Frontpage Financial statements Notes to the consolidated financial statements Note 1

Notes to the consolidated financial statements

NOTE 1

Accounting policies for the consolidated financial statements

Basic information about the company

Kesko is the leading provider of trading sector services and a highly valued listed company. Kesko has about 2,000 stores engaged in chain operations in the Nordic and Baltic countries, Russia and Belarus.

The Kesko Group’s reportable segments consist of its business divisions, namely the food trade, the home and speciality goods trade, the building and home improvement trade, and the car and machinery trade.

The Group’s parent company, Kesko Corporation, is a Finnish public limited company constituted in accordance with the laws of Finland. The company’s business ID is 0109862-8, it is domiciled in Helsinki, and its registered address is Satamakatu 3, FI-00016 KESKO. Copies of Kesko Corporation’s financial statements and the consolidated financial statements are available from Kesko Corporation, Satamakatu 3, Helsinki, and via the internet, at www.kesko.fi.

Kesko’s Board of Directors has approved these financial statements for disclosure on 2 February 2011.

GENERAL INFORMATION

Kesko’s consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) approved for adoption by the European Union, and they comply with the IAS and IFRS standards and respective IFRIC and SIC Interpretations valid at 31 December 2010. The International Reporting Standards refer to standards and their interpretations approved for adoption within the EU in accordance with the procedure enacted in EC regulation 1606/2002, included in the Finnish Accounting Standards and regulations based on them. Accounting standards not yet effective have not been adopted voluntarily for the consolidated financial statements. The notes to the consolidated financial statements also include compliance with the Finnish accounting and corporate legislation.

All amounts in the consolidated financial statements are in millions of euros and based on original cost, with the exception of items identified below, which have been measured at fair value in compliance with the standards.

With effect from 1 January 2010, the Group has adopted the following new and revised standards:

IFRS 3 Business Combinations (revised)

The revised standard continues to apply the acquisition method to business combinations but with some significant changes. For example, all payments to purchase a business are recorded at fair value at the acquisition date, with contingent payments classified as debt subsequently remeasured through the statement of comprehensive income. There is a choice on an acquisition-by-acquisition basis to measure the non-controlling interest in the acquiree either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s net assets. All acquisition-related costs are expensed. The revised standard has had no impact on the consolidated financial statements.

IAS 27 Consolidated and Separate Financial Statements (revised)

The revised standard requires the effects of all transactions with non-controlling interests to be recorded in equity if there is no change in control and these transactions will no longer result in goodwill or gains and losses. The standard also specifies the accounting when control is lost. Any remaining interest in the entity is re-measured to fair value, and a gain or loss is recognised in profit or loss.

The Group has applied the revised standard to transactions with non-controlling interests since 1 January 2010. The revision has had no impact on the current period, as none of the non-controlling interests have a deficit balance; there have been no transactions whereby an interest in an entity is retained after the loss of control of that entity, and there have been no transactions with non-controlling interests.

The following revised or amended IFRS standards and IFRIC interpretations have had no impact on the consolidated financial statements:

  • IAS 39 Eligible Hedged Items (amendment)
  • IFRS 2 Share-based Payments: Cash-settled Share-based Payment Transactions (amendment)
  • IFRIC 9 and IAS 39, Reassessment of Embedded Derivatives on Reclassification (amendment)
  • IFRIC 12 Service Concession Arrangements
  • IFRIC 15 Agreements for the Construction of Real Estate
  • IFRIC 16 Hedges of a Net Investment in a Foreign Operation
  • IFRIC 17 Distributions of Non-cash Assets to Owners
  • IFRIC 18 Transfers of Assets from Customers

In addition, IASB issued improvements to 12 standards in April 2009 as part of its annual improvements project. These improvements had no impact on the consolidated financial statements.

CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

The preparation of consolidated financial statements in conformity with IFRS requires the use of certain estimates and assumptions about the future that affect the reported amounts of assets and liabilities, contingent liabilities, and income and expense. The actual results may differ from these estimates and assumptions. The most significant estimates relate to the following.

Allocation of cost of acquisition

Assets and liabilities acquired in business combinations are measured at their fair values at the date of acquisition. The fair values on which cost allocation is based are determined by reference to market values to the extent they are available. If market values are not available, the measurement is based on the estimated earnings-generating capacity of the asset and its future use in Kesko’s operating activities. The measurement of intangible assets, in particular, is based on the present values of future cash flows and requires management estimates regarding future cash flows and the use of assets.

