UPM annual report 2014

Environmental provisions Operations of the Group are based on heavy process industry which requires large production facilities. In addition to basic raw materials, considerable amount of chemicals, water and energy is used in processes. The Group’s operations are subject to several environmental laws and regulations. The Group aims to operate in compliance with regulations related to the treatment of waste water, air emissions and landfill sites. The Group has provisions for normal environmental remediation costs. Unexpected events occurred during production processes and waste treatment could cause material losses and additional costs in the Group’s operations. Provisions are disclosed in Note 30. Income taxes Management judgement is required for the calculation of provision for income taxes and deferred tax assets and liabilities. The Group reviews at each balance sheet date the carrying amount of deferred tax assets. The Group considers whether it is probable that the subsidiaries will have sufficient taxable profits against which the unused tax losses or unused tax credits can be utilised. The factors used in estimates may differ from actual outcome which could lead to significant adjustment to deferred tax assets recognised in the income statement. Income taxes are disclosed in Note 13 and deferred income taxes in Note 28. Legal contingencies Management judgement is required in measurement and recognition of provisions related to pending litigation. Provisions are recorded when the Group has a present legal or constructive obligation as a result of past event, an unfavourable outcome is probable and the amount of loss can be reasonably estimated. Due to inherent uncertain nature of litigation, the actual losses may differ significantly from the originally estimated provision. Details of legal contingencies are presented in Note 39. Available-for-sale investments Group's available-for-sale investments include investments in unlisted equity shares that are measured at fair value in the balance sheet. The fair valuation requires management's assumptions and estimates of number of factors (e.g. discount rates, electricity price, start-up schedule of Olkiluoto 3 nuclear power plant), that may differ from the actual outcome which could lead to significant adjustment to the carrying amount of the available-for-sale investment and equity. Fair value esti- mation of financial assets is disclosed in Note 3 and available-for-sale investments in Note 22. The Group’s activities expose it to a variety of financial risks: market risk (including foreign exchange risk and interest rate risk), credit risk and liquidity risk. The objective of financial risk management is to protect the Group from unfavourable changes in financial markets and thus help to secure profitability. The objectives and limits for financing activities are defined in the Group Treasury Policy approved by the company’s Board of Directors. In financial risk management various financial instruments are used within the limits specified in the Group Treasury Policy. Only such instruments whose market value and risk profile can be continuously and reliably monitored are used for this purpose. Financial services are provided and financial risk management car- ried out by a central treasury department, Treasury and Risk Manage- ment (TRM). The centralisation of Treasury functions enables efficient financial risk management, cost-efficiency and efficient cash manage- ment. Foreign exchange risk The Group is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the USD the GBP and the JPY. Foreign exchange risk arises from future commercial transactions, from recognised assets and liabilities and from translation exposure. 3 Financial risk management

