are converted into euros using the exchange rates prevailing at the end of the reporting period.

Transactions in foreign currencies

Transactions denominated in a foreign currency are translated into euros using the exchange rate prevailing at the dates of the transactions. Receivables and liabilities are translated into euros at the exchange rate prevailing at the end of the reporting period. Exchange rate gains and losses related to non-financial receivables and liabilities are reported on the applicable line in the statement of income and are included in operating result. Exchange rate differences related to financial assets and financial liabilities are reported as financial items in the statement of income.

Net sales and revenue recognition

Sales are presented net of indirect sales taxes and discounts. Sales are recognised when the significant risks and rewards connected with ownership have been transferred to the buyer. This typically means that revenue recognition occurs when a product or service is delivered to the customer in accordance with the terms of delivery.

Revenue from long-term construction contracts and long-term operating and maintenance agreements is recognised in accordance with the percentage of completion method when the outcome of the contract can be estimated reliably. The percentage of completion is based on the ratio of costs incurred to total estimated costs to date for long-term construction contracts, whereas for long-term operating and maintenance agreements it is calculated on the basis of the proportion of the contracted services performed. When the final outcome of a long-term project cannot be reliably determined, the costs arising from the project are expensed in the same reporting period in which they occur, but revenue from the project is recorded only to the extent that the company will receive an amount corresponding to actual costs. Any losses due to projects are expensed immediately.

Research and development costs

Research costs are expensed in the reporting period during which they occur. Development costs are capitalised when it is probable that the development project will generate future economic benefits for the Group, and when the criteria of IAS 38 (Intangible assets), including commercial and technological feasibility, have been met. These projects involve the development of new or significantly improved products or production processes. Capitalised development costs are amortised and the cost of buildings, machinery and facilities for development depreciated on a systematic basis over their expected useful lives. Grants received are reported as other operating income.

Pension plans

Group companies in different countries have various pension plans in accordance with local conditions and practices. These pension plans are classified either as defined contribution or defined benefit plans.

The contributions to defined contribution plans are charged to the statement of income in the year to which they relate. The present value of the obligation arising from defined benefit plans is determined using the projected unit credit method and the plan assets are measured at fair value as at the measurement date. The Group's obligation with respect to a plan is calculated by identifying the extent to which the cumulative unrecognised actuarial gain or loss exceeds by more than 10 per cent the greater of the present value of the defined benefit obligation and the fair value of the plan assets. The excess is recognised in the statement of income over the expected average remaining working lives of employees participating in the plan. Defined benefit plans are calculated by qualified actuaries.

Share-based payments

The fair value of employee options is reported as an expense and an increase in shareholders' equity.

The company's bonus programme, which is fixed to share value, is valued at the fair value of the share on the reporting date and reported in the statement of income for the term-to-maturity of the bonus programme.

Goodwill and other intangible assets

The difference between the purchase price and the fair value of a company's net assets and contingent liabilities at the date of acquisition is reported as goodwill. Goodwill consists of the future economic benefit of those assets whose value the Group is unable to calculate either separately or individually at the date of acquisition. Goodwill is not amortised but tested for impairment at least annually, and more often if there are indications of impairment.

Other intangible assets include patents, licenses, capitalised development costs, software, customer relations and other intellectual property rights. These are valued at cost except for intangible assets identified in connection with acquisitions, which are valued at the fair value at the acquisition date. Intangible assets are amortised on a straight-line basis over their estimated useful lives. Intangible assets, for which the time limit for the right of use is agreed, are amortised over the life of the contract.

The general guidelines for scheduled amortisation are:
Development costs 5–10 years
Software 3 - 7 years
Other intangible assets 5 - 20 years

The estimated useful lives are reviewed at the end of each reporting period, and if they differ significantly from previous estimates, amortisation periods are adjusted accordingly.

Property, plant and equipment

Fixed assets acquired by the Group are recorded in the statement of financial position at cost less accumulated depreciation and impairment losses. Grants received are reported as a reduction in acquisition costs. The fixed assets of acquired subsidiaries are valued at their fair value at the acquisition date.