Impairment test

The amounts recoverable from cash generating units’ operating activities are determined based on value-in-use calculations. In the calculations, forecast cash flows are based on financial plans approved by the management, covering a period of 3 years (note 14).

Employee benefits

The Group operates both defined contribution pension plans and defined benefit pension plans. The calculation of items relating to employee benefits requires the consideration of several factors. Pension calculations under defined benefit plans in compliance with IAS 19 include the following factors that rely on management estimates (note 20):

  • expected return on plan assets
  • discount rate used in calculating pension expenses and obligations for the period
  • future salary level trend
  • employee service life

Changes in these assumptions can significantly impact the amounts of pension liability and future pension expenses. In addition, a significant part of the pension plan assets is invested in real estate and shares, whose value adjustments also impact the amounts of liabilities and pension expenses.

Measurement of inventories

The Group regularly reviews inventories for obsolescence and turnover, and for below-cost market values, and recognises obsolescence as necessary. Such reviews require assessments of future demand for products. Possible changes in these estimates may cause changes in inventory measurement in future periods.

Trade receivables

The Group companies apply a uniform practice to measuring mature receivables. Possible changes in customers’ solvency may cause changes in the measurement of trade receivables in future periods.

Critical judgements in the application of the accounting policy

The Group’s management makes judgements concerning the adoption and application of the accounting policies to the financial statements. The management has used its judgement in selecting and applying the accounting policies, for example, to the measurement of assets and classification of leases.

Consolidation principles

Subsidiaries

The consolidated financial statements combine the financial statements of Kesko Corporation and subsidiaries controlled by the Group. Control exists when the Group owns more than 50% of the voting rights of a subsidiary or otherwise exerts control. Control refers to the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. Acquired subsidiaries are consolidated from the date on which the Group gains control until the date on which control ceases. The existence of potential voting rights that are currently exercisable have been considered when assessing whether the Group controls another entity. The subsidiaries are listed in note 44.

Internal shareholdings are eliminated by using the acquisition cost method. The cost of acquisition is determined on the basis of the fair value of the acquired assets as on the date of acquisition, the issued equity instruments and liabilities resulting from or assumed on the date of the exchange transaction. Direct acquisition-related costs were included in the cost of acquisition up to 1 January 2010. The identifiable assets, liabilities and contingent liabilities of the acquiree are measured at the fair value on the date of acquisition, gross of non-controlling interest.

Intra-group transactions, receivables and payables, unrealised gains and internal distribution of profits are eliminated when preparing the consolidated financial statements. Unrealised losses are not eliminated, if the loss is due to the impairment of an asset. Non-controlling interests in the net income are disclosed in the income statement and the amount of equity attributable to the non-controlling interests is disclosed separately in the Group’s equity.

The Group has applied the revised standards IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements starting from 1 January 2010. Subsequently, the Group has not acquired entities to be accounted for as business combinations. Consequently, the amendments have not affected the consolidated financial statements.

The Group accounts for its real estate company acquisitions as acquisitions of assets.

Associates

Associates are all entities over which the group has significant influence but not control. In the Kesko Group, significant influence accompanies a shareholding of between 20% and 50% of the voting rights. Investments in associates are accounted for using the equity method of accounting and are initially recognised at cost.

The Group’s share of its associates’ post-acquisition profits or losses is recognised in the income statement. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in an associate equals or exceeds its interest in the associate, the Group does not recognise further losses.

Unrealised gains on transactions between the group and its associates are eliminated to the extent of the group’s interest in the associates. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Dividends received from associates are deducted from the Group’s result and the cost of the shares. An investment in an associate includes the goodwill generated by the acquisition. Goodwill is not amortised. The associates are listed in note 44.

Mutual real estate companies

Mutual real estate companies are consolidated as assets under joint control on a line-by-line basis in proportion to ownership. The Group’s share of mutual real estate companies’ loans and reserves is accounted for separately in the consolidation. The jointly controlled mutual real estate companies combined on a line-by-line basis are listed in note 44.

Foreign currency items

The consolidated financial statements are presented in euros, which is both the functional currency of the Group’s parent company and the reporting currency. On initial recognition, the figures relating to the result and financial position of Group entities located outside the euro zone are recorded in the functional currency of their operating environment. The operating currency of the real estate companies in St. Petersburg and Moscow in Russia has been determined to be the euro, which is why no significant exchange differences are realised from their balance sheets for the Group.

