ALFA GROUP
COMBINED FINANCIAL STATEMENTS AND AUDITORS’ REPORT
FOR THE YEAR ENDED 31 DECEMBER 2004
ALFA GROUP Combined Financial Statements For the year ended 31 December 2004
Table of Contents
Statement of Management’s Responsibilities
Auditors’ Report
Combined Balance Sheet...... 1 Combined Statement of Income ...... 2 Combined Statement of Cash Flows ...... 3 Combined Statement of Changes in Shareholders’ Equity...... 4
Notes to the Combined Financial Statements
1 Alfa Group...... 5 2 Operating Environment of the Group...... 6 3 Principal Accounting Policies ...... 7 4 Property, Plant and Equipment...... 17 5 Investment in Joint Ventures ...... 17 6 Investments in Associated Companies ...... 22 7 Investments Available for Sale...... 24 8 Loans and Advances to Customers...... 26 9 Due from Banks...... 27 10 Receivables and Other Assets...... 27 11 Trading Securities...... 28 12 Cash and Cash Equivalents...... 28 13 Share Capital and Share Premium ...... 29 14 Borrowings ...... 29 15 Customer Accounts ...... 31 16 Due to Banks ...... 31 17 Payables and Other Liabilities...... 32 18 Income Tax...... 32 19 Provisions on Operating Items ...... 35 20 Goodwill, Net ...... 35 21 Net Interest, Fees and Other Income on Banking Activities...... 36 22 Operating Expenses...... 36 23 Net Interest Expense on Non-banking Activities ...... 36 24 Minority Interest...... 37 25 Movements in Working Capital Balances ...... 37 26 Acquisition, Formation and Disposal of Subsidiaries...... 37 27 Analysis by Segment ...... 38 28 Fair Value of Financial Instruments ...... 42 29 Financial Risk Management ...... 42 30 Commitments and Derivative Financial Instruments...... 47 31 Contingent Liabilities ...... 50 32 Fiduciary Assets ...... 55 33 Related Party Transactions ...... 55 34 Principal Subsidiaries, Joint Ventures and Associated Companies ...... 58 35 Subsequent Events...... 59
STATEMENT OF MANAGEMENT’S RESPONSIBILITIES TO THE SHAREHOLDERS OF ALFA GROUP
1 International convention requires that Management prepare financial statements which give a true and fair view of the state of affairs of Alfa Group (the “Group”) at the end of each financial period and of the results, cash flows and changes in shareholders’ equity for each period. Management are responsible for ensuring that the Group keeps accounting records which disclose, with reasonable accuracy, the financial position of each entity and which enable it to ensure that the Group’s financial statements comply with International Financial Reporting Standards and that their statutory accounting reports comply with the applicable country’s laws and regulations. Furthermore, appropriate adjustments were made to such statutory accounts to present the accompanying combined financial statements in accordance with International Financial Reporting Standards. Management also have a general responsibility for taking such steps as are reasonably possible to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.
2 Management consider that, in preparing the combined financial statements set out on pages 1 to 60, the Group has used appropriate and consistently applied accounting policies, which are supported by reasonable and prudent judgments and estimates and that the appropriate International Financial Reporting Standards have been followed.
For and on behalf of Management
______Nigel J. Robinson 15 December 2006 ZAO PricewaterhouseCoopers Audit Kosmodamianskaya Nab. 52, Bld. 5 115054 Moscow Russia Telephone +7 (495) 967 6000 Facsimile +7 (495) 967 6001
AUDITORS’ REPORT
To the Management of Alfa Group:
We have audited the accompanying combined balance sheet of Alfa Group (the “Group” as defined in Note 1 to the combined financial statements) at 31 December 2004 and the related combined statements of income, of cash flows and of changes in shareholders’ equity for the year then ended. These combined financial statements are the responsibility of the Group’s Management. Our responsibility is to express an opinion on these combined financial statements based on our audit.
We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the combined financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the combined financial statements. An audit also includes assessing the accounting principles used and significant estimates made by Management, as well as evaluating the overall combined financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the accompanying combined financial statements present fairly, in all material respects, the combined financial position of the Group at 31 December 2004 and the combined results of its operations and its cash flows for the year then ended in accordance with International Financial Reporting Standards.
Moscow, Russian Federation 15 December 2006
The firm is an authorized licensee of the tradename and logo of PricewaterhouseCoopers. ALFA GROUP Combined Balance Sheet at 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
Note 2004 2003
ASSETS
Non-current assets Property, plant and equipment 4 390,109 359,804 Goodwill, net 20 14,596 4,783 Investment in joint ventures 5 1,507,733 2,170,968 Investments in associated companies 6 1,575,054 678,388 Investments available for sale 7 755,950 435,735 Loans and advances to customers 8 1,332,997 869,602 Due from banks 9 987 - Receivables and other assets 10 74,053 1,254,394 Deferred tax asset 18 18,241 1,079
Total non-current assets 5,669,720 5,774,753
Current assets Loans and advances to customers 8 2,740,444 2,522,242 Due from banks 9 2,996,519 135,222 Receivables and other assets 10 763,830 1,192,881 Trading securities 11 751,157 693,128 Mandatory cash balances with central banks 139,549 293,294 Cash and cash equivalents 12 1,217,687 1,460,080
Total current assets 8,609,186 6,296,847
Total assets 27 14,278,906 12,071,600
EQUITY AND LIABILITIES
Shareholders’ equity Share capital 13 1,406 1,325 Share premium 13 12,631 11,900 Fair value reserve for investments available for sale 7 157,939 79,359 Cumulative translation reserve (414,802) (177,533) Retained earnings and other reserves 5,872,447 4,733,566
Total shareholders’ equity 5,629,621 4,648,617
Minority interest 24 1,657,840 1,396,344
Non-current liabilities Borrowings 14 307,498 199,727 Customer accounts 15 39,388 39,538 Due to banks 16 80,760 13,458 Payables and other liabilities 17 53,913 90,621 Deferred tax liability 18 230,934 35,684
Total non-current liabilities 712,493 379,028
Current liabilities Borrowings 14 703,932 753,926 Customer accounts 15 3,678,252 2,997,975 Due to banks 16 419,198 782,843 Payables and other liabilities 17 1,477,570 1,112,867
Total current liabilities 6,278,952 5,647,611
Total liabilities 6,991,445 6,026,639
Total shareholders’ equity, minority interest and liabilities 14,278,906 12,071,600
Approved for issue by the Supervisory Board and signed on its behalf on 15 December 2006.
______Nigel J. Robinson The notes set out on pages 5 to 60 form an integral part of these combined financial statements.
1 ALFA GROUP Combined Statement of Income For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
Note 2004 2003
Sales 27 796,485 488,824 Cost of sales 27 (592,630) (358,970)
Gross profit 203,855 129,854 Net interest, fees and other income on banking activities 21 584,144 530,142 Commission income on trading operations 24,514 15,404 Gains less losses on derecognition of investments available for sale 7 254,581 48,671 Gains less losses arising from disposals of interests in joint ventures 5 245,424 2,057,667 Gains less losses arising from disposals of interests in associated companies 6, 24 367,156 25,233 Gains less losses arising from disposals of subsidiaries 26 39,010 9,072 Loss arising from disposal of receivable 5, 10 (41,233) - Provisions on operating items 19 (503,393) (46,588) Operating expenses 22 (835,844) (1,064,790)
Operating income 338,214 1,704,665 Share of results of joint ventures 5 616,515 949,929 Share of results of associated companies 6 180,038 64,418 Net interest expense on non-banking activities 23 (16,475) (21,482) Foreign exchange translation gains less losses (21,777) (89,407)
Profit before tax 1,096,515 2,608,123 Income tax expense 18 (61,321) (23,079)
Profit after tax 1,035,194 2,585,044 Minority interest 24 (264,147) (593,872)
Net profit 27 771,047 1,991,172
The notes set out on pages 5 to 60 form an integral part of these combined financial statements.
2 ALFA GROUP Combined Statement of Cash Flows For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
Note 2004 2003
Cash flows from operating activities Profit before tax 1,096,515 2,608,123 Depreciation of property, plant and equipment 4 49,234 37,629 Loss on disposal of property, plant and equipment 4 82 838 Gains less losses arising on derecognition of investments available for sale 7 (254,581) (48,671) Share of results of joint ventures 5 (616,515) (949,929) Share of results of associated companies 6 (180,038) (64,418) Gains less losses arising from disposals of interests in joint ventures 5 (245,424) (2,057,667) Gains less losses arising from disposals of interest in associated companies 6 (367,156) (25,233) Loss arising from disposal of receivable 5, 10 41,233 - Amortisation of goodwill, net 594 (718) Net increase in mandatory cash balances with central banks 165,407 (59,599) Provision on operating items 19 503,393 46,588 Gains less losses arising from disposals of subsidiaries 26 (39,010) (9,072) Net interest expense on non-banking activities 23 16,475 21,482 Effect of exchange rate changes on borrowings (36,336) (34,654) Effect of exchange rate changes on cash and cash equivalents 28,757 21,235 Movements in working capital balances 25 (3,371,865) 268,206
Cash used in operations (3,209,235) (245,860) Interest received on non-banking activities 23 3,352 11,645 Interest paid on non-banking activities 23 (21,819) (33,127) Income tax paid (43,621) (11,415)
Net cash used in operating activities (3,271,323) (278,757)
Cash flows from investing activities Capital expenditure 4 (102,092) (78,832) Proceeds from sale of property, plant and equipment 4 1,382 12,054 Acquisition of investments available for sale 7 (160,222) (112,241) Proceeds from sale of investments available for sale 7 174,767 67,029 Dividends received from joint ventures and associated companies 5, 6 991,765 156,202 Acquisition of associated companies 6 (285,349) (99,652) Acquisition of subsidiaries, net of cash acquired 26 (6,470) (22,054) Proceeds from sale of subsidiaries, net of cash disposed 26 49,820 4,000 Proceeds from sale of joint ventures 5 708,787 1,319,780 Proceeds from sale of receivable 5 1,788,665 -
Net cash from investing activities 3,161,053 1,246,286
Cash flows from financing activities Dividends paid to minority 24 (72,044) - Net increase in borrowings 14 32,160 10,726 Increase in share capital of subsidiaries by minority shareholders 24 10,984 27,855
Net cash (used in)/from financing activities (28,900) 38,581
Net (decrease)/increase in cash and cash equivalents (139,170) 1,006,110
Movement in cash and cash equivalents At the beginning of the year 12 1,460,080 405,694 Net (decrease)/increase in cash and cash equivalents (139,170) 1,006,110 Effects of translation from measurement currency to presentation currency (74,466) 69,511 Effects of exchange rate changes on cash and cash equivalents (28,757) (21,235)
At the year end 12 1,217,687 1,460,080
The notes set out on pages 5 to 60 form an integral part of these combined financial statements.
3 ALFA GROUP Combined Statement of Changes in Shareholders’ Equity For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
Share Share Fair value Cumulative Retained Total capital premium reserve for translation earnings and shareholders’ investments reserve other reserves equity available for sale
At 1 January 2003 19,510 11,027 53,161 (31,219) 2,464,696 2,517,175 Exchange differences from translation to presentation currency (Note 3) 97 873 3,820 (2,631) 282,443 284,602 Movements in fair value of investments available for sale, net of taxation (Notes 7 and 18) - - 76,287 - - 76,287 Transfer of net fair value gains arising on investments available for sale to net profit (Note 7) - - (18,992) - - (18,992) Effect of change in accounting treatment for an associate (Note 6) - - (34,460) - - (34,460) Translation movement - - - (226,731) - (226,731) Effect of disposal of interest in foreign entity (Note 5) - - - 42,955 (42,955) - Other movements (Notes 6 and 13) (18,282) - - - 30,984 12,702 Minority interest applicable to direct equity movements (Note 24) - - (457) 40,093 7,226 46,862 Total net gains not recognised in the combined statement of income (18,185) 873 26,198 (146,314) 277,698 140,270 Net profit for the year - - - - 1,991,172 1,991,172
At 31 December 2003 1,325 11,900 79,359 (177,533) 4,733,566 4,648,617
Exchange differences from translation to presentation currency (Note 3) 81 731 (2,762) (18,793) 373,518 352,775 Movements in fair value of investments available for sale, net of taxation (Notes 7 and 18) - - 185,048 - - 185,048 Transfer of net fair value gains arising on investments available for sale to net profit (Note 7) - - (67,428) - - (67,428) Translation movement - - - (349,102) - (349,102) Effect of disposal of interest in foreign entity (Note 5) - - - 29,613 - 29,613 Other movements - - 1,451 (1,072) 1,072 1,451 Minority interest applicable to direct equity movements (Note 24) - - (37,729) 102,085 (247) 64,109 Total net gains not recognised in the combined statement of income 81 731 78,580 (237,269) 374,343 216,466 Net profit for the year - - - - 771,047 771,047 Distribution to shareholders - - - - (6,509) (6,509)
At 31 December 2004 1,406 12,631 157,939 (414,802) 5,872,447 5,629,621
The notes set out on pages 5 to 60 form an integral part of these combined financial statements.
4 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
1 Alfa Group
The purpose of these combined financial statements is to aggregate the interests of Mr. Fridman, Mr. Khan and Mr. Kuzmichev (the “Controlling Shareholders”) in Alfa Group (the “Group”). The Group comprises CTF Holdings Limited (“CTFH”) and ABH Holdings Corp (“ABHH”) and their subsidiaries, including direct interests of the Controlling Shareholders in those subsidiaries. Refer to Note 34 for a comprehensive listing of principal entities forming the Group. The Controlling Shareholders collectively control and own a 100% interest in CTFH and a 77.07% interest in ABHH. None of the Controlling Shareholders controls and/or owns 50% or more of an interest in CTFH or ABHH. The Controlling Shareholders have entered into an agreement to vote as if they were a single shareholder and consistently in relation to all matters relating to CTFH and ABHH.
Prior to 2004 CTFH was the sole parent company of the Group and the Group was preparing consolidated financial statements. In 2004 the Controlling Shareholders restructured ownership over ABH Financial Limited and Alfastrakhovanie Holdings Limited, companies previously wholly owned by Alfa Finance Holdings S.A., a subsidiary of CTFH. The main purpose of the restructuring was to allow Open Joint Stock Company Alfa-Bank (“Alfa-Bank”) to participate in the State deposit insurance scheme introduced by the Federal Law #177-FZ “Deposits of individuals’ insurance in the Russian Federation” dated 23 December 2003. In the course of the restructuring, ABH Financial Limited and its subsidiaries, including Alfa-Bank, and Alfastrakhovanie Holdings Limited and its subsidiaries, were transferred to the newly created company, ABHH. ABHH is owned by the same beneficial shareholders and in the same proportions as ABH Financial Limited and Alfastrakhovanie Holdings Limited were owned prior to the restructuring by such beneficial shareholders. Following the restructuring, the Group is preparing combined financial statements including CTFH and ABHH and their subsidiaries, including direct interests of the Controlling Shareholders in those subsidiaries. Though the Group structure has changed, the collection of assets, liabilities and equity being reported on within these combined financial statements remains consistent. The combined financial statements include all entities under common control that are managed together as an economic entity.
CTF Holdings Limited is a Gibraltar registered company with a registered office at Suite 2, 4 Irish Place, Gibraltar. ABH Holdings Corp is a British Virgin Islands registered company with a registered office at Geneva Place, 2nd Floor, Waterfront Drive, PO Box 3339, Road Town, British Virgin Islands.
During 2004 the Group operated in the following main business segments: financial services, oil and gas, telecommunications, investment group and retail trade (Notes 27 and 34). A substantial part of the Group’s activities are carried out in the Russian Federation.
ABH Financial Limited, a British Virgin Islands registered company, is the parent company of Alfa-Bank Group including amongst other subsidiaries Alfa-Bank, a bank registered in the Russian Federation and operating under a full banking license issued by the Central Bank of the Russian Federation (“CBRF”) since 1991. Alfa-Bank operates in all sectors of the Russian financial markets including interbank and retail deposits, foreign exchange operations and debt and equity trading. In addition, a complete range of banking services is provided in Russian Roubles (“RR”) and foreign currencies to its clients. Since 2004 Alfa-Bank is accepted into the State deposit insurance scheme. Alfa- Bank is licensed by the Federal Service on Securities Market for trading in securities.