Depreciation is based on the following estimated useful lives:
Buildings 10-40 years
Machinery and equipment 5-20 years
Other tangible assets 3-10 years

The estimated useful lives are reviewed at the end of each reporting period, and if they differ significantly from previous estimates, depreciation periods are adjusted accordingly.

Borrowing costs

Borrowing costs that are directly attributable to the asset acquisition, construction or production, and to completion of the asset for its intended use or sale requiring necessarily a considerable length of time, will be activated in the statement of financial position as part of the cost of the asset. Other than immediate borrowing cost related costs are expensed in the period in which they are incurred.

Investment properties

Properties that are not used in the Group's operating activities, or that are held to earn rental income or for capital appreciation, or both, are classified as investment properties. Investment properties are treated as long-term investments and are valued at cost less accumulated depreciation and impairments.

Leases

Lease agreements where all material rewards and risks of ownership have been transferred to the Group are classified as finance leases. Assets acquired under finance lease are recognised as fixed assets at the lower of the fair value of the leased asset or the estimated present value of the underlying lease payments. The corresponding rental obligation, net of finance charge, is included in interest-bearing liabilities with the interest element of the finance charge being recognised in the statement of income over the lease period. Assets acquired under a finance lease are depreciated over their estimated useful lives in accordance with the same principles that apply to other similar fixed assets.

Lease agreements where the risks and benefits of ownership have not been transferred to the Group are classified as operating leases. Operating lease payments are reported as rental expenses.

Inventories

Inventories are carried at the lower of cost or net realisable value. Costs include allocated purchasing and manufacturing overhead costs in addition to direct manufacturing costs. Inventory valuation is primarily based on the weighted average cost.

Financial assets and financial liabilities

Financial assets are classified into the following categories: financial assets designated at fair value through profit or loss, investments held to maturity, loans and other receivables, and financial assets available for sale. Financial assets are classified on the basis of their purpose upon initial recognition.

Financial assets at fair value through profit and loss

The financial assets at fair value through profit or loss category includes derivatives that do not qualify for hedge accounting, cash and cash equivalents, as well as other financial assets recognised at fair value through the statement of income, which are financial assets held for trading. The financial asset is classified in this category if acquired principally for the purpose of selling in the short term.

Financial assets are recognised at fair value at the end of the reporting period using prevailing market rates.

Derivatives are initially reported at cost in the statement of financial position and are thereafter valued at their fair value at the end of each reporting period.

Investments held to maturity

Investments held to maturity are valued at cost. Investments held to maturity are assets with fixed or determinable payments, that mature on a fixed date, and which the Group intends and is able to hold until maturity.

Loan receivables as well as financial liabilities are recognised at the settlement date and measured at amortised cost using the effective interest rate method. Transaction costs are included in the initially recognised amount.

Loans and other receivables

Trade receivables are recognised at their anticipated realisable value, which is the original invoiced amount, less an estimated valuation allowance for impairment. Receivables are valued individually. Credit losses are expensed in the statement of income.

Financial assets available for sale

Investments in other companies are classified as financial assets available for sale and are recognised at fair value. Listed shares are valued at their market value. Unlisted shares for which the fair value cannot be reliably measured are valued at cost less impairment. Changes in fair value are reported directly in other comprehensive income until the shares are disposed of, at which point the accumulated fair value changes are released from equity to the statement of income. If the fair value of shares becomes permanently impaired or there is objective evidence that it is impaired, impairment is recognised in the statement of income.

Gains and losses on disposal and impairments of shares that are attributable to operating activities are included in operating income, while gains and losses on disposal and impairments of other shares are included in financial income and expenses.

Cash and cash equivalents

Cash and cash equivalents comprise cash in hand, deposits held at call with banks and similar investments. Other liquid funds comprise short-term highly liquid investments that are subject to only minor fluctuations in value.