Foreign currency transactions are recorded in euros by applying the exchange rate at the date of the transaction. Foreign currency receivables and liabilities are translated into euros using the closing rate. Gains and losses from foreign currency transactions and from receivables and liabilities are recognised in the income statement, with the exception of those loan exchange rate movements designated to provide a hedge against foreign net investments and regarded as effective. These exchange differences are recognised in equity, in compliance with the rules of hedge accounting, and their changes are presented in other comprehensive income. Foreign exchange gains and losses from operating activities are included in the respective items above operating profit. Gains and losses from forward foreign exchange contracts and options used to hedge financial transactions, and from foreign currency loans are included in financial income and expenses.

The income statements of Group entities operating outside the euro zone have been translated into euros at the average rate of the reporting period, and the balance sheets at the closing rate. The translation difference resulting from the use of different rates, and the translation differences arising from the elimination of the acquisition cost of subsidiaries outside the euro zone, and the hedging result of net investments made in them are recognised in equity, and the changes are presented in other comprehensive income. In connection with the disposal of a subsidiary, currency translation differences are disclosed in the income statement as part of the gains or losses on the disposal.

The goodwill arising from the acquisition of foreign units and the fair value adjustments of assets and liabilities made upon their acquisition have been treated as assets and liabilities of these foreign units and translated into euros at the closing rate.

Financial assets

The Group classifies financial assets in the following categories:

  • financial assets at fair value through profit or loss
  • available-for-sale financial assets
  • loans and receivables

The category is determined at initial recognition on the basis of why they were originally acquired.

Purchases and sales of financial assets are recognised using settlement date accounting. Financial assets are classified as non-current assets if they have a maturity date greater than twelve months after the balance sheet date. If financial assets are going to be held for less than 12 months, they are classified as current assets. Financial assets at fair value through profit or loss are classified as current assets.

Financial assets are derecognised when the contractual rights to the cash flow of the financial asset expire or have been transferred to another party, and when the risks and rewards of ownership have been transferred.

At each reporting date, the Group assesses whether there is any indication that a financial asset may be impaired. If any such indication exists, the recoverable amount of the asset is estimated. The recoverable amount is the fair value based on the market price or the present value of cash flows. The fair value of investment instruments is determined on the basis of a maturity-based interest rate quotation. An impairment loss is recognised if the carrying amount of a financial asset exceeds its recoverable amount. The impairment losses are recognised within the financial items of the income statement.

Financial assets at fair value through profit or loss

Financial assets at fair value through profit or loss include instruments initially classified as financial assets at fair value through profit or loss (the Fair Value Option). These instruments are accounted for based on fair value and they include investments in money market funds, as defined by the Group’s treasury policy, as well as investments in other interest-bearing instruments with over 3-month maturities. The interest income and fair value changes of these financial assets, as well as any commissions returned by funds are presented on a net basis in the income statement in the interest income of the category in question.

In addition, financial assets at fair value through profit or loss include all derivatives that do not qualify for hedge accounting in compliance with IAS 39. Derivatives are carried at fair value using prices quoted in active markets. The results of derivatives hedging purchases and sales are recognised in other operating income or expenses. The results of derivatives used to hedge financial items are recognised in financial items, unless the derivative has been designated as a hedging instrument.

Available-for-sale financial assets

Available-for-sale financial assets are non-derivative assets designated as available for sale at the date of initial recognition. Available-for-sale financial assets are measured at fair value at the balance sheet date and changes in fair value are recognised in equity, and the change is presented in other comprehensive income. The fair value of publicly quoted financial assets is determined based on their market value. Financial assets not quoted publicly are measured at cost if their fair values cannot be measured reliably.

The dividends from equity investments included in available-for-sale financial assets are recognised in financial items in the income statement. The interest income from available-for-sale financial assets is recognised in the financial items of the relevant class. When an available-for-sale financial asset is sold, the accumulated changes in fair value recognised in equity are included in the income statement as ‘Other financial income/expenses’.

Loans and receivables

Loans and receivables are non-derivative assets with fixed or measurable payments, and they are not quoted in active markets. Loans and receivables also include trade receivables and other receivables. They are recognised at amortised cost using the effective interest method.

Cash and cash equivalents

Cash and cash equivalents include cash on hand and balances with banks. The cash and cash equivalents in the consolidated balance sheet also include amounts relating to the retail operations of division parent companies, used as cash floats in stores, or amounts being transferred to the respective companies.

Financial liabilities

Financial liabilities have initially been recognised at their cost, net of transaction costs. In the financial statements, financial liabilities are measured at amortised cost using the effective interest rate method. The arrangement fees related to lines of credit are amortised over the validity period of the credit. Financial liabilities having a maturity period of over 12 months after the balance sheet date are classified as non-current liabilities. Those having a maturity period of less than 12 months after the balance sheet date are classified as current liabilities.