The activities of other subsidiaries of ABH Financial Limited include proprietary trading and brokerage activities, investment and merchant banking and asset management with a primary emphasis on securities within the Russian Federation and Ukraine.
Alfastrakhovanie Holdings Limited, a British Virgin Islands registered company, is the parent company of Alfastrakhovanie Group. The principal activities of Alfastrakhovanie Group are the provision of insurance and non- insurance related services within the Russian Federation. Alfastrakhovanie Group operates under insurance licenses issued by the Ministry of Finance of the Russian Federation. The insurance business of Alfastrakhovanie Group includes medical, property, casualty, life, personal insurance and re-insurance.
Alfa Petroleum Holdings Limited, a British Virgin Islands registered company, holds the Group’s investments in the oil and gas business represented by an investment in TNK-BP Limited (“TNK-BP”), a British Virgin Islands registered company (Note 5).
Alfa Telecom Limited, a British Virgin Islands registered company, holds the Group’s investments in the telecommunication business mainly represented by investments in VimpelCom Group, Golden Telecom Inc. (“Golden Telecom”), Closed Joint Stock Company Kyivstar GSM (“Kyivstar”) (Note 6) and Open Joint-Stock Company MegaFon (“MegaFon”) (Note 7). At the end of 2005 Alfa Telecom Group (Alfa Telecom Limited and its subsidiaries) was rebranded to Altimo and in 2006 Alfa Telecom Limited was renamed to Altimo Holdings and Investments Limited.
5 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
1 Alfa Group (Continued)
In 2004, the Group finalised a restructuring of its telecommunication assets in which all of the telecommunication assets held by the Group at that time (VimpelCom Group, Golden Telecom, Kyivstar and MegaFon) were transferred under a single holding company, Alfa Telecom Limited.
Eco Holdings Limited (together with its subsidiaries the “Alfa Eco Group”) is registered in Gibraltar and forms part of the Group’s investment group segment. Prior to the restructuring of its business in early 2004 Alfa Eco Group’s activities included trading in raw materials (crude oil, oil products and industrial wood) and food products (such as grain and vodka) primarily in the Russian Federation and to a lesser extent the CIS and Southeast Asia and also acting as agent in export oil, oil products and newsprint. Additionally, Alfa Eco Group was engaged in the proprietary and for-client acquisition and management of a range of industrial companies.
In early 2004, Alfa Eco Group restructured its business to focus exclusively on proprietary, for-client and special situation investments into a range of industrial and other companies in the Russian Federation, the CIS and other emerging markets. Depending upon the circumstances, Alfa Eco Group may acquire a company with a view to managing and developing the business or holding the investment for resale.
In 2005 the Group created group of companies A1 with parent company A1 Group Limited, a wholly owned subsidiary of CTFH, to also carry out proprietary, for client and special situation investments.
Russian Technologies Limited (together with its subsidiaries “Russian Technologies”) is registered in Gibraltar and forms part of the Group’s Investment Group segment. The principal activities of Russian Technologies is venture capital investment into promising, commercially exploitable Russian technologies for world-wide business and consumer use as well as the import of certain technologies into the Russian Federation.
Perekrestok Holdings Limited (together with its subsidiaries “Perekrestok”) is registered in Gibraltar. Perekrestok develops and manages a chain of supermarkets primarily in Moscow and other population centers in the Russian Federation and the CIS and operates 90 (2003: 64) supermarkets and a distribution centre. Perekrestok is the main company in the Group’s retail trade segment. Refer to Note 35 for information on the acquisition of control over Pyaterochka Group in 2006.
2 Operating Environment of the Group
The Group, through its operations, has significant exposure to Russia’s economy and financial markets.
The Russian Federation displays certain characteristics of an emerging market, including the existence of a currency that is not freely convertible in most countries outside of the Russian Federation, relatively high inflation and economic growth. The banking sector in the Russian Federation is sensitive to adverse fluctuations in confidence and economic conditions. The Russian economy occasionally experiences falls in confidence in the banking sector accompanied by reductions in liquidity. Management is unable to predict economic trends and developments in the banking sector and what effect, if any, a deterioration in the liquidity of or confidence in the Russian banking system could have on the financial position of the Group.
The tax, currency and customs legislation within the Russian Federation is subject to varying interpretations, and changes, which can occur frequently. Furthermore, the need for further developments in the bankruptcy laws, the absence of formalised procedures for the registration and enforcement of collateral, and other legal and fiscal impediments contribute to the difficulties experienced by banks currently operating in the Russian Federation. The future economic direction of the Russian Federation is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the government, together with tax, legal, regulatory, and political developments.
6 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies
(1) Basis of preparation
The combined financial statements of the Group are prepared in accordance with International Financial Reporting Standards (“IFRS”). The combined financial statements have been prepared using the historical cost convention, restated for the effects of inflation and modified by the revaluation of investments available for sale, financial assets and financial liabilities held for trading and all derivative contracts.
Subsidiaries, registered on the territory of the Russian Federation, maintain their accounting records in accordance with the Russian Banking and Russian Accounting regulations in the national currency of the Russian Federation, the Russian Rouble (“RR”). These combined financial statements have been prepared from those accounting records and adjusted as necessary in order to comply in all material respects with IFRS. Subsidiaries that are registered under the legislation of countries outside of the Russian Federation maintain financial statements, which are in accordance with IFRS.
In accordance with the requirements of IFRS, the Group applied IFRS 3 “Business Combinations” (“IFRS 3”), IAS 36 (Revised 2003) “Impairment of Assets” (“IAS 36 Revised”) and IAS 38 (Revised 2003) “Intangible Assets” (“IAS 38 Revised”) to the accounting for business combinations for which the agreement date was on or after 31 March 2004. Accounting policies have been adjusted for the effect of application of these new pronouncements as appropriate.
The preparation of these combined financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the combined financial statements, and the reported amounts of revenues and operating costs during the reporting period. Although these estimates are based on Management’s best knowledge of current events and actions, actual results ultimately may differ from those estimates.
(2) Combination
In preparing the combined financial statements, the individual financial statements of the combined entities are aggregated on a line-by-line basis by adding together the like items of assets, liabilities, equity, income and expenses. Transactions, balances, income and expenses among the combining entities are eliminated. The individual financial statements of the combined entities are prepared on a consolidated basis when they hold subsidiaries.
(3) Consolidation
Subsidiaries are those entities (including special purpose entities) in which the Group, directly or indirectly, has an interest of more than one half of the voting rights, or otherwise has power to exercise control over financial and operating policies. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are combined from the date on which effective control is transferred to the Group and are no longer combined from the date that control ceases. The purchase method of accounting is used to account for the acquisition of subsidiaries. The cost of an acquisition is measured at the fair value of the assets given up, equity instruments issued or liabilities undertaken at the date of acquisition, plus costs directly attributable to the acquisition. The excess of the cost of acquisition over the fair value of the net assets of the subsidiary acquired is recorded as goodwill separately in the combined balance sheet. Intercompany transactions, balances and unrealised gains on transactions between group companies are eliminated; unrealised losses are also eliminated unless cost cannot be recovered. Where necessary, accounting policies of subsidiaries have been changed to ensure consistency with the policies adopted by the Group.
Minority interest is that part of the net results and of the net assets of a subsidiary attributable to interests which are not owned, directly or indirectly, by the Group. Minority interest in the combined balance sheet is recorded separately from liabilities and shareholders’ equity and is affected by the foreign currency translation adjustment applicable to the minority shareholders’ interest in the subsidiary. Minority interest related to operational results of the current year is recorded in the combined statement of income.
7 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
A business combination involving entities or businesses under common control is a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory. Such transactions are accounted for using the pooling of interests method and assets and liabilities acquired are initially recorded in the financial statements of the acquirer at carrying values in the financial statements of the predecessor owner.
(4) Foreign currency translation
These combined financial statements have been measured in Russian Roubles, a currency which is used to a significant extent in, and has a significant impact on, the Group and reflects the economic substance of its underlying events and circumstances.
Items included in the financial statements of each entity of the Group are measured using the currency that best reflects the economic substance of the underlying events and circumstances relevant to that entity (the “measurement currency”).
Income statements and cash flows of foreign entities are translated into the Group’s measurement currency at actual exchange rates at the date of the transaction or at average exchange rates for the year as an approximation of actual exchange rates. Balance sheets are translated at the exchange rates effective at the balance sheet date. Exchange differences arising from the translation of the net investment in foreign entities are taken to shareholders’ equity. When a foreign entity is sold, such exchange differences are recognised in the combined statement of income as part of the gain or loss on sale.
Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing exchange rate.
Foreign currency transactions are translated into the measurement currency at the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recorded in the combined statement of income within foreign exchange translation gains less losses.
Translation differences on debt securities and other monetary financial assets measured at fair value are included in foreign exchange translation gains and losses. Translation differences on non-monetary items such as equity investments held for trading are reported as part of the fair value gain or loss. Thus, underlying translation differences on equity investments available for sale are included in the fair value reserve for investments available for sale in shareholders’ equity.
These combined financial statements have been presented in US Dollars (“USD”) in accordance with the pronouncements of SIC 30 “Reporting Currency – Translation from Measurement Currency to Presentation Currency”. The US Dollar has been selected as the presentation currency of the Group as US Dollars is the currency which Management of the Group uses to manage business risks and exposures, and measure the performance of its businesses. US Dollar amounts should not be construed as a representation that Russian Rouble amounts have been or could have been converted to US Dollars at the rates specified below.
The combined financial statements for the year ended 31 December 2004 have been translated to the presentation currency based on the following guidelines:
• Assets and liabilities were translated at the exchange rate effective at the date of each balance sheet presented; • Income and expense items for the respective year were translated at the exchange rates effective at the dates of the transactions or a rate that approximates the actual exchange rates; • Equity items other than the net profit (loss) for the year that was included in the balance of retained earnings were translated at the exchange rate effective at the date of each balance sheet presented; and • All exchange differences resulting from translation were recognised directly in shareholders’ equity as exchange differences from translation to presentation currency.
8 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
At 31 December 2004, the official rate of exchange, as determined by the CBRF, was RR 27.7487 to USD 1 (2003: RR 29.4545 to USD 1). Exchange restrictions and controls exist relating to converting the Russian Rouble into other currencies. The Russian Rouble is not a freely convertible currency in most countries outside of the Russian Federation.
(5) Accounting for the effects of hyperinflation
Prior to 1 January 2003 the adjustments and reclassifications made to the statutory records for the purpose of IFRS presentation included the restatement of balances and transactions for the changes in the general purchasing power of the RR in accordance with IAS 29 “Financial Reporting in Hyperinflationary Economies” (“IAS 29”). IAS 29 requires that the financial statements prepared in the currency of a hyperinflationary economy be stated in terms of the measuring unit current at the balance sheet date. As the characteristics of the economic environment of the Russian Federation indicate that hyperinflation ceased, effective from 1 January 2003 the Group no longer applies the provisions of IAS 29. Accordingly, the amounts expressed in the measuring unit current at 31 December 2002 were treated as the basis for the carrying amounts in these combined financial statements.
(6) Property, plant and equipment
Property, plant and equipment are stated at cost, restated to the equivalent purchasing power of the Russian Rouble at 31 December 2002 (for assets acquired prior to 1 January 2003), less accumulated depreciation and provision for impairment, where required. Cost includes expenditure that is directly attributable to the acquisition of the items.
Subsequent costs are included in the asset’s carrying value or recorded as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the costs of the items can be measured reliably. All other repairs and maintenance are expensed to the combined statement of income during the period in which they are incurred.
Depreciation is applied on a straight-line basis using the rates specified below, which are based on estimated useful lives of the respective assets:
Buildings 2-10% Plant, machinery and other equipment 9-20% Office and computer equipment 14-33%
Land and construction in progress are not depreciable items.
Gains and losses on disposal of property, plant and equipment are determined by comparing proceeds with the carrying amount and are taken into account in determining operating income.
At each reporting date the Group assesses whether there is any indication of impairment of premises and equipment. If any such indication exists, the Group estimates the recoverable amount, which is determined as the higher of an asset’s net selling price or its value in use. Where the carrying amount of an asset is greater than its estimated recoverable amount, it is written down to its recoverable amount and the difference is charged to the combined statement of income. An impairment loss recognised for an asset in prior years is reversed if there has been a change in the estimates used to determine the assets recoverable amount.
9 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
(7) Goodwill
Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net assets of the acquired subsidiary, joint venture or associate at the date of acquisition. Goodwill on the acquisition of joint ventures and associated companies is included in investment in joint ventures and associated companies. Goodwill is amortised using the straight-line method over its estimated useful life. Management determines the estimated useful life of goodwill based on its evaluation of the respective companies at the time of the acquisition, considering factors such as existing market share, potential growth and other factors inherent in the acquired companies.
Negative goodwill represents the excess of the fair value of the Group’s share of the net assets acquired over the cost of acquisition. To the extent that negative goodwill relates to expectations of future losses and expenses that are identified in the Group’s plan for the acquisition and can be measured reliably, but which do not represent identifiable liabilities, that portion of negative goodwill is recorded in the combined statement of income when the future losses and expenses are recorded. Any remaining negative goodwill, not exceeding the fair values of the non- monetary assets acquired, is recorded in the combined statement of income over the remaining weighted average useful life of depreciable and amortisable assets acquired; negative goodwill in excess of the fair values of those assets is recorded in the combined statement of income immediately.
In the case of TNK-BP Limited the amortisation of negative goodwill is based on the estimated life of oil reserves.
At each balance sheet date the Group assesses whether there is any indication of impairment. If such indications exist an analysis is performed to assess whether the carrying amount of goodwill is fully recoverable. A write down is made if the carrying amount exceeds the recoverable amount.
In accordance with the requirements of IFRS, the Group applied IFRS 3, IAS 36 Revised and IAS 38 Revised to the accounting for the acquisitions for which the agreement date was on or after 31 March 2004. For these acquisitions goodwill is carried at cost less accumulated impairment and not amortised but tested annually for impairment. Impairment losses or their reversals are recorded through the combined statement of income.
The gain or loss on disposal of an entity includes the related unamortised balance of goodwill or negative goodwill relating to the entity disposed of.
(8) Investments in joint ventures and associated companies
Investments in joint ventures and associated companies are accounted for by the equity method as described below.
A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity which is subject to joint control.
Associated companies are entities over which the Group generally has between 20% and 50% of the voting rights, or otherwise the Group has significant influence, but which it does not control.
Equity accounting involves recognising the Group’s share of the joint venture’s and associated company’s profit or loss for the year in the combined statement of income and other equity movements in the combined statement of changes in shareholders’ equity. The cumulative post-acquisition movements are adjusted against the cost of the investments. Unrealized gains or losses related to contributions to joint ventures and associated companies of non-monetary assets similar to those contributed by the other participants are eliminated against the underlying assets when applying the equity accounting. Unrealised gains on transactions between the Group and its joint ventures and associated companies are eliminated to the extent of the Group’s interest in the joint ventures and associated companies; unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. The Group’s investment in joint ventures and associated companies includes goodwill (net of accumulated amortisation) on acquisition. Where necessary, accounting policies for joint ventures and associated companies have been changed to ensure consistency with the policies adopted by the Group. Equity accounting is discontinued when the carrying amount of the investment in a joint venture or an associated company reaches nil, unless the Group has incurred obligations or guaranteed obligations in respect of the joint venture or the associated company.
(9) Investments available for sale
Investments available for sale include investments, which Management intends to hold for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates, or market prices. Management determines the appropriate classification of its investments at the time of purchase.