Derivatives

Certain foreign exchange derivatives are eligible for hedge accounting in accordance with IAS 39. Changes in the fair value of derivative contracts that have been signed to hedge future cash flows are reported under other comprehensive income and presented in the fair value reserve in equity, provided that they meet the requirements for hedge accounting. Changes in fair value due to interest rate differences are reported in the statement of income. Any accrued profit or loss in the hedge reserve under other comprehensive income is reported as an adjustment to selling proceeds or transaction costs in the same period as any transactions relating to the hedged obligations or estimates.

The Group documents the relationship between each hedging instrument and the hedged asset upon entering into a hedging arrangement, along with the risk management objective and the strategy applied. Through this process the hedging instrument is linked to the relevant assets and liabilities, projected business transactions or binding contracts. The Group also documents its ongoing assessment of the effectiveness of the hedge as regards the relationship between a change in the derivative's fair value and a change in the value of the hedged cash flows or transactions.

Equity in foreign subsidiaries situated outside the euro zone is hedged against exchange rate fluctuations, mainly through foreign exchange derivatives and foreign currency borrowings using the equity hedging method to reduce the effect of exchange rates on the Group's equity. When a foreign subsidiary is sold, these translation differences are included in the gain or loss on disposal reported in the statement of income.

For derivatives that do not satisfy the conditions for hedge accounting in accordance with IAS 39, changes in fair value are reported immediately in the statement of income.

The fair value of interest rate swaps is calculated by discounting the underlying future cash flows. Currency forwards are valued at existing forward rates at the end of the reporting period. Currency options are valued at their market value at the end of the reporting period.

Fair value hierarchy

Financial instruments measured at fair value are classified according to the following fair value hierarchy: instruments measured using quoted prices in active markets (level 1), instruments measured using inputs other than quoted prices included within level 1 observable either directly or indirectly (level 2) and instruments measured using inputs that are not based on observable market data (level 3). Financial instruments measured at fair value include financial assets and liabilities at fair value through the statement of income and financial assets available for sale.

Impairments

The carrying amounts of assets are reviewed at the end of the reporting period to determine whether there is any indication of impairment. The assets are divided into the smallest possible cash-generating units that are effectively independent of any other assets of the Group. An impairment loss is recognised whenever the carrying value of the assets or cash-generating unit exceeds their fair value. An asset's value in use is the higher of its net realisable value or the recoverable amount from the asset. The recoverable amount is based on discounted future cash flows. Previously reported impairment losses of property, plant and equipment are reversed if the assumptions for calculating the recoverable amount have changed.

Provisions

Provisions are recognised in the statement of financial position when the Group has a present legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. Provisions can arise, for example, from warranties, environmental risks, litigation, forecast losses on projects and restructuring costs.

Estimated future warranty costs relating to products supplied are recorded as provisions. The amount of future warranty costs is based on accumulated experience.

Provisions for restructuring costs are made once the personnel concerned have been informed of the terms or a restructuring plan has been established. The plan must indicate which activities and personnel will be affected and the timing and cost of implementation.

Income taxes

The statement of income includes taxes on the Group's consolidated taxable income for the reporting period in accordance with local tax regulations, tax adjustments for previous reporting periods, and changes in deferred taxes. Deferred tax liabilities and assets are calculated on all temporary differences arising from the difference between the tax basis of assets and liabilities and the carrying values using the enacted tax rates at the end of the reporting period. They are recognised in the statement of income unless related to items recognised directly in equity and other comprehensive income. The statement of financial position includes deferred tax liabilities in their entirety and deferred tax assets at their estimated probable amount.

Dividends

The dividend proposed by the Board of Directors is deducted from distributable equity when approved by the company's annual general meeting.

Adoption of new and updated IFRS standards

In 2011 the Group will adopt the following new and updated standards and interpretations issued by the IASB. The changes will have no significant impact on the consolidated financial statements.

  • Amendment to IAS 32 Financial instruments: Presentation - Classification of Rights Issues (effective for periods beginning or after 1 February 2010). The amendment concerns the classification of rights (share options, share subscription rights or other share rights) offered for a fixed amount of foreign currency.
  • Revised IAS 24 Related Party Disclosures (effective for periods beginning or after 1 January 2011). The change simplifies the disclosure requirements for government-related entities and clarifies the definition of a related party.