Derivative financial instruments and hedge accounting

When acquired, derivative financial instruments are carried at fair value and subsequently they are measured at fair value. The recognition of changes in the fair values of derivatives depends on whether the derivative financial instrument qualifies for hedge accounting, and if so, on the hedged item. When entered into, derivative financial instrumens are treated as fair value hedges of receivables or liabilities, or in the case of interest rate risk and electricity price risk, as cash flow hedges, as hedges of net investments in a stand-alone foreign entity, or as derivative financial instruments that do not meet the hedge accounting criteria. If the hedge accounting criteria are not met, the results of instruments hedging a commercial currency risk are recognised in profit or loss within other operating income or expenses. The portion of derivatives hedging financial transactions to be recognised in the income statement is included in financial items.

When a hedging arrangement is entered into, the relationship between the item being hedged and the hedging instrument, as well as the objectives of the Group’s risk management are documented. The effectiveness of the hedging relationship is tested regularly and the effective portion is recognised, against the change in the fair value of the hedged item, in translation differences in equity, or in the revaluation reserve. The ineffective portion is recognised in financial items or other operating income and expenses, depending on its nature. The effective portion of a change in the fair value of cash flow heding instruments, such as the long-term credit facility, is recognised in the revaluation reserve. A change in the fair value of forward foreign exchange contracts relating to the credit facility is recognised in the loan account and a change in the fair value of interest rate derivative contracts is recognised in other non-interest-bearing receivables or liabilities.

Hedge accounting is discontinued when the hedging instrument expires or is sold, the contract is terminated or exercised. Any cumulative gain or loss existing in equity remains in equity until the forecast transaction has occurred.

Measurement principles

The fair value of forward rate agreements is determined by reference to the market prices of the balance sheet date. The fair value of interest rate swaps is calculated on the basis of the present value of future cash flows, using the market prices at the balance sheet date. The fair value of forward foreign exchange contracts is determined by measuring the forward exchange contracts at the forward rate of the balance sheet date. Currency options are measured by using the counterparty’s price quotation, but the Group verifies the price with the help of the Black-Scholes method. Electricity derivatives are measured at fair value using the market quotations of the balance sheet date.

Hedging a net investment in a stand-alone foreign operation

The Group applies hedge accounting in accordance with IAS 39 to hedge foreign currency net investments in foreign operations. Forward foreign exchange contracts or foreign currency loans are used as hedging instruments. Spot price changes of forward foreign exchange contracts are recognised as translation differences under equity, and disclosed in components of comprehensive income. The interest rate differentials of forward exchange contracts are recognised as income within financial items. The exchange differences of foreign currency loans are stated as translation differences under equity. When a foreign operation is partially or totally disposed of or dissolved, the accumulated gains or losses on hedging instruments are recognised in profit or loss.

Embedded derivatives

The Group has prepared method descriptions for identifying embedded derivatives and applies fair value measurement to them. In the Kesko Group, embedded derivatives are included in firm commercial contracts denominated in a currency which is not the functional currency of either party and not commonly used in the economic environment in which the transaction takes place. The fair value of embedded derivatives is determined using the market prices of the measurement date and the change in the fair value is recognised in the income statement.

Property, plant and equipment

Property, plant and equipment mainly comprise land, buildings, machinery and equipment. Property, plant and equipment are carried at original cost net of planned depreciation and any impairment. The property, plant and equipment of acquired subsidiaries are measured at fair value at the date of acquisition.

Subsequent costs relating to items of property, plant and equipment are included in the asset’s carrying amount or recognised as a separate asset only when it is probable that future economic benefits associated with the item will flow to the group and the cost of the item can be measured reliably. The carrying amount of the replaced part is derecognised. The machinery and equipment of buildings are treated as separate assets and any significant expenditure related to their replacement is capitalised. All other repair, service and maintenance expenditures of items of property, plant and equipment are recognised as an expense as incurred.

Property, plant and equipment are written off on a straight-line basis during their estimated useful lives.

The most common estimated useful lives are:

Buildings
10–33 years
Components of buildings
8–10 years
Machinery and equipment
3–8 years
Cars and transport equipment
5 years


The residual values, useful lives and depreciation methods applied to property, plant and equipment are reviewed at least at the end of each accounting period. If the estimates of useful life and the expected pattern of economic benefits are different from previous estimates, the change in the estimate is accounted for in accordance with IAS 8.