10 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
Investments available for sale are initially recorded at cost (which includes transaction costs) and subsequently remeasured to fair value based on quoted bid prices. Certain investments available for sale for which there is no available external independent quotation have been fair valued by Management. Fair values of these assets were determined by Management on the basis of recent sales of equity interests in the investees between unrelated third parties, analysis of discounted cash flows and other financial data of the investees and the application of other valuation methodologies. Unrealised gains and losses arising from changes in the fair value of investments available for sale are recorded in the combined statement of changes in shareholders’ equity. When the investments available for sale are disposed of or impaired, the related accumulated fair value adjustments are included in the combined statement of income as gains less losses on derecognition of investments available for sale or provision on operating items, respectively. Impairment and reversal of impairment of investments available for sale is recorded through the combined statement of income. An investment available for sale is impaired if its carrying amount is greater than its estimated recoverable amount. The recoverable amount is the present value of expected future cash flows discounted at the current market rate of interest for a similar financial asset. Dividend and interest earned on investments available for sale are recorded in the combined statement of income.
Regular way purchases and sales of investments available for sale are recorded at trade date, which is the date that the Group commits to purchase or sell the asset. All other purchases and sales are recorded as derivative forward transactions until settlement.
(10) Originated loans and provisions for loan impairment
Originated loans, which also include loans and advances, are originated by the Group by providing money directly to the borrower or to a sub-participation agent at draw down, other than those that are originated with the intent of being sold immediately or in the short-term which are recorded as trading assets, are categorised as originated loans.
Originated loans are recorded when cash is advanced to borrowers. Initially, originated loans are recorded at cost, which is the fair value of the consideration given, and subsequently are carried at amortised cost less provision for loan impairment. The fair value of cash consideration given to originate those loans is determinable by reference to market prices at origination date. Third party expenses, such as legal fees incurred in securing a loan, are treated as a part of the cost of the transaction.
Loans originated at interest rates different from market rates are remeasured at origination to their fair value, being future interest payments and principal repayments discounted at market interest rates for similar loans. The difference between the fair value and the nominal value at origination is credited or charged to the combined statement of income. Subsequently, the carrying value of such loans is adjusted for amortisation of the gains/losses on origination and the related income is recorded as interest income within the combined statement of income using the effective yield method.
A credit risk provision for loan impairment is established if there is objective evidence that the Group will not be able to collect the amounts due according to original contractual terms. The amount of the provision is the difference between the carrying amount and estimated recoverable amount, calculated as the present value of expected cash flows, including amounts recoverable from guarantees and collateral, discounted at the instrument’s original effective interest rate.
The provision for loan impairment also covers losses where there is objective evidence that probable losses are present in components of the loan portfolio at the balance sheet date. These have been estimated based upon historical patterns of losses in each component, the credit ratings assigned to the borrowers and reflect the current economic environment in which the borrowers operate.
When a loan is uncollectable, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary legal procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off are credited to provision on operating items in the combined statement of income.
If the amount of the provision for loan impairment subsequently decreases due to an event occurring after the write- down, the release of the provision is credited to provision on operating items in the combined statement of income.
11 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
(11) Bills of exchange purchased
Purchased bills of exchange are included in trading securities, investments available for sale, loans and advances to customers, or in due from banks, depending on their substance, and are subsequently remeasured and are accounted for in accordance with the accounting policies for those categories of assets.
(12) Originated receivables
Originated receivables are carried at amortised cost less provision for impairment. A receivable is impaired if its carrying amount is greater than its estimated recoverable amount. The amount of the impairment loss is calculated as the difference between the asset’s carrying amount and the present value of expected future cash flows discounted at the original effective interest rate of the receivable. Provisions made during the period are included in the combined statement of income.
(13) Trading securities
Trading securities are securities which were either acquired for generating a profit from short-term fluctuations in price or dealer’s margin, or are securities included in a portfolio in which a pattern of short-term trading exists. The Group classifies securities into trading securities if it has an intention to sell them within a short period after purchase, i.e. within a one to three month period.
Trading securities are initially recorded at cost (which includes transaction costs) and are subsequently remeasured at fair value based on their market value or after the application of various valuation methodologies, including Management’s assessment as to the future realisability of these securities. In determining market value, all trading securities are valued at the last bid price.
All related realised and unrealised gains and losses are recorded within gains less losses arising from trading securities in the combined statement of income in the period in which the change occurs. Dividend and interest income earned on trading securities are recorded in the combined statement of income within net interest, fees and other income on banking activities.
Purchases and sales of trading securities that require delivery within the time frame established by regulation or market conversion (“regular way” purchases and sales) are recorded at trade date, which is the date that the Group commits to purchase or sell the asset. Otherwise such transactions are treated as derivatives until settlement occurs.
(14) Sale and repurchase agreements and lending of securities
Sale and repurchase agreements (“repo agreements”) are treated as secured financing transactions. Securities sold under sale and repurchase agreements are not derecognised. The corresponding liability is presented within due to banks or borrowings. Securities purchased under agreements to resell (“reverse repo agreements”) are recorded as due from banks or loans and advances to customers as appropriate. The difference between the sale and repurchase price is treated as interest and accrued over the life of repo agreements using the effective yield method.
Securities lent to counterparties are retained in the combined financial statements. Securities borrowed are not recorded in the combined financial statements, unless these are sold to third parties, in which case the purchase and sale are recorded within gains less losses arising from trading securities in the combined statement of income. The obligation to return them is recorded at fair value as a trading liability.
(15) Cash and cash equivalents
Cash and cash equivalents are items which can be converted into cash within a day. All short term interbank placements, beyond overnight deposits, are included in due from banks. Amounts, which relate to funds that are of a restricted nature, are excluded from cash and cash equivalents. Cash and cash equivalents are carried at amortised cost.
12 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
(16) Mandatory cash balances with central banks
Mandatory balances with the Central Bank of the Russian Federation and other local central banks represent mandatory reserve deposits, which are not available to finance the Group’s day-to-day operations and hence are not considered as part of cash and cash equivalents for the purposes of the combined statement of cash flows. Cash balances with central banks are carried at amortised cost.
(17) Share options
Share options are granted to certain directors and managers of certain of the Group’s companies. The related expense is recorded as staff costs within the combined statement of income at the date of grant. The effect of any outstanding option is remeasured at each balance sheet date. Intrinsic values are used to measure the value of the options both at the date of grant and subsequently.
The information in respect of shares in the Group and its subsidiaries that are puttable to the Group for cash or other financial assets is disclosed in the combined financial statements. No amounts are recorded in the combined financial statements until the option is exercised.
The information in respect of call options held by the Group which give the Group a right to buy equity instruments of the Group for a fixed amount of cash is disclosed in the combined financial statements. No amounts are recorded in the combined financial statements until the option is exercised.
Call options written by the Group which give option holders a right to buy from the Group equity instruments of the Group are recorded as if they are exercised if there is a high probability that the option will be exercised by the optionholder. Shares subject to such call options are classified as a minority interest.
(18) Borrowings
Borrowings are recorded initially at cost, being their issue proceeds (fair value of consideration received) net of transaction costs incurred. Subsequently, borrowings are carried at amortised cost and any difference between net proceeds and the redemption value is recorded in the combined statement of income within interest expense over the period of the borrowings using the effective yield method. The Group expenses borrowings as incurred.
Borrowings originated at interest rates different from market rates are remeasured at origination to their fair value, being future interest payments and principal repayments discounted at market interest rates for similar borrowings. The difference between the fair value and the nominal value at origination is credited or charged to the combined statement of income. Subsequently, the carrying value of such borrowings is adjusted for amortisation of the gains/losses on origination and the related expense is recorded as interest expense within the combined statement of income using the effective yield method.
If the Group purchases its own debt, it is removed from the combined balance sheet and the difference between the carrying amount of the liability and the consideration paid is recorded in the combined statement of income.
(19) Bills of exchange issued
Bills of exchange issued by the Group carry a fixed date of repayment. These may be issued against cash deposits or as a payment instrument which the customer can discount in the over-the-counter secondary market. Bills of exchange issued by the Group are recorded initially at cost being their issue proceeds (fair value of consideration received) net of transaction costs incurred. Subsequently, bills of exchange issued are carried at amortised cost and any difference between net proceeds and the redemption value is recorded in the combined statement of income within interest expense over the period of issuance using the effective yield method.
If the Group purchases its own bills of exchange, they are removed from the combined balance sheet and the difference between the carrying amount of the liability and the consideration paid is recorded in the combined statement of income.
13 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
(20) Dividends
Dividends declared by the Group are recorded as a liability and as a corresponding charge to equity in the year in which they are proposed and declared.
(21) Provisions
Provisions are recorded when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made.
(22) Income taxes
Taxation has been provided for in the combined financial statements in accordance with legislation currently in force in the respective territories where the Group operates. The income tax expense in the combined statement of income for the period comprises current income tax and movements in deferred income tax. Current income tax is calculated on the basis of the expected taxable profit for the period, using the tax rates enacted as at the balance sheet date. Taxes, other than on income, are recorded within operating expenses.
Deferred income tax is provided, using the balance sheet liability method, for all temporary differences arising between the tax basis of assets and liabilities and their carrying values for financial reporting purposes. A deferred tax asset is recorded only to the extent that it is probable that future taxable profit will be available against which the deductible temporary differences can be utilised. Deferred tax assets and liabilities are measured at tax rates that are expected to apply to the period in which the asset is realised or the liability is settled, based on tax rates which are enacted or substantially enacted at the balance sheet date.
Deferred income tax is provided on temporary differences arising on investments in subsidiaries, joint ventures and associated companies, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future.
Deferred income tax relating to the fair value remeasurement of investments available for sale which is charged or credited directly to equity, is also charged or credited directly to equity and is subsequently recorded in the combined statement of income within gains less losses on derecognition of investments available for sale when the gain or loss on the investments is realised.
(23) Income and expense recognition
The Group operates across a variety of business segments, which generate different types of income and expenses. Income and expenses are recorded on an accrual basis as earned or incurred. The following are the principal types of income and expenses and how they are recorded:
• Sales are recorded when significant risks and rewards of ownership of goods are transferred to the customers. Sales are shown net of VAT, sales tax and discounts, and after eliminating sales within the Group;
• Cost of goods sold comprises the purchase price, transportation costs, commissions relating to supply agreements and other related expenses;
• Interest income and expense are recorded in the combined statement of income on an accrual basis using the effective interest method based on the actual purchase price. The effective interest method is a method of calculating the amortised cost of a financial asset or financial liability and of allocating the interest income or interest expense over relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial assets or financial liability. When calculating the effective interest rate, the Group estimates cash flows considering all contractual terms of the financial instrument (for example, prepayment option) but does not consider future credit losses. The calculation includes all fees and points paid or received between the parties to the contract that are an integral part of the effective interest rate, transaction cost and all other premiums or discount. When loans become doubtful of collection, they are written down to their recoverable amount and interest income is thereafter recorded based on the interest rate that was used to discount the future cash flows for the purpose of measuring the recoverable amount.
14 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
• Fees, commissions and other income and expense items are generally recorded on an accrual basis when the service has been provided. Commissions and fees arising from negotiating or participating in the negotiation of a transaction for a third party, and other management advisory and service fees are recorded based on the applicable service contracts.
(24) Staff costs and related contributions
The Group’s subsidiaries’ contributions to the Russian Federation state pension and social insurance funds in respect of its employees are expensed as incurred and presented as staff costs in the combined statement of income.
(25) Accrued interest income and accrued interest expense
Accrued interest income and accrued interest expense, including both accrued coupon and amortised discount, are included in the carrying values of related balance sheet items.
(26) Other credit related commitments
In the normal course of business, the Group enters into other credit related commitments including loan commitments, letters of credit and guarantees. Specific provisions are raised against other credit related commitments when losses are considered probable.
(27) Derivative financial instruments
Derivative financial instruments are used primarily by Alfa-Bank Group for both economic hedging and non-hedging (trading) purposes. Although derivative financial instruments are sometimes used for economic hedging purposes, the Group does not make use of the elective hedge accounting rules under IAS 39 “Financial Instruments: Recognition and Measurement”.
Derivative financial instruments are initially recorded in the combined balance sheet at cost (including transaction costs) and subsequently are remeasured at fair value with the resulting gain or loss recorded immediately in the combined statement of income. Fair values are obtained from quoted market prices and if necessary from discounted cash flow or other models. All derivatives are carried as assets when fair value is positive and as liabilities when fair value is negative.
Changes in the fair value of derivative instruments are included in gains less losses arising from trading in foreign currency, gains less losses arising from trading securities and gains less losses from trading in precious metals within other operating income, depending on the related contracts.
(28) Accounting for operating leases – where the Group is the lessee
Leases of assets under which all the risks and benefits of ownership are effectively retained by the lessor are classified as operating leases. The total lease payments, including those on expected termination, are charged to the combined statement of income on a straight-line basis over the period of the lease.
(29) Finance leases
Where the Group is the lessor, upon inception of a finance lease, the present value of the lease payments (“net investment in leases”) is recorded within loans and advances to customers. Lease income is recorded over the term of the lease using the effective yield method. The inception of a lease is considered to be the date of the lease agreement, or commitment if earlier. Any advance payments made by the lessee prior to commencement of the lease reduces the net investment in the lease. Finance income from leases is recorded within other operating income in the combined statement of income. When impaired, a provision against net investment in lease is recorded. A finance lease is impaired if its carrying amount is greater than its estimated recoverable amount. The amount of the impairment loss is calculated as the difference between the asset’s carrying amount and the present value of expected future cash flows discounted at the original effective interest rate of the finance lease receivable.
15 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
3 Principal Accounting Policies (Continued)
(30) Discontinuing operations
The combined financial statements disclose information relating to the Group’s assets, liabilities, revenues, expenses and cash flows attributable to the discontinuing operations throughout the period of discontinuance in accordance with requirements of IAS 35 “Discontinuing Operations”.
(31) Segment reporting
A segment is a distinguishable component of the Group that is engaged either in providing products or services (business segment) or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments. Segments with a majority of revenue earned from sales to customers and whose revenue, result or assets are ten percent or more of all the segments are reported separately.
With regards to the geographical segments, sales are based on the country in which the customer is located. Assets, liabilities and credit related commitments have generally been based on the country in which the counterparty is located. Balances with Russian counterparties actually outstanding to/from off-shore companies of these Russian counterparties are allocated to the caption “Russia Federation”. Property, plant and equipment, inventories, precious metals and cash on hand have been allocated based on the country in which they are physically held.
(32) Fiduciary assets
Assets and liabilities held by the Group in its own name, but for the account of third parties, are not reported in the combined balance sheet. Commissions received from such business are recorded in the combined statement of income ratably over the period the service is provided.
(33) Offsetting
Financial assets and liabilities are offset and the net amount reported in the combined balance sheet only when there is a legally enforceable right to offset the recognised amounts, and there is an intention to either settle on a net basis, or to realise the asset and settle the liability simultaneously.
16 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
4 Property, Plant and Equipment
Land and Plant, Office and Construction Other Total buildings machinery computer in progress and other equipment equipment
Net book amount at 31 December 2003 173,863 65,312 51,826 25,666 43,137 359,804
Cost At 1 January 2004 202,970 98,802 108,547 25,666 58,231 494,216 Additions, net of transfer from construction in progress 45,569 27,285 19,957 3,086 6,195 102,092 Movements due to acquisition/disposal of subsidiaries (Note 26) (18,990) (31,377) (6,025) - 1,313 (55,079) Disposals (7,117) (4,622) (8,963) - (333) (21,035) Effect of translation to presentation currency 12,344 5,918 5,932 1,207 1,765 27,166
At 31 December 2004 234,776 96,006 119,448 29,959 67,171 547,360
Accumulated depreciation At 1 January 2004 29,107 33,490 56,721 - 15,094 134,412 Depreciation expense (Note 22) 9,098 12,509 18,956 - 8,671 49,234 Movements due to acquisition/disposal of subsidiaries (Note 26) (5,498) (15,975) (4,623) - - (26,096) Disposals (386) (1,602) (6,176) - (122) (8,286) Effect of translation to presentation currency 1,977 2,191 3,245 - 574 7,987
At 31 December 2004 34,298 30,613 68,123 - 24,217 157,251
Net book amount at 31 December 2004 200,478 65,393 51,325 29,959 42,954 390,109
At 31 December 2004 property, plant and equipment with a net book value of USD 99,079 thousand (2003: USD 33,702 thousand) were pledged to third parties as collateral (Note 14).