New and revised standards, interpretations and amendments to existing standards that are not yet effective and have not yet been early adopted by the Group IFRS 9 Financial Instruments includes requirements for classification, measurement and recognition of financial assets and financial liabilities. The complete version of IFRS 9 was issued in July 2014 and it replaces the guidance in IAS 39 that relates to the classification and measurement of financial instruments. IFRS 9 retains but simplifies the mixed measurement model and establishes three primary measurement categories for financial assets: amortised cost, fair value through other comprehensive income and fair value through profit or loss. The basis of classification depends on the entity’s business model and the contractual cash flow characteristics of the financial asset. Investments in equity instruments are required to be measured at fair value through profit or loss with the irrevocable option at inception to present changes in fair value in other comprehensive income not recycling. There is a new expected credit loss model that replaces the incurred loss impairment model used in IAS 39. The accounting and presentation for financial liabilities remained the same except for the recognition of changes in own credit risk in other comprehensive income for liabilities designated at fair value through profit or loss. IFRS 9 relaxes the requirements for hedge effectiveness by replacing the bright line hedge effectiveness tests. It requires an economic relationship between the hedged item and hedging instrument and for the hedged ratio to be the same as the one management actually use for risk management purposes. The standards is effective for accounting periods beginning on or after 1 January 2018. IFRS 9 standard is expected to have some impacts on accounting for Group's financial assets. The standard is not yet endorsed by the EU. IFRS 15 Revenues from contracts with customers deals with revenue recognition and establishes principles for reporting useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contracts with customers. Revenue is recognised when a customer obtains control of a good or service and thus has the ability to direct the use and obtain the benefits from the good or service. The standard replaces IAS 18 Revenue and IAS 11 Construction contracts and related Interpretations. The standard is effective for periods beginning on or after 1 January 2017. The Group is assessing the impact of IFRS 15. The standard is not yet endorsed by the EU. Amendments to IAS 19 Defined benefit plans: employee contribu- tions are effective for annual periods beginning on or after 1 July 2014. The amendments clarify the requirements that relate to how contribu- tions from employees or third parties that are linked to service should be attributed to periods of service. In addition, it permits a practical expe- dient if the amount of the contributions is independent of the number of years of service. The amendments are not expected to have material impacts on the Group’s financial statements. Annual improvements to IFRSs 2010–2012 cycle, a collection of amendments to IFRSs, in response to issues addressed during the 2010– 2012 cycle are effective for annual periods beginning on or after 1 July 2014. Seven standards are affected by the amendments. The amendments are not expected to have material impacts on the Group’s financial state- ments. Annual improvements to IFRSs 2011–2013 cycle, a collection of amendments to IFRSs, in response to issues addressed during the 2011– 2013 cycle are effective for annual periods beginning on or after 1 July 2014. Four standards are affected by the amendments. The amendments are not expected to have material impacts on the Group’s financial state- ments. Annual Improvements to IFRSs 2012–2014 cycle, a collection of amendments to IFRSs, in response to issues raised during the 2012-2014 cycle are effective for annual periods beginning on or after 1 January 2016. Four standards are affected by the amendments. The amendments are not expected to have material impacts on the Group's financial state- ments. The amendments are not yet endorsed by the EU. Amendment to IFRS 11 Joint arrangements is effective for annual periods beginning on or after 1 January 2016. The amendment provides guidance on how to account for the acquisition of an interest in a joint operation that constitutes a business. The amendments are not yet endorsed by the EU.

Amendment to IAS 16 Property, plant and equipment and IAS 38 Intangible assets regarding depreciation and amortisation are effective for annual periods beginning on or after 1 January 2016. The amend- ment clarifies that the use of revenue-based methods to calculate the depreciation of an asset is not appropriate. The amendments are not expected to impact on the Group’s financial statements. The amend- ments are not yet endorsed by the EU. Amendment to IFRS 10 and IAS 28 address an acknowledged inconsistency between the requirements in IFRS 10 and those in IAS 28, in dealing with the sale or contribution of assets between an investor and its associate or joint venture. The amendments are prospective and are effective from 1 January 2016. The amendments are not yet endorsed by the EU. Amendment to IAS 1 Presentation of financial statements is part of IASB major initiative to improve presentation and disclosures in finan- cial reports. The amendment is effective for annual periods beginning on or after 1 January 2016. The amendments are not expected to have mate- rial impacts on the Group’s financial statements. The amendments are not yet endorsed by the EU. There are no other IFRSs or IFRIC interpretations that are not yet effective that would be expected to have an impact on the Group. 2 Critical judgements in applying accounting policies and key sources of estimation uncertainty Impairment of non-current assets Goodwill, intangible assets not yet available for use and intangible assets with indefinite useful lives are tested at least annually for impairment. Other long-lived assets are reviewed when there is an indication that impairment may have occurred. Estimates are made of the future cash flows expected to result from the use of the asset and its eventual dispos- al. If the balance sheet carrying amount of the asset exceeds its recover- able amount, an impairment loss is recognised. Actual cash flows could vary from estimated discounted future cash flows. The long useful lives of assets, changes in estimated future sales prices of products, changes in product costs and changes in the discount rates used could lead to signif- icant impairment charges. Details of the impairment tests are provided in Note 16. Biological assets The Group owns about 1.1 million hectares of forest land and planta- tions. Biological assets (i.e. living trees) are measured at their fair value at each balance sheet date. The fair value of biological assets other than young seedling stands is based on discounted cash flows from continuous operations. The fair value of biological assets is determined based among other estimates on growth potential, harvesting, price develop- ment and discount rate. Changes in any estimates could lead to recogni- tion of significant fair value changes in income statement. Biological assets are disclosed in Note 20. Employee benefits The Group operates a mixture of pension and other post-employment benefit schemes. Several statistical and other actuarial assumptions are used in calculating the expense and liability related to the plans. These factors include, among others, assumptions about the discount rate, expected return on plan assets and changes in future compensation. Statistical information used may differ materially from actual results due to, among others, changing market and economic conditions, or changes in service period of plan participants. Significant differences in actual experience or significant changes in assumptions may affect the future amounts of the defined benefit obligation and future expense. Retire- ment benefit obligations are disclosed in Note 29.

