Hydro Annual Report 2011b

FINANCIAL STATEMENTS
Note 4 - Critical accounting judgment and key sources of estimation uncertainty F17
impacts the magnitude of changes in estimated fair value, which can be substantial, in particular on long-term contracts.
Historically, financial and commodity markets have been highly volatile.
Employee retirement plans
Hydro provides both defined benefit employee retirement plans and defined contribution plans. A declining, but still
significant share is defined benefit plans. Measurement of pension cost and obligations under such plans require numerous
assumptions and estimates that can have a significant impact on the recognized pension cost and obligation, such as future
salary levels, discount rates, turnover rate, and the rate of return on plan assets.
The discount rate is based on the yield from a portfolio of long-term debt instruments. Hydro provides defined benefit plans in
several countries and in various economic environments that affects the actual discount rate applied. Around 70 percent of
Hydro's projected benefit obligation (PBO) relates to Norway. The discount rate applied for Norwegian plans as of December
31, 2011 was 2.5 percent, based on government bond yield as required by IAS 19 Employee Benefits. The discount rates
applied in Germany and the UK are based on high quality corporate bonds, which are available in those markets. Hydro's
weighted average discount rates used are 4.9 percent for the main German plans and 4.7 percent for the main UK plans.
Hydro's weighted average discount rate declined by 0.9 percentage points in 2011 due to decreased interest levels. Around 85
percent of plan assets relates to Norway. The expected rate of return on plan assets is determined to be approximately 1.5
percentage points above the yield on government bonds in Norway. Assumptions for salary increase in the remaining service
period for active plan participants are based on expected salary increases for each country or economic area. Hydro expects a
somewhat lower salary increase for our Norwegian activities compared to the average development in Norway, based on the
challenged profitability and international competition in our industry.
Changes in these assumptions can influence the funded status of the plan as well as the net periodic pension cost. Hydro
incurred an actuarial loss of NOK 1,817 million for the year, mainly resulting from reduced discount rates. Actual return on
plan assets was NOK 292 million below the estimated return for the year. The PBO is sensitive to changes in assumed discount
rates and assumed compensation rates. Based on indicative sensitivities calculated for the Norwegian plans, a 0.5 percentage
point reduction or increase in the discount rate will increase or decrease the PBO in the range of 8 percent, for 2011 this is
around NOK 1.6 billion. A 0.5 percentage point reduction or increase in compensation rates for all plan member categories in
Norway will also decrease or increase the PBO in the range of 8 percent. The PBO is also sensitive to demographic
assumptions. An indicative sensitivity for change in mortality assumptions indicates that a one year increase in expected life for
each plan member increases the PBO with around 5 percent, for 2011 around NOK 1.0 billion. Changes in the
aforementioned parameters and changes in the PBO will affect net periodic pension cost in subsequent periods, both the
service cost and interest cost components, in addition to the amortization of any unrecognized net gains or losses.
Business combinations and goodwill
In a business combination consideration, assets and liabilities are recognized at fair value, and any excess purchase price
included in goodwill. Where Hydro had an existing ownership interest in the acquiree that interest is also reassessed to
determine its acquisition date estimated fair value, resulting in the acquisition date gain or loss. In the businesses Hydro
operates, fair values of individual assets and liabilities are normally not readily observable in active markets. This requires the
use of valuation models to estimate the fair value of acquired assets and liabilities. Such valuations are subject to numerous
assumptions including the useful lives of assets, replacement costs and the timing and amounts of certain future cash flows,
which may be dependent on future commodity prices, currency rates, discount rates and other factors.
In accordance with IAS 36, goodwill and certain intangible assets are reviewed at least annually for impairment. See discussion
above about impairment of non-current assets relating to the determination of a CGU and valuation principles and
methodologies.
Contingencies, uncertain liabilities and environmental liabilities
Liabilities that are uncertain in timing or amount are recognized when a liability arises from a past event and an outflow of cash
or other resources is probable and can be reasonably estimated. Contingent liabilities are possible obligations where a future
event will determine whether Hydro will be required to make a payment to settle the liability, or where the size of the payment
cannot be determined reliably. Contingent liabilities are disclosed unless a future payment is considered remote. Evaluation of
uncertain liabilities and contingencies requires judgment and assumptions regarding the probability of realization and the
timing and amount or range of amounts that may ultimately be incurred. Such estimates may vary from the ultimate outcome
as a result of differing interpretations of laws and the assessment of damages. Environmental liabilities and asset retirement