5 Investment in Joint Ventures
At 31 December 2004 and 2003 investment in joint ventures represented the Group’s investment in TNK-BP.
TNK Industrial
Before 29 August 2003 the Group jointly with its joint venture partner, Access-Renova Group, controlled TNK Industrial Holdings Limited (“TNK Industrial”), a British Virgin Islands company. The Group’s economic and voting interest in TNK Industrial was 50%. TNK Industrial, through its subsidiaries, conducts exploration activities and produces oil and gas in the Russian Federation and operates petroleum refineries and markets petroleum products primarily in the Russian Federation and Ukraine.
17 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
5 Investment in Joint Ventures (Continued)
TNK-BP
Effective 29 August 2003 the Group, Access-Renova Group and BP plc formed TNK-BP Limited (“TNK-BP”), a British Virgin Islands company, to hold their respective interests in their Russian and Ukrainian oil and gas assets.
The Group and Access-Renova Group contributed to TNK-BP their interests in TNK Industrial (excluding Slavneft), which in turn owned a 96.1% interest in OJSC Tyumen Oil Company (“TNK”) and a 68% interest in OJSC Sidanco (“Sidanco”). BP plc contributed to TNK-BP its 29.6% interest in Sidanco, a 33.4% interest in OJSC RUSIA Petroleum and a 75% interest in BP Moscow Retail and agreed to pay a balancing consideration (see below) to the Group and Access-Renova Group in exchange for a 50% ownership in TNK-BP (excluding Slavneft).
On formation of TNK-BP, TNK Industrial held a 49.5% equity interest in Slavneft. Under the terms of the agreement between the Group, Access-Renova Group and BP plc, Slavneft was included in TNK-BP only from January 2004. Consequently, until January 2004 TNK-BP’s interest in Slavneft was beneficially held 50% by the Group and 50% by Access-Renova Group. The Group accounted for the interest in Slavneft using its beneficial ownership.
As a result of the transaction, the Group and Access-Renova Group each hold 25% of TNK-BP and BP plc holds 50% of TNK-BP. The Group has a contractual arrangement with Access-Renova Group whereby their 50% interest in TNK-BP is subject to joint control. In addition there are further contractual arrangements between BP plc on one side and the Group and Access-Renova Group on the other side whereby TNK-BP is subject to joint control.
Consideration Relating to the Formation of TNK-BP
The total balancing consideration due from BP plc, in equal parts to the Group and Access-Renova Group, consisted of USD 2,603,294 thousand cash paid on 29 August 2003 and three tranches of ordinary shares of BP plc equivalent to USD 1,250,000 thousand each payable on 29 August 2004, 2005 and 2006. In June 2004 the parties agreed to change the settlement dates to 20 September 2004, 2005 and 2006 respectively. The number of shares receivable at each settlement date is to be calculated based on the weighted market price of the shares during a thirty day period immediately preceding the settlement date so that the value of the shares based on this weighted market price equals USD 1,250,000 thousand. In exceptional and unanticipated circumstances BP plc may be required to settle these tranches in cash rather than in shares.
The Group’s receivable from BP plc arising from its obligation to deliver tranches of ordinary shares of BP plc carried no interest and was initially recorded in the combined financial statements at its estimated fair value at origination of USD 1,796,082 thousand which was calculated by discounting future payments at the market interest rate for similar instruments. The weighted effective interest rate used for discounting was 2.075%. The fair value of the shares based on the current market price as at the settlement date may not be equal to the contractual amount receivable at each settlement date. Management has estimated that at 31 December 2003 the fair value of the derivative financial instrument arising from the method of calculation of number of shares receivable by the Group approximated nil.
In July 2004, together with Access-Renova Group, the Group sold all its right to receive tranches of BP plc shares for USD 3,577,330 thousand. The Group’s share was USD 1,788,665 thousand. At the date of the transaction the carrying value of the receivable in the combined financial statements of the Group was USD 1,829,898 thousand. A loss on the transaction in the amount of USD 41,233 thousand was recorded in the combined statement of income for the year ended 31 December 2004.
In January 2004 BP plc, in relation to the inclusion of Slavneft in TNK-BP, paid in cash an additional balancing consideration of USD 1,417,574 thousand to the Group and Access-Renova Group. The Group’s share was USD 708,787 thousand.
Also, in relation to the formation of TNK-BP, the Group and Access-Renova Group granted an option to BP plc, whereby the directors of TNK-BP, nominated by BP plc, had a right, by 29 August 2004, to request the transfer of TNK-BP’s interest in CJSC Rospan International, a gas extraction company, to the Group (50%) and to Access-Renova Group (50%) in exchange for the payment by the Group and Access-Renova Group to TNK-BP of a total consideration of USD 314,000 thousand subject to certain adjustments. The option expired on 29 August 2004 without being exercised or extended. The Group estimated that at the date of granting of the option and subsequently, the option was out of money and had no value. As such, the Group did not record any amounts in these combined financial statements in respect of that option.
18 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
5 Investment in Joint Ventures (Continued)
In addition, also in relation to the formation of TNK-BP, BP plc granted an option to the Group and Access-Renova Group, whereby the Group and Access-Renova Group, acting together, had the right, by 29 August 2004, to request BP plc to transfer BP plc’s interest in Sakhalin IV and Sakhalin V, oil and gas extraction projects, to TNK-BP in exchange for payment by TNK-BP to BP plc of consideration in the amount of USD 240,000 thousand subject to certain adjustments. BP plc’s obligations under the option were subject to BP plc obtaining the consents of regulatory authorities and other participants of Sakhalin IV and Sakhalin V. The option expired on 29 August 2004 without being exercised or extended. The Group, at the date of granting of the option and subsequently, did not assign any value to the option. As such, the Group did not record any amounts in these combined financial statements in respect of that option.
Commitments and Contingencies Relating to the Formation of TNK-BP
In relation to the formation of TNK-BP the Group made certain guarantees, provided certain warranties, commitments and indemnities, including those related to the historic tax position of TNK Industrial and its subsidiaries. The maximum liability of the Group, with respect to these warranties, is limited to USD 3,885,434 thousand, the total balancing consideration received and receivable by the Group in relation to the transaction (including consideration related to inclusion of Slavneft in TNK-BP). Also, the Group agreed that prior to 31 December 2007 it shall not directly or indirectly sell, transfer or dispose of any of its interest in TNK-BP without the prior written consent of BP plc.
As detailed below, during 2004 and 2005 the Russian tax authorities performed tax audits of certain of TNK-BP's subsidiaries. At 31 December 2004, in relation to these audits and in addition to provisions recorded by TNK-BP, the Group recorded a provision in the amount of USD 465,920 thousand (Notes 17 and 19) being the best estimate of the present value of expected payments of the Group to BP plc under TNK-BP formation indemnities arising from the probable additional tax liabilities of TNK-BP. Further developments in the investigation by the tax authorities of the operations of TNK-BP may result in additional tax liabilities for TNK-BP and additional liabilities for the Group in respect of the TNK-BP formation indemnities.
Tax audits of TNK-BP
During 2004 and 2005 the Russian tax authorities performed tax audits on certain of the TNK-BP’s subsidiaries relating to their 2001-2003 activities.
In December 2004 the Russian tax authorities issued a decision challenging, among other things, the use of profit tax concessions claimed by TNK with respect to the reinvestment of profits in fixed production assets in 2001 and made a claim for approximately USD 143 million (RR 4 billion) including fines and penalty interest. Management of TNK-BP and the Management of the Group believe that an adequate provision has been made for the outcome of this matter in their respective financial statements.
In February 2005 the Russian tax authorities presented tax acts, which, among other things, challenged TNK-BP’s internal transfer pricing activities in 2001; these totalled approximately USD 288 million (RR 8 billion) including fines and penalty interest. Following objections presented by TNK-BP, the amount of the tax acts was reduced and the Russian tax authorities issued final decisions with respect to such tax acts in the total amount of approximately USD 7 million (RR 183 million) including penalty interest. This amount was paid by TNK-BP in August 2005.
The Russian tax authorities performed a repeat tax audit on TNK’s 2001 activities and in April 2005 presented TNK with a tax act totalling approximately USD 578 million (RR 16 billion) which, among other things, challenged the use of reduced tax rate economic zones. Following objections presented by TNK-BP, the tax act amount was reduced and the Russian tax authorities issued a final decision in the amount of USD 247 million (RR 7 billion) including penalty interest and fines. In August 2005 TNK-BP paid this amount in full.
In November 2005 a separate claim for 2001 was lodged in respect of profit tax concessions of a trading subsidiary of TNK-BP in the amount of approximately USD 340 million (RR 9.8 billion). A tax decision in the same amount was received in January 2006 and is currently being challenged in the courts. In October 2006 TNK-BP received favourable court rulings which would reduce the amount of the exposure to USD 276 million (RR 7.3 billion) although legal proceedings are expected to continue. The Management of TNK-BP and the Management of the Group believe that an adequate provision has been made for the outcome of this matter in their respective financial statements.
19 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
5 Investment in Joint Ventures (Continued)
In December 2005 and February 2006 the Russian tax authorities presented tax acts relating to 2002 and 2003 in respect of profit tax concessions claimed by TNK and Sidanco during the period. These acts amounted to approximately USD 1,402 million (RR 40.4 billion) and USD 442 million (RR 12.7 billion), respectively. Following objections presented by TNK-BP the total claim was reduced and in October 2006 the Russian tax authorities issued a decision for the final amount of USD 1,418 million (RR 38 billion) including interest. No fines were assessed. In November 2006 TNK-BP paid this amount in full.
At 31 December 2004 TNK-BP had a provision in its financial statements in the amount of USD 1,863,679 thousand related to the remaining open tax issues discussed above.
Other significant contingencies of TNK-BP
Gas production and marketing activities. Russian independent gas producers are currently only able to access the domestic gas transmission system subject to agreement with Gazprom, Russia's gas monopoly which owns and operates the system. Because of limited access to the system TNK-BP has not fully commercialized its upstream gas interests and, accordingly, has not recognised proved gas reserves. At 31 December 2004 TNK-BP’s net investments in its gas producing subsidiaries amounted to USD 816,000 thousand.
Oilfield licenses. TNK-BP is subject to periodic reviews of its activities by governmental authorities with respect to the requirements of its oilfield licenses. Management of TNK-BP correspond with governmental authorities to agree on remedial actions, if necessary, to resolve any findings resulting from these reviews. Failure to comply with the terms of a license could result in fines, penalties or license limitation, suspension or revocation. TNK-BP and the Group’s Management believes any issues of non-compliance will be resolved through negotiations or corrective actions without any materially adverse effect on the financial position or the operating results of TNK-BP.
Environmental liabilities. TNK-BP and its predecessor entities have operated in the Russian Federation for many years and certain environmental issues have arisen. Governmental authorities continue to assess current environmental regulations and their enforcement and TNK-BP periodically evaluates its obligations related thereto. At 31 December 2004 TNK-BP’s estimated environmental liability was USD 158,000 thousand. The estimates used by management included uncertainties about a variety of factors including the extent of necessary remediation, the technology to be used for remediation and the standards that will constitute an acceptable remediation. As additional information becomes available TNK-BP’s management will continue to adjust its estimated provision to an appropriate level. TNK-BP’s environmental obligations could range up to USD 300,000 thousand.
20 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
5 Investment in Joint Ventures (Continued)
Movements in the Group’s Interest in TNK-BP The Group accounts for its interest in TNK-BP (including Slavneft) using the equity method of accounting. The table below summarises the movements in the Group’s net investment in TNK-BP (including Slavneft):
2004 2003
At 1 January 2,170,968 2,522,847 Share of results of joint venture before amortisation of negative goodwill 603,606 922,781 Amortisation of negative goodwill 12,909 21,515 Dividends from joint venture (963,500) (265,875) Carrying value of disposed interest in Slavneft (375,000) - Waiver of receivable from TNK-BP relating to Slavneft’s dividends 58,750 - Carrying value of disposed interest in TNK Industrial (excluding Slavneft) - (1,034,729) Effect of BP plc’s contribution of assets to TNK-BP - 4,429
At 31 December 1,507,733 2,170,968
The Group’s share of TNK-BP’s income tax expense amounted to USD 719,920 thousand for 2004 (2003: USD 141,707 thousand).
The table below summarises the movements in the negative goodwill with respect to the Group’s investment in TNK-BP. There was no negative goodwill in relation to acquisition of interest in Slavneft.
2004 2003
At 1 January 154,907 335,632 Amortisation of negative goodwill (12,909) (21,515) Effect of disposal of interest in TNK Industrial - (159,210)
At 31 December 141,998 154,907
The gain on formation of TNK-BP (including that arising on inclusion of Slavneft in TNK-BP) was recorded in the combined statement of income and was calculated as follows:
2004 2003
Cash consideration received from BP plc 708,787 1,301,647 Carrying value of disposed interest in Slavneft (375,000) - Carrying value of disposed receivable from TNK-BP relating to Slavneft’s dividends (58,750) - Cumulative translation reserve relating to disposed interest in Slavneft (29,613) - Fair value of future tranches of ordinary shares of BP plc - 1,796,082 Effect of BP plc’s contribution of assets to TNK-BP - 4,429 Carrying value of disposed interest in TNK Industrial (excluding Slavneft) - (1,034,729) Transaction costs - (15,641)
Gain on formation of TNK-BP 245,424 2,051,788
21 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
5 Investment in Joint Ventures (Continued)
The consolidated financial information of TNK-BP (including Slavneft) adjusted for the effect of individual acquisitions of the interest in TNK-BP by the Group is summarised as follows:
2004 2003
Assets 18,654,092 16,626,789 Liabilities 11,032,168 7,837,633 Minority interest 1,023,000 948,655 Consolidated shareholders’ equity 6,598,924 7,840,501 Revenues 14,298,000 10,379,343 Net profit 2,339,764 2,294,339
Share of results of joint ventures and gain less losses arising from disposals of interests in joint ventures for 2003 included a share of results of and gain on disposal of an interest in Hayard Investments Limited, the parent company of OJSC Volga.
6 Investments in Associated Companies
VimpelCom Golden Kyivstar Other Total Group Telecom
At 1 January 2003 219,049 143,943 94,366 - 457,358
Share of net assets acquired (at fair value) 67,485 - 5,746 17,389 90,620 Goodwill arising on acquisition (8,547) - 1,757 1,250 (5,540) Adjustment to fair value (4,885) - - - (4,885) Share of results of associated companies before amortisation of goodwill 49,398 15,327 19,623 981 85,329 Amortisation of goodwill (2,142) (4,074) (9,748) (62) (16,026) Share of other equity movements of associated companies 12,702 - - - 12,702 Effect of acquisition of OJSC Comincom - 25,233 - - 25,233 Effect of translation to presentation currency 21,537 12,032 28 - 33,597
At 31 December 2003 354,597 192,461 111,772 19,558 678,388
Share of net assets acquired (at fair value) 323,900 - 170,417 18,785 513,102 Goodwill arising on acquisition 283,065 - 100,158 4,172 387,395 Share of results of associated companies before amortisation of goodwill 116,242 15,942 51,921 13,199 197,304 Dividends from associated companies - (8,585) (21,741) - (30,326) Amortisation of goodwill (3,078) (4,164) (10,024) - (17,266) Carrying value of disposed interest in VimpelCom (217,271) - - - (217,271) Effect of translation to presentation currency 34,363 11,402 17,921 42 63,728
At 31 December 2004 891,818 207,056 420,424 55,756 1,575,054
22 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
6 Investments in Associated Companies (Continued)
The table below summarises the movements in the goodwill with respect to the Group’s investment in associated companies:
VimpelCom Golden Kyivstar Other Total Group Telecom
At 1 January 2003 91,657 13,214 63,360 - 168,231
Goodwill arising on acquisition (8,547) - 1,757 1,250 (5,540) Adjustment to fair value (50,132) - - - (50,132) Amortisation of goodwill (2,142) (4,074) (9,748) (62) (16,026) Effect of translation to presentation currency 3,190 1,046 11 - 4,247
At 31 December 2003 34,026 10,186 55,380 1,188 100,780
Goodwill arising on acquisition 283,065 - 100,158 4,172 387,395 Amortisation of goodwill (3,078) (4,164) (10,024) - (17,266) Effect of merger of VimpelCom and VimpelCom-Region 24,738 - - - 24,738 Effect of translation to presentation currency 6,852 466 8,017 - 15,335 Other movements (13,566) - - - (13,566)
At 31 December 2004 332,037 6,488 153,531 5,360 497,416
VimpelCom Group
At 31 December 2004, the Group owned shares of OJSC Vimpel-Communications (VimpelCom) representing a 32.9% (2003: 25%+1 share) voting interest and a 24.5% (2003: 13.05%) ownership interest. At 31 December 2003, the Group owned shares of CJSC VimpelCom-Region (VimpelCom-Region), a subsidiary of VimpelCom, representing 29.8% voting and ownership interest. VimpelCom is one of the largest mobile telecommunications companies in the Russian Federation. VimpelCom-Region was created as an operator for the purposes of regional development of the “Beeline” network.