The objective of foreign exchange risk management is to limit the uncertainty created by changes in foreign exchange rates on the future value of cash flows and earnings as well as in the Group’s balance sheet by hedging foreign exchange risk in forecast cash flows and balance sheet exposures. Transaction exposure The Group hedges transaction exposure related to highly probable future commercial foreign currency cash flows on a rolling basis over the next 12-month period based on the units’ forecasts. According to the Group’s Treasury Policy 50% hedging is considered risk neutral. Some highly probable cash flows have been hedged for longer than 12 months ahead while deviating from the risk neutral hedging level at the same time. Forward contracts are used in transaction exposure management. Most of the derivatives entered into to hedge foreign currency cash flows meet the hedge accounting requirements. At 31 December 2014, 47% (46%) of the forecast 12-month currency flow was hedged. The table below shows the nominal values of all cash flow hedging instruments at 31 December 2014 and 2013

Nominal values of hedging instruments

2014 EURm

2013 EURm

Currency

USD GBP

439 288 134

462 196 142

JPY

AUD

45

41 10

Others

1

Total

907

851

External forwards are designated at group level as hedges of foreign exchange risk of specific future foreign currency sales on gross basis. The Group has several currency denominated assets and liabilities in its balance sheet such as foreign currency loans and deposits, accounts payable and receivable and cash in other currencies than functional cur- rency. The aim is to hedge this balance sheet exposure fully using finan- cial instruments. The Group might, however, within the limits set in the Group Treasury Policy have unhedged balance sheet exposures. At 31 December 2014 unhedged balance sheet exposures in interest-bearing assets and liabilities amounted to EUR 18 million (7 million). In addi- tion the Group has non-interest-bearing accounts receivable and payable balances denominated in foreign currencies. The nominal values of the hedging instruments used in accounts payable and receivable hedging were EUR 575 million (675 million). Translation exposure The Group has net investments in foreign subsidiaries that are subject to foreign currency translation differences. The exchange risks associated with net investments in foreign subsidiaries are hedged in Canada and Uruguay. The net investments of all other foreign operations are not hedged. Foreign exchange risk sensitivity At 31 December 2014, if Euro had weakened/strengthened by 10% against the USD with all other variables held constant, pre-tax profit for the year would have been EUR 11 million (8 million) lower/higher due to balance sheet foreign exchange exposure. The effect in equity would have been EUR 36 million (42 million) lower/higher, arising mainly from foreign currency forwards used to hedge forecasted foreign currency flows. As of 31 December 2014, if Euro had weakened/strengthened by 10% against the GBP with all other variables held constant, pre-tax profit for the year would have been EUR 0 million (0 million) higher/ lower due to balance sheet foreign exchange exposure. The effect in equity would have been EUR 29 million (20 million) lower/higher, aris- ing mainly from foreign currency forwards used to hedge forecasted for- eign currency flows. As of 31 December 2014, if Euro had weakened/strengthened by 10% against the JPY with all other variables held constant, pre-tax profit for the year would have been EUR 2 million (1 million) higher/lower.

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ACCOUNTS

91

92

UPM Annual Report 2014

UPM Annual Report 2014