The depreciation of property, plant and equipment ceases when the asset is classified as held for sale in accordance with IFRS 5. Land is not depreciated.

Gains and losses from sales and disposals of property, plant and equipment are recognised in the income statement and presented as other operating income and expenses.

Intangible assets

Goodwill and trademarks

Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net assets and liabilities of an enterprise at the date of the acquisition. The goodwill of business combinations entered into prior to 1 January 2004 corresponds to their carrying amounts reported in accordance with the previous accounting practices used as the deemed cost, in compliance with IFRS.

Goodwill is not amortised but tested annually for impairment and whenever there is an indication of impairment. For testing purposes goodwill is allocated to the cash generating units. Goodwill is measured at original cost and the share acquired prior to 1 January 2004 at deemed cost net of impairment. Any negative goodwill is immediately recognised as income in accordance with IFRS 3.

Intangible assets with indefinite useful lives are not amortised. They are tested for impairment annually and whenever there is an indication of impairment. These intangible assets include trademarks capitalised upon acquisition.

Other intangible assets

The cost of intangible assets with definite useful lives are stated in the balance sheet and recognised as expenses during their useful lives. Such intangible assets include software licences and customer relationships to which acquisition cost has been allocated upon acquisition, and leasehold interests that are amortised during their probable terms. The estimated useful lives are:

computer software and licences
3–5 years
customer and supplier relationships
10 years

Research and development expenses

The costs of research and development activities have been expensed as incurred. The Group does not have development costs eligible for capitalisation. Development costs previously recognised as an expense are not recognised as an asset in a subsequent period.

Computer software

The labour costs and other direct expenditure of the Group employees working on new software development projects are capitalised as part of the software cost. In the balance sheet, computer software is included in intangible assets and its cost is written off during the useful life of the software. Software maintenance expenditure is recognised as an expense as incurred.

Impairment of non-financial assets

At each reporting date, the Group assesses whether there is any indication that an asset may be impaired. If any such indication exists, the recoverable amount of the asset is estimated. The recoverable amount of goodwill and intangible assets with indefinite useful lives is assessed every year whether or not there is an indication of impairment. In addition, an impairment test is performed whenever there is an indication of impairment.

The recoverable amount is the higher rate of an asset’s fair value less the costs of disposal, and its value in use. Often it is not possible to assess the recoverable amount for an individual asset. Then, as in the case of goodwill, the recoverable amount is determined for the cash generating unit to which the goodwill or asset belongs.

An impairment loss is recognised if the carrying amount of an asset exceeds its recoverable amount. The impairment loss is disclosed in the income statement. An impairment loss recognised for an asset in prior years is reversed if there has been an increase in the reassessed recoverable amount. However, the reversal of an impairment loss of an asset should not exceed the carrying amount of the asset without impairment loss recognition. For goodwill, a recognised impairment loss is not reversed under any circumstances.

Leases

The Group acts as both lessor and lessee of real estate and machines. Leases in which risks and rewards incident to ownership are not transferred to the lessee are classified as operating leases. Lease payments related to them are recognised in the income statement on a straight-line basis over the lease term.

Leases that substantially transfer all the risks and rewards incident to ownership to the Group are classified as finance leases. An asset leased under a finance lease is recognised in the balance sheet at the lower rate of its fair value at the inception date and the present value of minimum lease payments. The rental obligations of finance leases are recorded in interest-bearing liabilities in the balance sheet. Lease payments are allocated between the interest expense and the liability. Finance lease assets are amortised over the shorter period of the useful life and the lease term.

Leases in which assets are leased out by the Group, and substantially all the risks and rewards incident to ownership are transferred to the lessee, are also classified as finance leases. Assets leased under such contracts are recognised as receivables in the balance sheet and are stated at present value. The financial income from finance leases is determined so as to achieve a constant periodic rate of return on the remaining net investment for the lease term.

In sale and leaseback transactions the sale price and the future lease payments are usually interdependent. If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount is not immediately recognised as income. Instead it is deferred and amortised over the lease term. If a sale and leaseback transaction results in an operating lease and the transaction is established at fair value, any profit or loss is recognised immediately.

If the sale price is below fair value, any profit or loss is recognised immediately unless the loss is compensated by future lease payments at below market price, in which case the loss is deferred and amortised over the period for which the asset is expected to be used. If the sale price is above fair value, the excess over fair value is deferred and amortised over the period for which the asset is expected to be used. If the fair value at the time of a sale and leaseback transaction is less than the carrying amount of the asset, a loss equal to the amount of the difference between the carrying amount and fair value is recognised immediately.