In November 2004, pursuant to the terms of the merger of VimpelCom and VimpelCom-Region, the Group exchanged its 29.8% interest in VimpelCom-Region for newly issued common shares representing 11.45% voting and ownership interest in VimpelCom. This transaction was accounted for as a disposal of 12.52% of effective interest in VimpelCom-Region and an acquisition of 11.45% interest in VimpelCom, excluding its investment in VimpelCom-Region. The accounting gain of the Group relating to the merger of VimpelCom and VimpelCom- Region amounted to USD 389,694 thousand and was recorded in the combined statement of income within gains less losses arising from disposals of interests in associated companies in 2004.
On 10 January 2005, KaR-Tel, a wholly owned subsidiary of VimpelCom, received an “order to pay” issued by the Savings Deposit Insurance Fund (the “Fund”), a Turkish state agency, in the amount of approximately USD 5,500,000 thousand. The order does not provide any information regarding the nature of or basis for, the asserted debt, other than to state that it is a debt to the Turkish Treasury and the term for payment is 6 May 2004. On 17 January 2005, KaR-Tel delivered to the Turkish consulate in Almaty a petition to the Turkish court objecting to the propriety of the order. Although VimpelCom believes that the order to pay is without merit and that any attempted enforcement of the order to pay in relevant jurisdictions outside of Turkey is subject to procedural and substantive hurdles, there can be no assurance that KaR-Tel will prevail with respect to the objections filed (either on substantive or procedural grounds), that claims will not be brought by the Fund directly against VimpelCom or its other subsidiaries nor that KaR-Tel and/or VimpelCom or its other subsidiaries will not be required to pay amounts owed in connection with the order or on the basis of other claims made by the Fund. The adverse resolution of this matter, and any other matters that may arise in connection therewith, could have a material adverse effect on VimpelCom’s business, financial condition and results of operations. The “order to pay” amount is not reflected as a liability in VimpelCom’s financial statements and the Group’s Management is unable to estimate the effect that any ultimate resolution of these matters might have on these combined financial statements.
23 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
6 Investments in Associated Companies (Continued)
In addition, VimpelCom Group is a party to a number of legal, tax and shareholder disputes. Also, VimpelCom’s ability to generate revenues is dependent upon the operation of the wireless telecommunications networks under its licences expiring in future and there is no assurance that those licences will be renewed in a timely manner or on the same terms and conditions.
Management of the Group is currently unable to estimate the maximum potential losses, which the Group may incur in the future if the resolution of these contingencies is adverse for VimpelCom. At 31 December 2004 the Group’s share of recorded VimpelCom’s contingencies was USD 4,787 thousand.
Golden Telecom
At 31 December 2004, the Group owned a 29.58% (2003: 29.9%) interest in Golden Telecom, a telecommunications and internet provider operating in the Russian Federation and Ukraine.
Kyivstar
At 31 December 2004, the Group owned a 43.48% (2003: 22.36%) interest in Kyivstar, a mobile telecommunications provider operating in Ukraine.
Kyivstar is a party to a number of legal, regulatory, tax and shareholder disputes. Management of the Group is currently unable to estimate the potential losses which the Group may incur in the future if the resolution of these contingencies is adverse for Kyivstar.
In April 2004, under a previously concluded option agreement, the Group sold a 0.58% interest in Kyivstar to Telenor, Kyivstar’s majority shareholder, for USD 2,551 thousand. In July 2004, the Group acquired an additional 21.69% interest in Kyivstar for USD 270,575 thousand.
7 Investments Available for Sale
Note 2004 2003
At 1 January 435,735 145,616 Movements in fair value 346,103 76,287 Acquisitions 170,490 300,826 Disposals at value of sales proceeds (402,492) (70,127) Gains less losses on derecognition of investments available for sale 254,581 48,671 Transfer of net fair value gains on investments available for sale to net profit (67,428) (18,992) Impairment of investments available for sale 19 (1,314) - Effect of change in accounting treatment for an associate - (42,110) Effect of translation to presentation currency 20,275 (4,436)
At 31 December 755,950 435,735
External independent market quotations were not available for certain investments available for sale. As such, the fair values of these assets were determined by Management on the basis of recent sales of equity interests in the investees between unrelated third parties, analysis of discounted cash flows and other financial data of the investees and the application of other valuation methodologies.
24 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
7 Investments Available for Sale (Continued)
The investments available for sale are:
Name Nature of business Country of Fair value registration 2004 2003
MegaFon Telecommunications Russia 677,000 310,000 Patra Brewery Russia 54,890 - Metrosvyaz Telecommunications Cyprus 7,000 - Fellowes Telecommunications BVI 3,570 - TD GUM Retail Russia - 64,522 Akrikhin Pharmaceutical Russia - 38,630 Kosmos Hotel Russia - 14,000 Other 13,490 8,583
Total investments available for sale 755,950 435,735
MegaFon
In August 2003, the Group acquired, through the acquisition of a 100% stake in CT Mobile, a 25%+1 share of MegaFon, the third largest mobile operator in the Russian Federation, for consideration of USD 295,000 thousand.
The Group’s Management classified its investment in MegaFon as an investment available for sale rather than as an investment in associated company since from the date of acquisition and to the date of these combined financial statements the Group did not have significant influence over MegaFon due to pending litigation in respect of the title of its investment in MegaFon. At 31 December 2004 and 2003, shares representing a 7.75% interest in MegaFon were pledged by CT Mobile as collateral in respect of loans obtained by MegaFon (refer to Note 30). Refer to Note 31 for the information on litigation to the Group’s investment in MegaFon. At 31 December 2004 shares representing 25%+1 share interest in MegaFon and owned by the Group were blocked in relation to the pending litigation.
Patra
During 2004, the Group acquired a 59.28% interest in ZAO Patra Brewery (“Patra”) for a consideration of USD 18,900 thousand. In addition the Group obtained 18.56% of Patra shares as consideration for the sale of investment in a different brewing company (see below). In 2005 the Group sold its entire interest in Patra for USD 71,000 thousand.
TD GUM
In January 2004 the Group disposed of its interest in TD GUM for USD 64,860 thousand. The realised gain on this sale in amount of USD 39,141 thousand was recorded in the combined statement of income for the year ended 31 December 2004 within gains less losses on derecognition of investments available for sale.
Significant Transaction with Equity Securities
Included in acquisition of available for sale securities in 2004 are shares of brewing company which the Group sold by the end of 2004. The gain on disposal amounted to USD 171,214 thousand, which is included in gains less losses arising on derecognition of investments available for sale. Also the Group provided agency services to a third party in selling the brewing company shares resulting in commission amounting to USD 11,743 thousand. In addition to cash consideration, the Group obtained an 18.56% interest in Patra. At 31 December 2004 the amount of USD 236,857 thousand was outstanding as receivable from the sale. In January 2005, the full amount of consideration was received by the Group.
25 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
8 Loans and Advances to Customers
Note 2004 2003
Current loans 4,158,358 3,510,791 Net investment in lease 79,967 25,626 Overdue loans 32,962 31,150 Less: Provision for impairment 19 (197,846) (175,723)
Total loans and advances to customers 4,073,441 3,391,844
Less: Due in more than 12 months 1,395,798 913,645 Less: Provision for impairment of balances due in more
than 12 months (62,801) (44,043)
Total loans and advances to customers – current portion 2,740,444 2,522,242
Economic sector risk concentrations within the customer loan portfolio were as follows:
2004 2003 Amount % Amount %
Manufacturing and construction 1,881,503 44 1,471,294 41 Energy and oil and gas 1,065,922 25 1,049,572 30 Trade and commerce 636,549 15 471,529 13 Telecommunications 178,708 4 205,547 6 Individuals 46,119 1 49,858 1 Other 462,486 11 319,767 9
Total loans and advances to customers (before provision for impairment) 4,271,287 100 3,567,567 100
At 31 December 2004, the estimated fair value of loans and advances to customers was USD 4,076,468 thousand (2003: USD 3,405,413 thousand) (Note 28).
At 31 December 2004, the Group had 20 borrowers (2003: 16 borrowers) with aggregated loan amounts above USD 50,000 thousand. The total aggregate amount of these loans was USD 1,928,999 thousand (2003: USD 1,742,925 thousand) or 45.2 % (2003: 48.9%) of the gross loan portfolio.
At 31 December 2004, loans totalling USD 78,624 thousand (2003: USD 23,765 thousand) were pledged to third parties as collateral with respect to due to banks (Note 16).
For interest rates, maturity and currency analyses of loans and advances to customers at 31 December 2004, refer to Note 29. Information on related party balances is disclosed in Note 33.
26 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
9 Due from Banks
2004 2003
Term placements with banks 2,991,449 95,153 Reverse sale and repurchase agreement with banks 6,057 40,069
Total due from banks 2,997,506 135,222
Less: Due in more than 12 months 987 -
Total due from banks – current portion 2,996,519 135,222
At 31 December 2004 the fair value of securities purchased under reverse sale and repurchase agreements with banks was USD 6,963 thousand (2003: USD 45,626 thousand).
At 31 December 2004, the estimated fair value of due from banks was USD 2,997,506 thousand (2003: USD 135,222 thousand) (Note 28).
For interest rates, maturity and currency analyses of amounts due from banks at 31 December 2004, refer to Note 29.
10 Receivables and Other Assets
Note 2004 2003
Receivables relating to securities transactions 358,654 133,374 Trade receivables and advances to suppliers 78,524 141,843 Other receivables on banking operations 79,093 52,287 Originated loans related to the non-banking operations 77,452 62,536 Inventory 55,930 54,874 Receivables relating to insurance operations 55,662 33,477 Prepaid taxes 55,625 40,161 Receivable from BP plc 5 - 1,808,519 Receivable from TNK-BP relating to Slavneft dividends 5 - 117,500 Other 108,860 31,773 Less: Provision for impairment 19 (31,917) (29,069)
Total receivables and other assets 837,883 2,447,275
Less: Due in more than 12 months 74,053 1,254,394
Total receivables and other assets – current portion 763,830 1,192,881
At 31 December 2004, the estimated fair value of receivables and other assets was USD 837,883 thousand (2003: USD 2,449,210 thousand) (Note 28).
At 31 December 2004, gold (included in the caption “other”) with a carrying value of USD 21,432 thousand (2003: USD 19,943 thousand) was sold to third parties under a sale and repurchase agreement with banks (Note 16).
For information on currency and maturity analyses of receivables and other assets at 31 December 2004, refer to Note 29. Information on related party balances is disclosed in Note 33.
27 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
11 Trading Securities
2004 2003
Corporate shares 348,658 35,119 Corporate Eurobonds 113,659 183,300 Corporate bonds 109,664 69,588 Russian Federation Eurobonds 91,272 305,759 Eurobonds of other states 12,457 52,644 Other securities 75,447 46,718
Total trading securities 751,157 693,128
Corporate shares are shares of Russian and Ukrainian companies.
Corporate Eurobonds are interest bearing securities denominated in US Dollars and Euros, issued mainly by large Russian companies and are freely tradable internationally. These bonds have maturity dates ranging from 2005 to 2014. The annual coupon rates on these bonds range from 5.0% to 12.8% and yields to maturity from 4.5% to 12.0% at 31 December 2004, depending on bond issue.
Corporate bonds are interest bearing securities denominated in Russian Roubles, issued by large Russian and Ukrainian companies and are freely tradable in the Russian Federation and Ukraine. These bonds have maturity dates ranging from 2005 to 2009. The annual coupon rates of these bonds range from 7.6% to 17.5% and yields to maturity from 5.1% to 17.0% at 31 December 2004, depending on bond issue.
Russian Federation Eurobonds are interest bearing securities denominated in US Dollars, issued by the Ministry of Finance of the Russian Federation, and are freely tradable internationally. These bonds have maturity dates ranging from 2005 to 2030. The annual coupon rates on these bonds range from 5.0% to 12.8%, and yields to maturity from 3.5% to 7.1% at 31 December 2004, depending on bond issue.
At 31 December 2004 trading securities with a fair value of USD 83,594 thousand (2003: USD 319,126 thousand) were sold to third parties under sale and repurchase agreements with banks (Note 16).
For information on interest rate and currency analysis of trading securities at 31 December 2004, refer to Note 29. Information on trading securities issued by related parties and owned by the Group is disclosed in Note 33.
12 Cash and Cash Equivalents
2004 2003
Correspondent and overnight accounts 580,679 1,063,453 Cash balances with the CBRF (other than mandatory cash balances) 379,633 227,528 Cash on hand 257,375 169,099
Total cash and cash equivalents 1,217,687 1,460,080
For interest rates and currency analyses of cash and cash equivalents at 31 December 2004, refer to Note 29.
28 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
13 Share Capital and Share Premium
CTF Holdings Limited
At 31 December 2004 and 2003 the authorised, issued and fully paid share capital of CTFH was represented by 985,774 ordinary shares of GBP 1.00 each. All shares rank equally and each share carries one vote.
The share premium represents GBP 9.00 (USD 15.40) for each of the 983,774 new shares that were issued in 1996.
During 2003, a portion of the investment into Alfa Finance Holdings S.A. previously owned directly by members of the Group was transferred to CTFH. Accordingly, this direct investment of USD 18,282 thousand has been reclassified from share capital to retained earnings.
In 2004 and 2003 CTFH declared no dividends. Refer to Note 35 for the information on dividends declared subsequent to 31 December 2004.
ABH Holdings Corp.
From the date of incorporation and at 31 December 2004 the authorised, issued and fully paid share capital of ABHH was represented by 490,882 ordinary shares of USD 0.01 each. All shares rank equally and each share carries one vote.
From the date of inception and to the date of these combined financial statements ABHH declared no dividends.
14 Borrowings
The principal borrowings for particular business segments are:
2004 2003
Financial Services Syndicated loans 225,218 82,237 Bills of exchange 204,730 557,959 Euro Medium Term Notes 191,348 - Eurobonds 175,690 174,535 Russian Rouble denominated bonds 68,309 16,703 Euro-commercial papers 46,390 50,442
Retail Trade Syndicated loan 72,829 - Other loans 12,545 25,103
Investment Group Loans 7,037 14,179 Loans from shareholders 5,441 5,126 Other borrowings 1,893 27,369
Total borrowings 1,011,430 953,653
Less: Non-current portion 307,498 199,727
Total borrowings – current portion 703,932 753,926
At 31 December 2004, the estimated fair value of borrowings was USD 1,015,148 thousand (2003: USD 966,842 thousand) (Note 28).
29 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
14 Borrowings (Continued)
In December 2003 Alfa-Bank Group received a syndicated loan in amount of USD 82,000 thousand from a consortium of large international banks. Initially the loan had a maturity date of 24 November 2004 and bore a floating interest rate equal to LIBOR plus 2.4% per annum payable semi-annually. On 24 November 2004 the Alfa- Bank Group repaid USD 41,000 thousand of this loan and rolled over the balance in the amount of USD 41,000 thousand which was subsequently repaid on 23 May 2005. At 31 December 2004 the effective interest rate was 6.7% per annum. Issue proceeds net of transaction cost amounted to USD 81,174 thousand.
