6. ESTIMATES AND ASSUMPTIONS

The preparation of the consolidated financial statements entails that management make estimates and assumptions which, under certain circumstances, are based on difficult and subjective assessments and estimates that are based on historical experience, and assumptions that are periodically considered reasonable and realistic in light of the circumstances. The results that actually emerge could therefore differ from such estimates. Estimates and assumptions are reviewed regularly and the effects of each change made to them are recognised in the Income Statement for the year when the estimate is revised if the revision itself only affects that year, or also in subsequent periods if the revision affects both the current period and future ones.

In this context it is important to note that the situation caused by the current economic and financial crisis has entailed making extremely uncertain assumptions about future performance. Therefore, it cannot be ruled out that next year’s results will be different from those estimated and that adjustments to the carrying value of the relevant items might be necessary, including significant adjustments, which obviously cannot be estimated or foreseen at this time. Such estimates affect the carrying amounts of certain assets and liabilities, costs and revenues, and also disclosures relating to contingent assets/liabilities at the reporting date.

The estimates and assumptions relate mainly to assessments of the recoverability of intangible assets, to the definition of the useful lives of property, plant and equipment, to the recoverability of receivables and to the recognition/measurement of provisions, pension schemes and other post-employment benefits and are based on data that reflect the current state of available knowledge.

 

Estimates entailing greater subjectivity and having a particularly material impact

What follows is a brief description of the accounting policies that, more than others, require management to exercise greater subjectivity in the calculation of estimates, and for which a change in the conditions underlying the assumptions used could have a material impact on the Consolidated Financial Statements, or for which there is a risk that material adjustments to the carrying amount of assets and liabilities may emerge in the year subsequent to the reference period.

Goodwill

In accordance with the accounting standards adopted for preparation of the financial statements, goodwill is tested annually in order to ascertain the existence of any impairment losses to be recognised in the Income Statement. In particular, the test in question entails allocation of goodwill to cash generating units and subsequent determination of their recoverable amount, understood as the greater of fair value and value in use.

If the recoverable amount proves to be less than the carrying amount of the cash generating units, the goodwill allocated to them must be impaired. Determination of the recoverable amount of the cash generating units entails using estimates that depend on subjective assessments and on factors that can change over time, with consequent and possibly material effects on the measurements made by management.

Impairment of property, plant and equipment and intangible asets

In accordance with the reference accounting standards, non-current assets are tested to ascertain whether there has been an impairment loss, which must be recognised through impairment, when there are signs that difficulties are to be expected for recovery of their net carrying amount through use. Testing whether these symptoms exist requires that the directors use subjective assessments based on information available from both internal and external sources, and on historical experience. Moreover, if it is determined that a potential impairment loss may be generated, this loss is calculated using appropriate measurement techniques.

The proper identification of elements indicating the existence of a potential impairment loss, and the estimates for calculating the amount of such losses, depend on subjective assessments and factors that may vary over time, affecting the assessments and estimates made by management.

Pension plans and other post-employment benefits

Group companies have set up pension plans, healthcare plans and other defined benefit plans for their employees, mainly in the United States, the United Kingdom and Italy.

Management uses different actuarial assumptions to calculate the liabilities and the expected returns on plan assets. Actuarial assumptions of a financial nature regard the discount rate, the expected return on plan assets, the rates of future salary increases and trends in healthcare costs.

Demographic actuarial assumptions regard essentially the rates of mortality, disability and resignations.

The Group has identified discounting rates deemed to be balanced, considering the context.

Deferred taxes assets

Deferred tax assets are accounted for on the basis of expected future taxable earnings. The measurement of future earnings to account for deferred taxes depends on factors that may change over time and materially impact the measurement of deferred tax assets.

The determination of such deferred taxes reflects budget figures and plans consistent with those used for the impairment tests and described in the previous paragraph in relation to the recoverable amount of non-current assets. Moreover, it is believed that the deferred taxes recognised adequately cover the risk of further worsening in the plan assumptions, considering that the recognised net deferred tax assets refer to temporary differences or tax losses for which a significant amount can be recovered over a very long period of time (without limit for the deferred tax assets on tax losses carried forward from the Italian tax consolidation of Pirelli & C. S.p.A., recognised at December 31, 2011 in the amount of euro 128,092 thousand, following amendments to tax laws governing the use of such losses, which represent 64% of all deferred tax assets), and thus compatible with a situation where emergence from the financial crisis and economic recovery will extend beyond the implicit time horizon of the aforementioned plans.

Provisions for liabilities and charges

Provisions are set aside against contingent legal and fiscal liabilities, representing the risk of losing lawsuits. The amount of provisions recognised in relation to these liabilities represents the best estimate at the reporting date made by management for lawsuits and tax claims regarding a vast range of issues which are subject to the jurisdiction of various countries. Such an estimate entails making assumptions that depend on factors that may change over time and which could therefore have a material impact with respect to the current estimates made by management for preparation of the Consolidated Financial Statements.