Operating and Financial Review and Prospects
44
Ahold Annual Report 2003
Operating and Financial Review and Prospects
Income tax/deferred tax
We operate in various tax jurisdictions in the U.S.,
Europe, South America and Asia Pacific. Each of these
jurisdictions utilize a set of tax laws with which we are
required to comply and we are subject to challenges by
any of the residing tax authorities. The carrying value of
our net deferred tax assets reflects our estimate that we
will be able to generate sufficient future taxable income
in certain tax jurisdictions, based on estimates and
assumptions, and continue operating under the current
and future presently enacted tax rates. We believe the
accounting estimate related to deferred tax is a critical
accounting estimate because any changes to these
assumptions and estimates in the future could cause us
to record additional valuation allowances against our
deferred tax assets, resulting in an additional income tax
expense in our consolidated statement of operations.
The estimate for deferred taxes is a critical accounting
estimate for all of our segments.
Management evaluates the likelihood that deferred
tax assets will be realized and assesses the need for
additional valuation allowances at the end of each
quarter. As of year-end 2003, we had a deferred tax
asset of approximately EUR 1.1 billion under Dutch
GAAP and EUR 1.5 billion under US GAAP, which
related primarily to operating loss carry-forwards,
capitalized lease commitments, benefit plans and
provisions not yet deductible. Because it is not probable
that all the deferred tax assets will be fully realized, we
recorded EUR 377 million of valuation allowances under
Dutch GAAP and EUR 391 under US GAAP related to
these deferred tax assets.
Financial instruments and other financing activities
Under Dutch GAAP, derivative instruments designated
and qualifying as hedges under applicable hedge
accounting rules are not included in our balance sheet;
rather, any associated gains or losses on the instruments
are deferred and are recognized in the statement of
operations in the same period in which the underlying
hedged exposure affects earnings. Derivatives to hedge
firm commitments and forecasted future transactions
are not accounted for until the firm commitment or
forecasted transaction occurs.
Under US GAAP, SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS No.
133"), was adopted by us as of January 1, 2001. SFAS
No. 133 establishes accounting and reporting standards
for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging
activities. SFAS No. 133 requires that all derivatives be
recognized as either assets or liabilities in the consolidated
balance sheet and measured at fair value. Depending on
the documented designation of a derivative instrument,
any change in fair value is recognized either in income or
shareholders' equity (as a component of accumulated
other comprehensive income ("OCI")).
Management's judgment is required to determine
if a transaction meets the definition of a derivative and,
if so, whether the normal sales and purchases exception
applies or whether individual transactions qualify for
hedge accounting. Determining the fair value of
derivatives under SFAS No. 133 is a critical accounting
estimate because the fair value of a derivative is
susceptible to significant change resulting from a
number of factors, including foreign currency exchange
rates and interest rates. For a discussion of our
exposure to currency exchange and interest rate
fluctuations, please see "Risk Factors - Unfavorable
currency exchange fluctuations could have a material
adverse effect on our financial condition, results of
operations and liquidity" and "Risk Factors - We face
risks related to fluctuations in interest rates."
SFAS No. 133 prescribes requirements for
designation and documentation of hedging relationships
and ongoing retrospective and prospective assessments
of effectiveness in order to qualify for hedge accounting.
Hedge accounting is considered to be appropriate if the
assessment of hedge effectiveness indicates that the
change in fair value of the designated hedging
instrument is highly effective at offsetting the change in
fair value due to the hedged risk of the hedged item or
transaction. Measurement of amounts to be recorded in
income due to hedge ineffectiveness is based on the
dollar-offset method as required by SFAS No. 133.
Contracts that do not in their entirety meet the
definition of a derivative in their entirety may contain
embedded derivative instruments. If certain conditions
are met, SFAS No. 133 requires an embedded derivative
to be separated from its host contract and accounted for
separately at fair value.
Changes in the fair value of derivatives, classified
as fair value hedges, that hedge interest rate risk are
recorded in net financial expense each period with the
offsetting changes in the fair values of the related debt
are also recorded in net financial expense. For 2003
and 2002, we did not recognize any ineffectiveness
related to fair-value hedges. All components of our
interest rate swap gains or losses were included in the
assessment of hedge effectiveness.
The effects of hedges of financial instruments in
foreign currency-denominated cash receipts are
reported in net financial expense, and the effects of
hedges of payments are reported in the same line item
of the underlying payment. The effects of hedges of
commodity prices are reported in cost of sales. In 2003,
hedge ineffectiveness for cash flow hedges resulted in
less than EUR 1 being recognized in the consolidated
statements of operations and no amounts were
reclassified to earnings for forecasted transactions that
did not occur. During 2003, we reclassified a loss of
EUR 9 million (net of a EUR 3 million tax benefit) from
OCI to other financial income and expense related to its
cash flow hedges. Cash flow hedge results are
reclassified into earnings during the same period in
which the related exposure impacts earnings. If a
hedged forecasted transaction is no longer probable of
occurring, application of hedge accounting ceases and
amounts previously deferred in accumulated other
comprehensive income are frozen and reclassified to