In June 2004 the Alfa-Bank Group received a syndicated loan in the amount of USD 120,000 thousand from a consortium of large international banks. Initially the loan had a maturity date on 24 June 2005 and a floating interest rate equal to LIBOR plus 2.0% per annum payable semi-annually. On 24 June 2005 the Group repaid USD 47,000 thousand of this loan and rolled over the balance in the amount of USD 73,000 thousand. The rolled over balance matured on 15 June 2006. At 31 December 2004 the effective interest rate was 5.9% per annum. Issue proceeds net of transaction cost amounted to USD 118,757 thousand.
In December 2004 the Alfa-Bank Group received a syndicated loan in the amount of USD 65,000 thousand from a consortium of large international banks. The loan matured on 2 December 2005 and bore a floating interest rate equal to LIBOR plus 1.8% per annum payable semi-annually. At 31 December 2004 the effective interest rate was 5.5% per annum. Issue proceeds net of transaction cost were equal to USD 64,323 thousand.
In June 2004 the Alfa-Bank Group established a Euro Medium Term Note Programme (“MTN Programme”). The aggregate principal amount of outstanding notes issued under the MTN Programme at any time may not exceed USD 2,000,000 thousand. On 12 October 2004 the Alfa-Bank Group issued notes under the MTN Programme with an aggregate nominal amount of USD 190,000 thousand. The notes carry a fixed coupon at a rate of 8.0% per annum payable semi-annually and matured on 13 April 2006. Issue proceeds net of transaction costs and discount amounted to USD 187,776 thousand and the effective interest rate at origination was 9.1%.
In November 2002 Alfa-Bank Group issued US Dollar denominated Eurobonds with a nominal value of USD 175,000 thousand. The bonds carry a fixed coupon at a rate of 10.8% per annum payable semi-annually and matured on 19 November 2005. Issue proceeds net of transaction costs and discount amounted to USD 171,093 thousand and the effective interest rate at origination was 12.0%.
In April 2004 the Alfa-Bank Group issued Russian Rouble denominated bonds maturing in March 2010 at a nominal value of RR 2,000,000 thousand. The bonds have a floating interest rate and the coupon is payable semi-annually. At 31 December 2004 coupon was to be paid at an interest rate of 7.4% per annum.
In December 2003 Alfa-Bank Group established a Euro-Commercial Paper Programme (the “ECP Programme”). The aggregate principal amount of outstanding notes issued under the ECP Programme at any time may not exceed USD 200,000 thousand and the tenor of the notes may not be more than 365 days. In November 2005 the maximum allowed principal amount of outstanding notes was increased to USD 350,000 thousand. In November 2006 the maximum allowed principal amount of outstanding notes was increased to USD 1,000,000 thousand. At 31 December 2004 the nominal value of outstanding notes was USD 46,800 thousand (2003: USD 51,550 thousand). The notes were issued at a discount to the nominal value ranging from 4.2% to 8.3%. At 31 December 2004 the average effective interest rate at origination was 6.5%.
In 2004 Perekrestok received a syndicated loan from a group of international banks in the amount of USD 75,000 thousand with an interest rate of LIBOR plus 4.3% per annum. Under this loan agreement Perekrestok has pledged property, plant and equipment, inventory and all shares of CJSC TD Perekriostok. At 31 December 2004 the net book value of the pledged property, plant and equipment was USD 91,995 thousand (Note 4). The loan was fully repaid in November 2005.
For interest rate, maturity and currency analyses of borrowings at 31 December 2004, refer to Note 29. Information on related party balances is disclosed in Note 33.
30 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
15 Customer Accounts
Economic sector concentrations within customer accounts were as follows:
2004 2003 Amount % Amount %
Individuals 1,397,962 38 1,293,163 43 State and public organisations 535,502 14 86,178 3 Energy and oil and gas 405,306 11 582,203 19 Finance and investment companies 345,986 9 163,771 5 Manufacturing and construction 299,861 8 337,220 11 Trade and commerce 210,840 6 158,600 5 Other 522,183 14 416,378 14
Total customer accounts 3,717,640 100 3,037,513 100
Less: Non – current portion 39,388 39,538
Total customer accounts - current portion 3,678,252 2,997,975
At 31 December 2004, the estimated fair value of customer accounts was USD 3,717,640 thousand (2003: USD 3,037,513 thousand) (Note 28).
At 31 December 2004, the Group had 4 customers (2003: 3 customers) with aggregated balances equal to or above USD 50,000 thousand. The aggregate amount of these deposits was USD 1,125,389 thousand (2003: USD 566,662 thousand) or 30.3% (2003: 18.7%) of total customer accounts.
Included in customer accounts are deposits of USD 97,556 thousand (2003: USD 45,337 thousand) held as collateral for irrevocable commitments under import letters of credit (Note 30).
For interest rates, maturity and currency analyses of customer accounts at 31 December 2004, refer to Note 29. Information on related party balances is disclosed in Note 33.
16 Due to Banks
2004 2003
Term placement of banks 315,138 369,465 Sale and repurchase agreements with banks 126,131 289,341 Correspondent accounts of banks 58,689 137,495
Total due to banks 499,958 796,301
Less: Non-current portion 80,760 13,458
Total due to banks - current portion 419,198 782,843
At 31 December 2004, trading securities with a fair value of USD 83,594 thousand (2003: USD 319,126 thousand) were sold to third parties under sale and repurchase agreements with banks (Note 11).
In addition, at 31 December 2004, securities purchased by the Group under reverse sale and repurchase agreements with a fair value of USD nil (2003: USD 13,775 thousand) were sold by the Group under sale and repurchase agreements with banks (Note 9).
31 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
16 Due to Banks (Continued)
At 31 December 2004, gold with a carrying value of USD 21,432 thousand (2003: USD 19,943 thousand) was sold to third parties under sale and repurchase agreement with banks (Note 10). At 31 December 2004 loans to customers in the amount of USD 48,624 thousand (2003: Nil) have been sold to third parties under sale and repurchase agreements with other banks and loans to customers in the amount of USD 30,000 thousand (2003: USD 23,765 thousand) have been pledged as collateral with respect to due to banks (Note 8).
At 31 December 2004, the estimated fair value of due to banks was USD 499,958 thousand (2003: USD 796,301 thousand) (Note 28). For interest rates, maturity and currency analyses of amounts due to banks at 31 December 2004, refer to Note 29.
17 Payables and Other Liabilities
Note 2004 2003
Provision relating to TNK-BP formation indemnities 5, 19 465,920 - Accrued staff compensation expenses 294,706 615,237 Accounts payable relating to securities transactions 220,211 306,292 Trade payables and advances from customers 189,409 92,991 Liabilities relating to insurance operations 113,374 78,414 Conversion operations and derivative financial instruments 96,589 7,005 Settlements with customers on banking operations 31,921 25,306 Taxes payable 29,165 21,319 Provision for losses on credit related commitments 19, 30 21,123 7,782 Other 69,065 49,142
Total payables and other liabilities 1,531,483 1,203,488
Less: Non-current portion 53,913 90,621
Total payables and other liabilities - current portion 1,477,570 1,112,867
Accrued staff compensation expenses mainly relate to employee bonus plans based on certain performance indicators and transaction related bonuses.
At 31 December 2004, the estimated fair value of payables and other liabilities was USD 1,531,483 thousand (2003: USD 1,203,488 thousand) (Note 28).
For maturity and currency analyses of payables and other liabilities at 31 December 2004, refer to Note 29. Information on related party balances is disclosed in Note 33.
18 Income Tax
2004 2003
Current income tax expense 45,475 12,804 Deferred income tax expense 176,901 10,275 Less: Deferred tax recorded directly in equity (161,055) -
Income tax expense 61,321 23,079
32 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
18 Income Tax (Continued)
In addition, the Group’s share of income tax expense of joint ventures (Note 5) and associated companies (Note 6) included in share of results of joint ventures and associated companies amounted to USD 799,662 thousand.
Profit before tax for financial reporting purposes is reconciled to income tax expense as follows:
2004 2003
IFRS profit before tax 1,096,515 2,608,123
Theoretical tax at applicable statutory rate 99,325 21,646 Tax effect of items which are not deductible or not assessable for taxation purposes: - Tax exempt income (6,370) (2,211) - Non-deductible expenses 2,876 7,826 - Movement in loss carried forward (6,158) (2,506) - Difference in provisions in accordance with IFRS and tax rules (32,513) (15,459) Other IFRS adjustments of a non-temporary nature 4,161 13,783
Income tax expense for the year 61,321 23,079
During 2004 the theoretical tax rate of the Group increased from 0.8% to 9.1% due to changes in composition of taxable income by types of activity and tax jurisdiction.
Differences between IFRS and applicable statutory taxation regulations give rise to certain temporary differences between the carrying amount of certain assets and liabilities for financial reporting purposes and their tax bases. An analysis of the temporary differences and calculations of deferred tax was performed individually for each company included in the combined financial statements. To determine the tax effect, tax rates effective on the date of the financial statements were used, taking into consideration the type of activity and each company’s status (24% for financial services, trading activities and some investments in telecommunication assets; nil%-5% for oil and gas, telecommunications and other activities conducted through low tax and tax free jurisdictions). For companies engaged in several types of activities subject to different tax rates, the tax was calculated on the basis of the main type of activities. Thus, the theoretical tax at the applicable statutory rates calculated above is an aggregation of the aforementioned tax rates. Investments available for sale are held and disposed of primarily by subsidiaries of the Group operating in tax-free jurisdictions. Therefore, part of the net fair value gains arising on investments available for sale recorded directly in the combined statement of changes in shareholders’ equity had no impact on the deferred tax position of the Group. Taxation of the Group and its investees. Deferred taxes should be measured consistently with the expected manner of recovery of the Group’s assets. The expected manner of recovery of the carrying amount of an asset may affect (i) the applicable tax rate; and (ii) the tax base of the asset. The Management of the Group has performed an analysis of the dividends policies at the Group’s investee companies with regards to the Group’s potential deferred tax liabilities. No deferred taxes related to future dividends from or sale of TNK-BP (Note 5) are recognised in these combined financial statements because the parent company of TNK-BP is located in a tax free jurisdiction and any sale would occur in a tax free jurisdiction. For VimpelCom, Golden Telecom, Kyivstar (Note 6) and MegaFon (Note 7), Management expects that the carrying value of the investments would be recovered through a sale rather than through dividends distributing the companies’ capital. No deferred taxes related to a future sale are recognised in these combined financial statements in respect of VimpelCom and Golden Telecom because any sale would occur in a tax free jurisdiction. Deferred taxes are recognised in respect of Kyivstar and MegaFon because these are held through subsidiaries in taxable jurisdictions, Ukraine and Russia, respectively. With respect to VimpelCom, Kyivstar and MegaFon, Management considers any future dividends and related withholding taxes to be related to the investees’ future profits which are not recognised in these combined financial statements. Consequently, no accruals were made in these combined financial statements in respect of the withholding taxes relating to such future profits and dividends. With respect to Golden Telecom, which has a history of paying dividends, the Group accrues withholding taxes related to its share of profits of the associated company to the extent such taxes are material to the combined financial statements.
33 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
18 Income Tax (Continued)
Deferred tax assets and liabilities and the deferred tax charge/(credit) in the combined statement of income are attributable to the following items:
31 Acquisition/ Movement Effect of 31 Acquisition/ Movement Effect of 31 December Disposal currency December Disposal currency December 2002 translation 2003 translation 2004
Tax effect of deductible temporary differences: Provision for loan impairment (4,857) - 5,523 (213) 453 - 28,221 15 28,689 Property, plant and equipment 7,865 - 3,861 142 11,868 - 943 69 12,880 Payables and other liabilities 331 - 4,002 30 4,363 - 3,025 28 7,416 Taxable losses carried forward 4,848 - 2,506 174 7,528 - (6,158) 100 1,470 Receivables and other assets 184 - 4,716 267 5,167 - (4,370) 156 953 Other 5,721 - (3,849) 64 1,936 - 2,260 (81) 4,115 -
Deferred tax asset 14,092 - 16,759 464 31,315 - 23,921 287 55,523
Tax effect of taxable temporary differences: Fair valuation of investments available for sale ------(161,055) - (161,055) Property, plant and equipment (24,893) - (8,855) (1,295) (35,043) (2,003) 3,999 (1,303) (34,350) Trading securities - - (7,315) - (7,315) - (20,737) (449) (28,501) Investments in associated companies - - (9,105) - (9,105) - (17,951) (92) (27,148) Payables and other liabilities (932) - (13,169) (148) (14,249) - 4,716 (60) (9,593) Receivables and other assets (5,480) - 4,815 (49) (714) - 666 (16) (64) Other (3,335) - 3,841 - 506 - (8,457) 446 (7,505)
Deferred tax liability (34,640) - (29,788) (1,492) (65,920) (2,003) (198,819) (1,474) (268,216)
Acquisition/disposal of subsidiaries - (2,754) 2,754 - - 2,003 (2,003) - -
Net deferred tax liability (20,548) (2,754) (10,275) (1,028) (34,605) - (176,901) (1,187) (212,693)
Deferred tax asset - 1,079 18,241 Deferred tax liability (20,548) (35,684) (230,934)
34 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
19 Provisions on Operating Items
Provision for Provision for Provision for Provision for Provision Total impairment loan impairment losses on relating to provisions of impairment of receivables credit related TNK-BP investments (Note 8) and other commitments formation available for assets (Notes 17 and indemnities sale (Note 10) 30) (Notes 5 and (Note 7) 17)
Balance at 1 January 2003 5,090 132,133 14,795 9,463 - 161,481
Charge/(recovery) during the year - 34,383 14,633 (2,428) - 46,588 Effect of translation to presentation currency - 10,525 769 747 - 12,041 Movements due to disposal of subsidiaries - - 1,280 - - 1,280 Use of provisions during the year (5,090) (1,318) (2,408) - - (8,816)
Balance at 31 December 2003 - 175,723 29,069 7,782 - 212,574
Charge during the year 1,314 13,873 8,945 13,341 465,920 503,393 Effect of translation to presentation currency - 10,097 600 478 - 11,175 Movements due to acquisition/disposal of subsidiaries - - (2,646) - - (2,646) Use of provisions during the year (1,314) (1,847) (4,051) (478) - (7,690)
Balance at 31 December 2004 - 197,846 31,917 21,123 465,920 716,806
20 Goodwill, Net
2004 2003
Positive goodwill 17,617 11,130 Negative goodwill (3,021) (6,347)
Total goodwill, net 14,596 4,783
35 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
21 Net Interest, Fees and Other Income on Banking Activities
2004 2003
Interest income 582,631 464,637 Interest expense (214,884) (239,508) Net interest income 367,747 225,129
Fee and commission income 143,413 176,344 Fee and commission expense (32,396) (41,150) Net fees and commission income 111,017 135,194
Gains less losses arising from trading securities 63,514 18,987 Gains less losses arising from dealing in foreign currencies (9,006) 38,914 Structured debt operations 22,897 36,161 Other operating income 27,975 75,757
Net interest, fees and other income on banking activities 584,144 530,142
Information on related party transactions is disclosed in Note 33.
22 Operating Expenses
Note 2004 2003
Staff costs 481,579 783,569 Consulting, legal and other professional services 87,155 42,782 Rent and utilities 63,104 47,318 Depreciation and amortisation 4 41,527 30,165 Taxes other than on income 25,032 29,395 Telecommunications 21,288 14,734 Other 116,159 116,827
Total operating expenses 835,844 1,064,790
Total operating expenses included selling and distribution expenses in the amount USD 132,718 thousand (2003: USD 90,219 thousand).
The average number of employees employed by the Group during 2004 was 20,254 (2003: 18,432).
Additional depreciation expense in the amount of USD 7,707 thousand (2003: USD 7,464 thousand) was recorded in the combined statement of income within cost of sales.
The caption “other” includes mainly advertising and marketing, repairs and maintenance, product distribution and travel costs.
