Annual Report - EDP

notes to the consolidated EDP and - Energias company de Portugal, financial S.A. statementsfor the Notes years to the ended Consolidated 31 december and Company 2012 Financial and Statements 2011for the years ended 31 December 2012 and 20113. CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS IN PREPARING THE FINANCIAL STATEMENTSIFRS require the use of judgement and the making of estimates in the decision process about certain accounting treatments, with impact in total assets, liabilities,equity, costs and income. The actual effects may differ from these estimates and judgements, namely in relation to the effect of actual costs and income.The main accounting estimates and judgements used in applying the accounting policies are discussed in this note in order to improve the understanding of how itsapplication affects the Group’s reported results and disclosures. A broader description of the accounting policies employed by the Group is disclosed in note 2 to theseConsolidated Financial Statements.Considering that in many cases there are alternatives to the accounting treatment adopted by EDP Group, the reported results could differ if a different treatment waschosen. The Executive Board of Directors believes that the choices made are appropriate and that the financial statements present fairly, in all material respects, theGroup’s financial position and results.Impairment of available-for-sale investmentsThe Group determines that available-for-sale investments are impaired when there has been a significant or prolonged decline in their fair value.Determination of a significant or prolonged decline requires judgement. In making this judgement, the Group assesses, among other factors, the normal share pricevolatility, assuming as significant a decline of more than 20% in listed shares. In addition, valuations are generally obtained through market prices or determined byexternal entities, or through valuation models that require assumptions or judgment in making estimates of fair value.Alternative methodologies and the use of different assumptions and estimates could result in different impairment losses being recognised with a consequent impactin the Group’s income statement.Fair value of financial instrumentsFair values are based on listed market prices, if available, otherwise fair value is determined either by the price of similar recent transactions under market conditionsor determined by external entities, or by pricing models based on net present value of estimated future cash flows techniques considering market conditions, timevalue, yield curves and volatility factors. These methodologies may require the use of assumptions or judgements in estimating fair values.Consequently, the use of different methodologies or different assumptions or judgements in applying a particular model, could have produced different financialresults from those reported.Contractual Stability Compensation - CMECFollowing a Portuguese Government decision to extinguish the Power Purchase Agreement (PPA), EDP and REN agreed to the early termination of the PPAs, with effectfrom 1 July 2007.As a result of the PPAs termination and in accordance with the applicable legislation, a contractual stability compensation (CMEC) was granted to EDP Group. Themechanism for granting g the compensation includes three types of compensation: initial compensation, compensation resulting from the revisable mechanism andfinal compensation.Initial compensation was recognised when the PPAs terminated as an account receivable of 833,467 thousands of Euros, booked at its net present value, againstdeferred income. Part of the initial compensation is recognised as operating income each year against a reduction of the deferred initial compensation. According tothe applicable legislation, securitization of this amount is possible. Compensation resulting from the revisable mechanism refers to the correction of the initialcompensation for each year considering the actual conditions and is recognised as a loss or gain in the year to which it relates. Final compensation will be calculatedin accordance with the terms defined by the legislation relating to the termination of the PPAs, after termination of the revisable mechanism period (10 years). Interestresulting from the discount rate used is booked in the period to which it relates, based on the respective implicit rate, against income for each period.Contractual Stability Compensation – Revisable mechanismThe revisable mechanism consists in correcting on an annual basis, for a period of 10 years after termination of the PPAs, the positive and negative variations betweenthe estimates made to calculate the initial stability compensation for a period and the actual amounts occurred in the market for that period. This mechanism givesrise to compensation resulting from the correction of the estimate referred to as CMEC revisable mechanism. In each period, the EDP Group calculates the CMECconsidering market prices and the actual quantities sold, using the assumptions defined in the Valorágua model, according to the current legislation. Consequently,the use of different methodologies or assumptions from the used model, could give rise to different financial results from those considered.Review of the useful life of the assetsIn 2010 EDP Gestão de Produção, S.A. reviewed the useful lives of the hydroelectric and thermoelectric generating assets which, consequently, led to a prospectivechange in the depreciation charge of the period.The useful lives of the hydroelectric power plants were redefined based on an assessment performed by an external entity of the corresponding equipment,considering its current conservation state and the future maintenance plan. Based on this information, the remaining useful lives were identified for each asset, beingthe maximum term established at the corresponding final date of the public hydric domain associated to each hydroelectric power plant. This analysis considered theuse of estimates and judgement in order to determine the useful lives of these assets.In the second quarter of 2011 EDPR Group changed the useful life of the wind farms from 20 to 25 years. The redefinition of the useful life of the wind generation assetswas based on a technical study performed by an independent entity which considered the technical availability for an additional period of 5 years of useful life ofthese assets. The referred study covered 95% of wind installed capacity of EDPR Group, in the different geographies (Europe and North America), consideringassumptions and estimates that required judgement.188A World Full Of Energy