Inventories

Inventories are measured at the lower cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs to sell. The cost is primarily assigned by using the weighted average cost formula. The cost of certain classifications of inventory is assigned by using the FIFO formula. The cost of an acquired asset comprises all costs of purchase including freight. The cost of self-constructed goods comprise all costs of conversion including direct costs and allocations of variable and fixed production overheads.

Trade receivables

Trade receivables are recognised initially at the original sales amounts. Impairment is recognised when there is objective evidence of impairment loss. The Group has established a uniform basis for the determination of impairment of trade receivables based on the time receivables have been outstanding. In addition, impairment is recognised if there is other evidence of a debtor’s insolvency, bankruptcy or liquidation. Losses on loans and advances are recognised as an expense in the income statement as part of ‘Other operating expenses’.

Non-current assets held for sale and discontinued operations

Assets (or a disposal group) and assets and liabilities relating to discontinued operations are classified as held for sale, if their carrying amount will be recovered principally through the disposal of the assets rather than through continuing use. For this to be the case, the sale must be highly probable, the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary, the management must be committed to selling and the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification.

Non-current assets held for sale (or assets included in the disposal group) and assets and liabilities linked to a discontinuing operation are measured at the lower rate of the carrying amount and fair value net of costs to sell. After an asset has been classified as held for sale, or if it is included in the disposal group, it is not depreciated. If the classification criterion is not met, the classification is reversed and the asset is measured at the lower rate of the carrying amount prior to the classification less depreciation and impairment, and recoverable amount. A non-current asset held for sale and assets included in the disposal group classified as held for sale are disclosed separately in the balance sheet. Liabilities included in the disposal group of assets held for sale are also disclosed separately in the balance sheet. The profit from discontinued operations is disclosed as a separate line item in the income statement.

The comparative information in the income statement are adjusted for operations classified as discontinued during the latest financial period being reported. Consequently, the profit from discontinued operations is presented as a separate line item also for the comparatives. The Group did not have discontinued operations in the financial years 2010 and 2009.

Provisions

A provision is recognised 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 resources embodying economic benefits will be required to settle the obligation, and that a reliable estimate can be made of the amount of the obligation. Provision amounts are reviewed at each balance sheet date and adjusted to reflect the current best estimate. Changes in provisions are recorded in the income statement in the same item in which the provision was originally recognised. The most significant part of the Group’s provisions relates to warranties given to products sold by the Group, and to onerous leases.

A warranty provision is recognised when a product fulfilling the terms is sold. The provision amount is based on historical experience about the level of warranty expenses. Leases become onerous if the leased premises become vacant, or if they are subleased at a rate lower than the original. A provision is recognised for an estimated loss from vacant lease premises over the remaining lease term, and for losses from subleased premises.

Employee benefits

Pension plans

The Group has both defined contribution plans and defined benefit plans. The contributions payable under defined contribution plans are recognised as expenses in the income statement of the period to which the payments relate. In defined contribution plans, the Group does not have a legal or constructive obligation to make additional payments, in case the payment recipient is unable to pay the retirement benefits.

In defined benefit plans, after the Group has paid the amount for the period, an excess or deficit may result. The pension obligation represents the present value of future cash flows from payable benefits. The present value of pension obligations has been calculated using the Project Unit Credit Method. Pension costs are expensed during employees’ service lives based on actuarial calculations. The discount rate assumed in calculating the present value of the pension obligations is the market yield of high-quality bonds issued by companies. Their maturity substantially corresponds to the maturity of the calculated pension liability. The assets corresponding to the pension obligation of the retirement benefit plan are carried at fair values at the balance sheet date. Actuarial gains and losses are recognised in the income statement for the average remaining service lives of the employees participating in the plan to the extent that they exceed 10 percent of the higher rate of the present value of the defined benefit plans and the fair value of assets belonging to the plan.

Relating to the arrangements taken care of by the Kesko Pension Fund, the funded portion and the disability portion under the Finnish Employees’ Pension Act are treated as defined benefit plans. In addition, the Group operates a pension plan in Norway which is treated as a defined benefit plan. The plan is not significant for the Group. Other pension plans are treated as defined contribution plans.

Share-based payments

The share options granted as part of the Group management’s and other key personnel’s incentive and commitment programme are measured at fair value at the grant date and expensed on a straight-line basis over the option’s vesting period. The counter-item is recognised in retained earnings. The expenditure determined at the grant date is based on the Group’s estimate of the number of options expected to vest at the end of the vesting period. The Group updates the estimate of the final number of options at each balance sheet date. Any movements in estimates are recorded in the income statement. The fair value of the options has been calculated using the Black-Scholes option pricing model.