23 Net Interest Expense on Non-banking Activities
2004 2003
Interest income 3,393 11,645 Interest expense (19,868) (33,127)
Total net interest expense on non-banking activities (16,475) (21,482)
36 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
24 Minority Interest
2004 2003
At 1 January 1,396,344 743,916
Effect of restructuring of telecommunication assets 22,538 - Effect of changes in percentage ownership of subsidiaries 5,975 27,706 Minority interest applicable to cumulative translation reserve movements (102,085) (40,093) Minority interest applicable to changes in fair value of investments available for sale 37,729 457 Minority interest applicable to other direct equity movements 247 (7,226) Share of net profit for the year 264,147 593,872 Dividends paid to minority (72,044) (6,880) Effect of currency translation 104,989 84,592
At 31 December 1,657,840 1,396,344
In 2004, the Group finalised a restructuring of its ownership over telecommunication assets in which all of the telecommunication assets held by the Group at that time (VimpelCom Group, MegaFon, Kyivstar and Golden Telecom) were transferred under a single holding company, Alfa Telecom Limited. The related accounting loss in the amount of USD 22,538 thousand was recorded in the combined statement of income for the year ended 31 December 2004 within gains less losses arising from disposals of interest in associated companies.
25 Movements in Working Capital Balances
Movements in working capital balances comprised:
2004 2003
Movements in loans and advances to customers and due from banks 3,557,754 (945,544) Movements in receivables and other assets 27,610 (102,008) Movements in trading securities 58,029 (241,702) Movements in customer accounts and due to banks (383,784) 987,154 Movements in payables and other liabilities 112,256 570,306
Net increase in working capital balances 3,371,865 268,206
26 Acquisition, Formation and Disposal of Subsidiaries
In December 2004, the Group sold its entire interest in ZAO Petrosakh for a consideration of USD 44,899 thousand to the Urals Energy Group. Gain on disposal amounted to USD 29,949 thousand.
There were no other significant acquisitions/disposals of subsidiaries during 2004 and 2003. Refer to Note 35 for information on acquisition of control over Pyaterochka Group.
37 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
27 Analysis by Segment
Analysis by business segment (primary) Intersegment transfers or transactions are entered into under the normal commercial terms and conditions that would also be available to unrelated third parties.
Year ended 31 December 2004 Financial Services Oil & Gas Tele- Investment Group Retail Trade Other Eliminations Combined (Note 21) communications
SALES – (including banking activities - Note 21) - external sales 840,430 - - 136,438 660,047 - - 1,636,915 - inter-segment sales 5,811 - - - - 798 (6,609) -
Total sales (including banking activities – Note 21) 846,241 - - 136,438 660,047 798 (6,609) 1,636,915
Cost of sales (including banking activities – Note 21) (263,179) - - (111,636) (481,284) - 7,183 (848,916)
GROSS PROFIT (including banking activities – Note 21) 583,062 - - 24,802 178,763 798 574 787,999 Commission income on trading operations - - 2,347 22,167 - - - 24,514 Gain less losses on derecognition of investments available for sale 34,009 - (467) 177,892 - 43,147 - 254,581 Gain less losses arising from disposals of interests in joint venture - 245,424 - - - - - 245,424 Gain less losses arising from disposals of interests in associated companies - - 389,694 - - - (22,538) 367,156 Gain less losses arising from disposals of interest in subsidiaries - - - 39,657 - (647) - 39,010 Loss arising from disposal of receivable (41,233) ------(41,233) Provisions on operating items (34,034) (465,920) - (3,439) - - - (503,393) Operating expenses (379,869) (122,000) (37,638) (142,541) (148,722) (4,414) (660) (835,844) Operating income/segment result 161,935 (342,496) 353,936 118,538 30,041 38,884 (22,624) 338,214 Share of results of joint ventures - 616,515 - - - - - 616,515 Share of results of associated companies 13,621 - 166,839 (422) - - - 180,038 Non-banking finance expense, net 10,828 - (18,314) (5,923) (7,491) 229,324 (224,899) (16,475) Foreign exchange translation gains less losses (64,001) - 28,909 17,237 6,108 (10,046) 16 (21,777) Profit before tax 122,383 274,019 531,370 129,430 28,658 258,162 (247,507) 1,096,515 Income tax (expense)/credit (31,996) - (19,238) 1,585 (11,672) - - (61,321) Profit after tax 90,387 274,019 512,132 131,015 16,986 258,162 (247,507) 1,035,194 Minority interest (21,092) (62,816) (134,987) (38,688) (3,439) (3,125) - (264,147)
Net profit 69,295 211,203 377,145 92,327 13,547 255,037 (247,507) 771,047
38 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
27 Analysis by Segment (Continued)
Year ended 31 December 2004 Financial Services Oil & Gas Telecommu- Investment Group Retail Trade Other Eliminations Combined nications
OTHER INFORMATION Segment assets 9,955,446 - 762,354 437,195 370,576 585,935 (915,387) 11,196,119 Investments in joint ventures and associated companies 50,248 1,507,733 1,519,298 5,508 - - - 3,082,787 Combined total assets 10,005,694 1,507,733 2,281,652 442,703 370,576 585,935 (915,387) 14,278,906 Combined total liabilities 5,925,508 587,920 670,012 178,495 209,436 4,229 (584,155) 6,991,445 Capital expenditure 22,503 - 385 4,810 74,383 11 - 102,092 Depreciation expense 25,833 - 273 8,160 14,944 24 - 49,234 Provisions on operating items for the year 34,034 465,920 - 3,439 - - - 503,393
39 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
27 Analysis by Segment (Continued)
Year ended 31 December 2003 Financial Services Oil &Gas Telecommu- Russia, CIS and Retail Trade Other Eliminations Combined (Note 21) nications Southeast Asia Commodities
SALES – (including banking activities – Note 21) - external sales 810,800 - - 115,419 373,402 3 - 1,299,624 - inter-segment sales 29,613 - - 18 - 855 (30,486) -
Total sales (including banking activities – Note 21) 840,413 - - 115,437 373,402 858 (30,486) 1,299,624
Cost of sales (including banking activities – Note 21) (281,341) - - (88,445) (270,525) - 683 (639,628)
GROSS PROFIT (including banking activities – Note 21) 559,072 - - 26,992 102,877 858 (29,803) 659,996 Commission income on trading operations - external - - - 15,404 - - - 15,404 - inter-segment - - - 283 - - (283) - Gains less losses on derecognition of investments available for sale 31,054 - - 13,215 - 4,402 - 48,671 Gains less losses arising from disposals of interests in joint ventures - 2,051,788 - 5,879 - - - 2,057,667 Gains less losses arising from disposals of interests in associated companies - - 25,233 - - - - 25,233 Gains less losses arising from disposals of interests in subsidiaries - - - 4,876 - 4,196 - 9,072 Provisions on operating items (38,085) - - (8,503) - - - (46,588) Operating expenses (383,097) (550,000) - (67,576) (89,534) (4,243) 29,660 (1,064,790) Operating income/segment result 168,944 1,501,788 25,233 (9,430) 13,343 5,213 (426) 1,704,665 Share of results of joint ventures - 944,296 - 5,633 - - - 949,929 Share of results of associated companies 919 - 63,499 - - - - 64,418 Non-banking finance expense, net - - - (16,564) (2,951) 20,773 (22,740) (21,482) Foreign exchange translation gains less losses (104,327) - - 17,665 1,898 (4,449) (194) (89,407) Profit/(loss) before tax 65,536 2,446,084 88,732 (2,696) 12,290 21,537 (23,360) 2,608,123 Income tax (expense)/credit (17,534) - - 1,319 (6,850) (14) - (23,079) Profit/(loss) after tax 48,002 2,446,084 88,732 (1,377) 5,440 21,523 (23,360) 2,585,044 Minority interest (11,733) (560,931) (23,343) 2,521 (1,111) 725 - (593,872)
Net profit 36,269 1,885,153 65,389 1,144 4,329 22,248 (23,360) 1,991,172
40 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
27 Analysis by Segment (Continued)
Year ended 31 December 2003 Financial Oil & Gas Telecommu- Russia, CIS and Retail Trade Other Eliminations Combined Services nications Southeast Asia Commodities
OTHER INFORMATION Segment assets 8,722,712 117,500 310,000 366,581 219,199 106,777 (620,525) 9,222,244 Investments in joint ventures and associated companies 19,558 2,170,968 658,830 - - - - 2,849,356 Combined total assets 8,742,270 2,288,468 968,830 366,581 219,199 106,777 (620,525) 12,071,600 Combined total liabilities 5,208,601 550,000 - 736,753 130,733 21,077 (620,525) 6,026,639 Capital expenditure 32,947 - - 4,406 41,303 176 - 78,832 Depreciation expense (19,400) - - (8,595) (9,544) (90) - (37,629) Provisions on operating items for the year 38,085 - - 8,503 - - - 46,588
41 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
27 Analysis by Segment (Continued)
Analysis by geographical segment
At 31 December 2004 assets in the amount of USD 10,964,985 thousand (2003: USD 8 848 698 thousand) or 77% (2003: 73.3%) of total assets were located in the Russian Federation and assets in the amount of USD 2,508,124 thousand (2003: USD 2 823 316 thousand) or 18% (2003: 23.4%) of total assets were located in Europe. Substantially all sales to external customers both in 2004 and 2003 were related to transactions with Russian counterparties. Substantially all of the capital expenditures of the Group both in 2004 and 2003 were made in the Russian Federation.
28 Fair Value of Financial Instruments
Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by an active quoted market price.
The estimated fair values of financial instruments have been determined by Management using available market information, where it exists, and appropriate valuation methodologies. However, judgement is necessarily required to interpret market data to determine the estimated fair value.
The Russian Federation continues to display some characteristics of an emerging market and economic conditions continue to limit the volume of activity in the financial markets. Market quotations may not be reflective of the values for financial instruments, which would be determined in an efficient, active market involving willing buyers and willing sellers. While Management has used available market information in estimating the fair value of financial instruments, the market information may not be fully reflective of the value that could be realised in the current circumstances.
Financial instruments carried at fair value. Cash and cash equivalents, trading securities and investments available for sale are carried on the balance sheet at their fair value. As set out in Note 7, external independent market quotations were not available for certain investments available for sale. As such, the fair values of these assets were determined by Management on the basis of recent sales of equity interests in the investees between unrelated third parties, analysis of discounted cash flows and other financial data of the investees and the application of other valuation methodologies.
Loans and receivables originated carried at amortised cost less provision for impairment. The fair value of floating rate instruments is normally their carrying amount. The estimated fair value of fixed interest rate instruments is based on estimated future cash flows expected to be received discounted at current interest rates for new instruments with similar credit risk and remaining maturity. Refer to Notes 8, 9 and 10 for the estimated fair values of loans and advances to customers, due from banks and receivables, respectively.
Liabilities carried at amortised cost. The fair value of instruments with a quoted market price is based on quoted market prices. The estimated fair value of instruments with no stated maturity is the amount repayable on demand. The estimated fair value of fixed interest rate instruments without a quoted market price is based on expected cash flows discounted at current interest rates for new instruments with similar credit risk and remaining maturity. Refer to Notes 14, 15, 16 and 17 for the estimated fair values of borrowings, customer accounts, due to banks and payables, respectively.
Derivative financial instruments. All derivative financial instruments are carried at fair value as asset when the fair value is positive and as a liability when the fair value is negative. The fair value of derivative instruments is disclosed in Note 30.
29 Financial Risk Management
The risk management function within the Group is carried out in respect of financial risks (interest rate, liquidity, market, credit, currency and geographical), operational risks and legal risks. The Group’s companies’ individual risk management programmes focus on the unpredictable nature of financial markets and seek to minimise potential adverse effects on financial performance. Group subsidiary company’s Boards of Directors, as well as special- purpose committees, set, analyse and approve acceptable levels of financial risk which may be taken by the Group’s subsidiary companies. Certain of the Group’s companies use financial instruments, derivatives and other means to economically hedge certain exposures. The primary objectives of the financial risk management function are to establish risk limits, and then ensure that exposure to risks stays within these limits. The operational and legal risk management functions are intended to ensure proper functioning of internal policies and procedures to minimise operational and legal risks.
42 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
29 Financial Risk Management (Continued)
Interest rate risk. The Group takes on exposure to the effects of fluctuations in the prevailing levels of market interest rates on its financial position and cash flows. Interest margins may increase as a result of such changes but may reduce or create losses in the event that unexpected movements arise.
The Group is exposed to interest rate price risk, principally through Alfa-Bank Group, as a result of lending and advances to customers and banks at fixed interest rates, in amounts and for periods which differ from those of customer accounts and other borrowings at fixed interest rates. In practice, interest rates are generally fixed on a short-term basis. Also, interest rates, which are contractually fixed on both assets and liabilities, are often renegotiated to reflect current market conditions.
Other parts of the Group have a modest exposure to interest rate risk, principally as a result of borrowings and other credit related commitments which are largely at floating interest rates with relatively short maturities or interest reset dates.
The table below summarises the effective average interest rates, by major currencies, for monetary financial instruments at 31 December 2004. The analyses have been prepared using year end effective contractual rates.
2004 2003 RR USD EURO Other RR USD EURO Other currencies currencies
Loans and advances to customers 13.6% 11.2% 8.1% 14.3% 16.1% 11.9% 9.6% 14.2% Due from banks 2.1% 5.4% - 11.7% 4.3% 3.7% 6.5% 5.0% Debt trading securities 10.2% 7.9% 4.9% 7.8% 11.1% 7.5% 5.7% 5.1% Correspondent accounts and overnight placements with banks 0.5% 1.4% 0.0% 2.1% 2.3% 4.0% 2.3% 0.0% Mandatory cash balances with central banks 0.0% - 0.0% 0.0% 0.0% - 0.0% 0.0%
Borrowings: -bills of exchange 6.6% 3.8% 6.7% 13.0% 12.5% 4.0% 2.7% - -other borrowings 7.4% 8.2% - - 15.9% 9.6% - - Customer accounts: -current and settlement accounts 1.1% 0.6% 0.9% 1.0% 0.5% 1.8% 0.2% 0.0% -term deposits 5.2% 5.7% 5.5% 9.8% 6.2% 3.9% 3.3% 4.8% Due to banks 2.3% 2.8% 3.3% 0.9% 7.1% 3.2% 3.8% 1.0%
The sign “-” in the table above means that the Group does not have the respective assets or liabilities in corresponding currency.
The Group’s interest rate sensitivity analysis based on the re-pricing of the Group’s assets and liabilities does not differ significantly from the maturity analysis disclosed in the table below; the differences arise mainly because of floating rate loans and borrowings where interest rate review period is shorter than remaining maturity, and equity trading securities and other assets and liabilities which are non-interest bearing.
Liquidity risk. Liquidity risk is defined as the risk when the maturity of assets and liabilities does not match. The Group is exposed to daily calls on its available cash resources from overnight deposits, current accounts, maturing deposits and payables, loan draw downs, guarantees and from margin and other calls on cash settled derivative instruments. The Group does not maintain cash resources to meet all of these needs as experience shows that a minimum level of reinvestment of maturing funds can be predicted with a high level of certainty.
The table below shows assets and liabilities at 31 December 2004 by their remaining contractual maturity, unless there is evidence that any of these assets are impaired and will be settled after their contractual maturity dates, in which case the expected date of settlement is used. Some of the assets, however, may be of a longer term nature; for example, loans are frequently renewed and accordingly short term loans can have a longer term duration.