When share options are exercised, the proceeds received from share subscriptions, adjusted for possible transaction costs, are recognised in shareholders’ equity. Proceeds from share subscriptions based on options granted prior to the entry into force of the new Limited Liability Companies Act (1 Sept. 2006), have been recorded in shareholders’ equity and share premium, in accordance with the plan rules. The proceeds from share subscriptions based on option plans implemented after the new Limited Liability Companies Act entered into force are recorded in shareholders’ equity and the reserve of invested non-restricted equity, in accordance with the plan rules.

Revenue recognition policies

Net sales comprise the sale of products, services and energy. The amount of services and energy represent an insignificant portion of net sales.

For net sales, sales revenue is adjusted by indirect taxes, sales adjustment items and the exchange differences of foreign currency sales. Sales adjustment items take into account of the loyalty award credits relating to the K-Plussa customer loyalty programme, which are recognised at fair values as part of sales transactions. Loyalty award credits affect the net sales of those segments which grant K-Plussa customer loyalty credits and conduct retail operations.

The Group sells products to retailers and other retail dealers, and engages in own retailing. Revenue from the sale of goods is recognised when the significant risks, benefits and control relating to the ownership of the goods have transferred to the buyer, and it is probable that the economic benefits associated with the transaction will flow to the Group. Normally revenue from the sale of goods can be recognised at the time of delivery of the goods. Sales to retailers and other retail dealers are based on central invoicing. Retail sales are mainly on cash and credit card basis.

Revenue from the rendering of services is recognised after the service has been rendered and when a flow of economic benefits associated with the service is probable.

Interest is recognised as revenue on a time proportion basis using the effective interest method. Dividends are recognised as revenue when the right to receive payment is established.

Other operating income and expenses

Other operating income includes income other than that associated with the sale of goods or services, such as rent income, store site and chain fees and various other service fees and commissions. Profits and losses from the sale and disposal of property, plant and equipment are disclosed in other operating income and expenses. Other operating income and expenses also include realised and unrealised profits and losses from derivatives used to hedge currency risks of trade.

Excise taxes presented within other operating expenses in prior periods have been included in the cost of goods sold. The change has been applied retrospectively.

Borrowing costs

The Group has not capitalised interest costs as part of the cost of the asset, because the Group does not have qualifying assets.

Directly attributable transaction costs clearly associated with a certain borrowing are included in the original amortised cost of the borrowing and amortised to interest expense by using the effective interest method.

Income taxes

The taxes disclosed in the consolidated income statement recognise the Group companies’ taxes on current net profits on an accrual basis, prior period tax adjustments and changes in deferred taxes. The Group companies’ taxes are calculated from the taxable profit of each company determined by local jurisdiction.

Deferred tax assets and liabilities are recognised for all temporary differences between the tax bases and carrying amounts of assets and liabilities. Deferred tax has not been calculated on goodwill insofar as goodwill is not tax deductible. Deferred tax on subsidiaries’ undistributed earnings is not recognised unless a distribution of earnings is probable, causing tax consequences.

Deferred tax is calculated using tax rates enacted by the balance sheet date, and if the rates change, at the new rate expected to apply. A deferred tax asset is recognised to the extent that it is probable that it can be utilised against future taxable income. The Group’s deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority.

The most significant temporary differences arise from defined benefit plans, property, plant and equipment (depreciation difference, finance lease) and measurement at fair value of asset items in connection with business acquisitions.

Dividend distribution

The dividend proposed by the Board to the Annual General Meeting has not been deducted from equity. Instead dividends are recognised on the basis of the decision of the Annual General Meeting.

New IFRS standards and IFRIC interpretations and
amendments to the existing standards and interpretations

In addition to the standards and interpretations presented in the 2010 financial statements, the Group will adopt the following standards, interpretations and amendments to standards and interpretations issued for application in its 2011 financial statements.

IAS 24 Related Party Disclosures (revised)

The revised standard clarifies and simplifies the definition of a related party and removes the requirement for government-related entities to disclose details of all transactions with the government and other government-related entities. The standard will not have a material impact on the consolidated financial statements.

IAS 32 Financial Instruments: Presentation – Classification of Rights Issues (amendment)

The amendment addresses the accounting for rights issues that are denominated in a currency other than the functional currency of the issuer. The amendment will not have any impact on the consolidated financial statements.

IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments

The interpretation clarifies the accounting by an entity when the terms of a financial liability are renegotiated and result in the entity issuing equity instruments to a creditor of the entity to extinguish all or part of the financial liability (debt for equity swap). It requires a gain or loss to be recognised in profit or loss, which is measured as the difference between the carrying amount of the financial liability and the fair value of the equity instruments issued. If the fair value of the equity instruments issued cannot be reliably measured, the equity instruments should be measured to reflect the fair value of the financial liability extinguished. The standard will not have any impact on the consolidated financial statements.

IFRIC 14 Prepayments of a Minimum Funding Requirement (amendment)

The amendment corrects an unintended consequence of IFRIC 14, ‘IAS 19 – The limit on a defined benefit asset, minimum funding requirements and their interaction’. Without the amendments, entities are not permitted to recognise as an asset some voluntary prepayments for minimum funding contributions. This was not intended when IFRIC 14 was issued, and the amendments correct this. The standard will not have any impact on the consolidated financial statements.

In July 2010, IASB also issued improvements to seven existing standards or interpretations as part of its annual improvement project. These amendments have not yet been endorsed by the European Union. The Group will adopt the amendments in its consolidated financial statements for 2011 after they have been endorsed by the European Union. The following is a summary of the amendments which the Group’s management assesses to possibly have an impact on the consolidated financial statements.

IFRS 3 Business Combinations (amendments)

The amendment clarifies that the amendments to IFRS 7, Financial instruments: Disclosures, IAS 32, Financial instruments: Presentation, and IAS 39, Financial instruments: Recognition and measurement, that eliminate the exemption for contingent consideration, do not apply to contingent consideration that arose from business combinations whose acquisition dates precede the application of IFRS 3 revised.

The choice of measuring noncontrolling interests at fair value or at the proportionate share of the acquiree’s net assets applies only to instruments that represent present ownership interests and entitle their holders to a proportionate share of the net assets in the event of liquidation. All other components of noncontrolling interest are measured at fair value unless another measurement basis is required by IFRS. The application guidance in IFRS 3 applies to all share-based payment transactions that are part of a business combination, including unreplaced and voluntarily replaced share-based payment awards. The amendments will not have a material impact on the consolidated financial statements.

IFRS 7 Financial instruments: Disclosures (amendment)

The amendment emphasises the interaction between quantitative and qualitative disclosures about the nature and extent of risks associated with financial instruments. The amendment will not have a material impact on the consolidated financial statements.

IAS 34 Interim Financial Reporting (amendment)

The amendment provides guidance to illustrate how to apply disclosure principles in IAS 34 and add disclosure requirements around the circumstances likely to affect fair values of financial instruments and their classification, around transfers of financial instruments between different levels of the fair value hierarchy, around changes in classification of financial assets, and around changes in contingent liabilities and assets. The amendment will not have a material impact on the consolidated financial statements.

In 2012 or later, the Group will adopt the following standards, interpretations and amendments to existing standards:

IFRS 9 Financial Assets – Classification and Measurement

The part of IFRS 9 dealing with the classification and measurement of financial assets was issued in November 2009. It is the first step in the process to replace IAS 39, ‘Financial Instruments: Recognition and Measurement’ with a new standard. IFRS 9 introduces new requirements for classifying and measuring financial assets. The second part of IFRS 9 was issued in October 2010. It complements the first phase of the revision of IAS 39, ‘Financial Instruments: Recognition and Measurement’. The new standard retains the existing guidance regarding classifying and measuring financial liabilities, except for those liabilities where the fair value option has been elected.

The Group is likely to adopt the new standard in 2013 at the earliest provided that the amendment has been endorsed by the EU. The standard is likely to affect the Group’s accounting for its financial assets. It is estimated that the new standard will affect the Group’s accounting for available-for-sale debt assets. IFRS 9 only permits the recognition of fair value gains and losses in other comprehensive income, if they relate to equity investments that are not held for trading. Fair value gains and losses on available-for-sale debt investments, for example, will therefore have to be recognised directly in profit or loss.

IFRS 7 Financial Instruments: Financial Statement Disclosures (amendment)

The amendment adds disclosure requirements related to risk exposures derived from transferred assets. Additional disclosures, where financial assets have been derecognised but the entity is still exposed to certain risks and rewards associated with the transferred asset, are required. The amendment can increase the disclosures in the notes to financial statements in the future. The Group will adopt the amendment in its financial statements for 2012, provided that it has been endorsed by the EU. The Group’s management estimates that the amendment will not have a material impact on the consolidated financial statements.