43 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
29 Financial Risk Management (Continued)
The liquidity position of the Group at 31 December 2004 is set out below:
Demand and From 1 to From 6 to More than No stated Total less than one 6 months 12 months 1 year maturity month
Property, plant and equipment - - - - 390,109 390,109 Goodwill, net - - - - 14,596 14,596 Investment in joint ventures - - - - 1,507,733 1,507,733 Investment in associated companies - - - - 1,575,054 1,575,054 Investments available for sale - - - - 755,950 755,950 Loans and advances to customers 199,596 1,329,878 1,210,970 1,332,997 - 4,073,441 Due from banks 2,951,202 35,255 10,062 987 - 2,997,506 Receivables and other assets 1,058 676,376 86,396 2,040 72,013 837,883 Deferred tax asset - - - - 18,241 18,241 Trading securities 751,157 - - - - 751,157 Mandatory cash balances with central banks 139,549 - - - - 139,549 Cash and cash equivalents 1,217,687 - - - - 1,217,687
Total assets 5,260,249 2,041,509 1,307,428 1,336,024 4,333,696 14,278,906
Borrowings 101,909 550,558 51,465 307,498 - 1,011,430 Customer accounts 1,640,522 1,373,334 664,396 39,388 - 3,717,640 Due to banks 260,592 141,421 17,185 80,760 - 499,958 Payables and other liabilities 247,065 312,167 918,338 53,913 - 1,531,483 Deferred tax liability - - - - 230,934 230,934
Total liabilities 2,250,088 2,377,480 1,651,384 481,559 230,934 6,991,445
Net liquidity gap at 31 December 2004 3,010,161 (335,971) (343,956) 854,465 4,102,762 7,287,461
Cumulative liquidity gap at 31 December 2004 3,010,161 2,674,190 2,330,234 3,184,699 7,287,461
Cumulative liquidity gap at 31 December 2003 451,543 (456,448) 649,236 2,429,888 6,044,961
The entire portfolio of trading securities is classified within “demand and less than one month” column as the portfolio is of a trading nature and Management believes this is a fairer portrayal of its liquidity position. Mandatory cash balances with the central banks are included within “demand and less than one month” as the majority of liabilities to which these balances relate to is also included in this category.
Management believes that in spite of a substantial portion of customer accounts being of a short term nature, diversification of these deposits by number and type of depositors, and the past experience of the Group would indicate that these customer accounts provide a long-term and stable source of funding for the Group. However, in accordance with the Russian Civil Code, individuals have a right to withdraw their deposit prior to maturity.
Liquidity requirements to support calls under guarantees and standby letters of credit are considerably less than the amount of the commitment because the Group does not generally expect the third party to draw funds under the agreement.
44 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
29 Financial Risk Management (Continued)
The matching and/or controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of the Group. It is unusual for banks ever to be completely matched since business transacted is often of an uncertain term and of different types. An unmatched position potentially enhances profitability, but can also increase the risk of losses. The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest-bearing liabilities as they mature, are important factors in assessing the liquidity of the Group and its exposure to changes in interest and exchange rates.
Market risk. The Group takes on exposure to market risks. Market risks arise from open positions in interest rate, currency and equity products, all of which are exposed to general and specific market movements. The Board of Directors of each company in the Group sets limits on the value of risk that may be accepted, which is monitored on a daily basis. However, the use of this approach does not prevent losses outside of these limits in the event of more significant market movements.
Credit risk. The Group is exposed to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. The two principal types of credit risk result from lending to banks and other customers and from sale of products and services on credit.
Alfa-Bank Group is the principal company in the Group, which is engaged in lending. In order to manage credit risk, Alfa-Bank Group structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one borrower, or groups of borrowers, and to geographical and industry segments. Such risks are monitored on a continual basis and subject to an annual or more frequent review.
The exposure to any one borrower including banks and brokers is further restricted by sub-limits covering on and off-balance sheet exposures and daily delivery risk limits in relation to trading items such as forward foreign exchange contracts. Actual exposures against limits are monitored daily.
Exposure to credit risk is managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing these lending limits where appropriate. Exposure to credit risk is also managed, in part, by obtaining collateral and corporate and personal guarantees.
Through credit sales, all of the Group’s companies are exposed to credit risk, which is managed accordingly. Each of the Group’s companies has policies in place to ensure that sales of products and services are made to customers with an appropriate credit history. Derivatives and cash transactions are limited to high credit quality financial institutions and counterparties.
The Group’s maximum exposure to credit risk is primarily reflected in the carrying amounts of financial assets on the combined balance sheet. The impact of possible netting of assets and liabilities to reduce potential credit exposure is not significant.
Credit risk for off-balance sheet financial instruments is defined as the possibility of sustaining a loss because any other party to a financial instrument fails to perform in accordance with the term of the contract. The Group uses the same credit policies in making conditional obligations as it does for on-balance sheet financial instruments through established credit approvals, risk control limits and monitoring procedures.
Currency risk. The Group takes on exposure to effects of fluctuations in the prevailing foreign currency exchange rates on its financial position and cash flows. The table below summarises the Group’s exposure to foreign currency exchange rate risk at 31 December 2004. Included in the table are the Group’s assets and liabilities at carrying amounts, categorised by currency. The off-balance sheet net notional position represents the difference between the notional amounts of foreign currency derivative financial instruments and their fair values.
45 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
29 Financial Risk Management (Continued)
At 31 December 2004 the Group had the following positions in currencies:
RR USD EURO Other Total currencies
Property, plant and equipment 375,903 - 1,138 13,068 390,109 Goodwill, net 14,321 275 - - 14,596 Investment in joint ventures - 1,507,733 - - 1,507,733 Investments in associated companies 1,154,630 - - 420,424 1,575,054 Investments available for sale 677,000 78,950 - - 755,950 Loans and advances to customers 1,322,071 2,461,579 246,962 42,829 4,073,441 Due from banks 219,875 2,756,921 - 20,710 2,997,506 Receivables and other assets 247,763 293,919 256,653 39,548 837,883 Deferred tax asset 18,241 - - - 18,241 Trading securities 128,792 578,236 21,861 22,268 751,157 Mandatory cash balances with central banks 107,920 - 28,756 2,873 139,549 Cash and cash equivalents 663,886 380,211 107,951 65,639 1,217,687
Total assets 4,930,402 8,057,824 663,321 627,359 14,278,906
Borrowings 238,544 769,585 2,740 561 1,011,430 Customer accounts 2,049,660 1,196,045 354,133 117,802 3,717,640 Due to banks 114,391 260,142 97,925 27,500 499,958 Payables and other liabilities 269,913 1,204,607 52,914 4,049 1,531,483 Deferred tax liability 203,787 - - 27,147 230,934
Total liabilities 2,876,295 3,430,379 507,712 177,059 6,991,445
Net balance sheet position 2,054,107 4,627,445 155,609 450,300 7,287,461
Off-balance sheet net notional position (Note 30) (389,629) 688,362 57,645 (435,562) (79,184)
Credit related commitments (Note 30) 173,645 775,546 132,304 900 1,082,395
At 31 December 2003 the Group had the following positions in currencies:
RR USD EURO Other Total currencies
Net balance sheet position 933,182 4,910,912 54,013 146,854 6,044,961
Off-balance sheet net notional position (26,026) (34,973) 70,659 374 10,034
Credit related commitments (Note 30) 93,694 667,296 60,531 784 822,305
46 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
29 Financial Risk Management (Continued)
The Group has extended loans and advances denominated in currencies other than operating currencies of the borrowers. Depending on the revenue stream of the borrower, the appreciation of the foreign currencies against the operating currencies may adversely affect the borrowers’ repayment ability and therefore may increase the likelihood of future loan losses.
30 Commitments and Derivative Financial Instruments
Capital expenditure commitments
At 31 December 2004, the Group had capital expenditure commitments totalling USD 42,025 thousand (2003: USD 26,098 thousand).
Credit related commitments
The primary purpose of these instruments is to ensure that funds are available to a customer as required. Guarantees and standby letters of credit, which represent irrevocable assurances that the Group will make payments in the event that a customer cannot meet its obligations to third parties, carry the same credit risk as loans. Documentary and commercial letters of credit, which are written undertakings by the Group on behalf of a customer authorising a third party to draw drafts on the Group up to a stipulated amount under specific terms and conditions, are collateralised by the underlying shipments of goods to which they relate or cash deposits and therefore carry less risk than a direct borrowing.
Note 2004 2003
Guarantees issued 604,650 513,073 Export letters of credit 346,945 241,843 Import letter of credit 15 151,923 75,171 Less: Provision for losses on credit related commitments 17,19 (21,123) (7,782)
Total credit related commitments 1,082,395 822,305
Prior to acquisition of CT Mobile by the Group, CT Mobile and other shareholders of MegaFon issued irrevocable guarantees in respect of loans obtained by MegaFon from the European Bank for Reconstruction and Development and other financial institutions. At 31 December 2003, loans amounted to USD 126,000 thousand and this amount was included in the amount of total guarantees issued. Additionally, shareholders of MegaFon signed a subordination agreement for the purpose of reallocation of commitments under the above guarantees. Under the above subordination agreement, CT Mobile pledged the shares representing a 7.75% interest in MegaFon. Refer to Note 7. By 31 December 2004 the loans were fully repaid by MegaFon. However the formal procedures related to the release of the Group from the guarantees were not yet completed. At 31 December 2004 this guarantee and related pledge were not included in the amount of total guarantees issued.
The total outstanding contractual amount of guarantees and letters of credit does not necessarily represent future cash requirements, as they may expire or terminate without being funded.
For the information on credit related commitments with related parties refer to Note 33.
47 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
30 Commitments and Derivative Financial Instruments (Continued)
Operating Lease Commitments
At 31 December 2004 and 2003, respectively, the Group had annual commitments under non-cancellable operating leases for land and buildings as set out below:
2004 2003
Amounts payable: Within 1 year 27,715 24,140 Between 2 and 5 years 59,618 69,498 After 5 years 27,530 60,952
Total operating lease commitments 114,863 154,590
Derivative Financial Instruments
Foreign exchange and other derivative financial instruments are generally traded in an over-the-counter market with professional market counterparties on standardised contractual terms and conditions.
The principal amounts of certain types of financial instruments provide a basis for comparison with instruments recorded on the balance sheet but do not necessarily indicate the amounts of future cash flows involved or the current fair value of the instruments and, therefore, do not indicate the Group’s exposure to credit or price risks. The derivative instruments become favourable (assets) or unfavourable (liabilities) as a result of fluctuations in market variables such as interest rates or foreign exchange rates relative to their terms. The aggregate contractual or principal amount of derivative financial instruments on hand, the extent to which instruments are favourable or unfavourable and, thus the aggregate fair values of derivative financial assets and liabilities can fluctuate significantly over time.
The principal or agreed amounts and fair values of derivative instruments held are set out in the following table. This table reflects the gross position before the netting of any counterparty position by type of instrument and covers contracts with a maturity date subsequent to 31 December 2004. These contracts were entered into by Alfa-Bank Group.
48 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
30 Commitments and Derivative Financial Instruments (Continued)
Domestic counterparties Foreign counterparties Principal or Negative fair Positive fair Principal or Negative fair Positive fair agreed value value agreed value value amount amount
Deliverable forwards Foreign currency - sale of foreign currency 20,542 - 542 131,566 - - - purchase of foreign currency 36,403 (1,148) 259 306,322 (5,471) 3,031 Securities - sale of securities 108,818 (140) 1,024 333,570 (79,017) 153 - purchase of securities 29,685 - 2,065 - - -
Non-deliverable forwards Foreign currency - sale of foreign currency - - - 6,063 (358) - - purchase of foreign currency 9,617 - 604 68,468 - 1,846 Securities - sale of securities 1,120 - 1 - - - - purchase of securities 34,719 (19) 173 - - - Precious metals - sale of precious metals - - - 23,857 (27) 595 - purchase of precious metals - - - 4,712 (54) 12 Commodities - sale of commodities 5,290 (59) 87 - - - - purchase of commodities 5,838 (119) 40 - - -
Futures Foreign currency - sale of foreign currency - - - 81,312 (1,839) 59 - purchase of foreign currency - - - 365,451 (4,876) 1,123 Securities - sale of securities - - - 39,178 (206) 20 - purchase of securities - - - 5,597 (1) 36 Precious metals - sale of precious metals - - - 12,553 (19) 215 - purchase of precious metals - - - 13,016 (427) 43 Commodities - sale of commodities - - - 5,356 (52) 76 - purchase of commodities - - - 4,950 (53) 75
Spot Foreign currency - sale of foreign currency 9,478 (13) 12 48,309 - 168 - purchase of foreign currency 9,478 (321) 61 44,712 (89) 1,463 Precious metals - sale of precious metals - - - 13,016 - 15
Call options Securities - sale of call options 19,190 (643) - 19,179 (1,160) - - purchase of call options 51,190 - 1,389 5,805 - 643
Put options Securities - purchase of put options 10,225 - 149 14,530 - 948
Total (2,462) 6,406 (93,649) 10,521
49 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
30 Commitments and Derivative Financial Instruments (Continued)
Deliverable forward positions in securities at 31 December 2004 are summarized below. At 31 December 2004 respective securities long balance sheet positions of the Group exceeded respective securities short deliverable forward positions. Refer to Note 11.
2004 Sale Purchase Fair value Fair value
Corporate shares of Russian entities 306,713 - US Treasury Notes 40,298 40,316 Russian Federation Eurobonds 90,958 23,748 Corporate Eurobonds 34,017 - Eurobonds of other states 10,700 5,937
Total 482,686 70,001
31 Contingent Liabilities
Legal proceedings
From time to time and in the normal course of business, claims against the Group are received from customers and other parties. On the basis of its own estimates and both internal and external professional advice, Management is of the opinion that no material unaccrued losses will be incurred in respect of claims and accordingly no provision has been made in these combined financial statements.
Since 2002, certain entities of the Group, have been listed as the defendants in an action commenced by Norex Petroleum Limited (“Norex”) in the United States District Court for the Southern District of New York in relation to the ownership of a company which is currently owned by TNK-BP Limited. On 18 February 2004, the court dismissed the claim on the grounds of “forum non conveniens”. Norex representatives filed a notice of appeal against the court decision and on 21 July 2005 the court of appeal vacated the previous court’s decision and remanded the case for further proceedings. Management believes that the allegations are without merit and intends to vigorously defend this action.
Since August 2003 various subsidiaries of the Group participated in an ongoing dispute with IPOC International Growth Fund Limited (“IPOC”) in respect of the title to 25% +1 share stake in MegaFon (Note 7). This dispute has involves a number of proceedings in various jurisdictions. Management of the Group is vigorously defending the Group’s rights and is confident of a positive outcome for the Group. At 31 December 2004 shares representing 25% +1 share interest in MegaFon and owned by the Group were blocked in relation to the pending litigation.
50 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
31 Contingent Liabilities (Continued)
Taxation
Russian tax, currency and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Management’s interpretation of such legislation as applied to the transactions and activity of the Group may be challenged by the relevant regional and federal authorities. Recent events within the Russian Federation suggest that the tax authorities may be taking a more assertive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged. As a result, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances reviews may cover longer periods. In addition, in some instances new tax regulations have had retroactive affect.
In addition, the tax consequence of transactions for Russian taxation purposes is frequently determined by the form in which transactions are documented and the underlying accounting treatment prescribed by Russian Accounting Rules. Accordingly, the Group structures certain transactions so as to take advantage of such form driven determinations to reduce the overall effective tax rate of the Group. The combined statement of income as presented in these combined financial statements includes reclassifications to reflect the underlying economic substance of those transactions. The effect of these reclassifications does not have an effect on the Group’s profit before taxation or the tax charge recorded in these combined financial statements.
Russian transfer pricing legislation introduced 1 January 1999 provides the possibility for tax authorities to make transfer pricing adjustments and impose additional tax liabilities in respect of all controllable transactions, provided that the transaction price differs from the market price by more than 20%. Controllable transactions include transactions with interdependent parties, as determined under the Russian Tax Code, all cross-border transactions (irrespective whether performed between related or unrelated parties), transactions where the price applied by a taxpayer differs by more than 20% from the price applied in similar transactions by the same taxpayer within a short period of time, and barter transactions. There is no formal guidance as to how these rules should be applied in practice. In the past, the arbitration court practice in this respect has been contradictory.
The Group occasionally conducts intercompany transactions at off-market rates. Tax liabilities arising from intercompany transactions are determined using actual transaction prices. It is possible with the evolution of the interpretation of the transfer pricing rules in the Russian Federation and the changes in the approach of the Russian tax authorities, that such transfer prices could potentially be challenged in the future. Given the brief nature of the current Russian transfer pricing rules, the impact of any such challenge cannot be reliably estimated; however, it may be significant.
As mentioned in Note 1 the Group operates primarily in the Russian Federation. A number of the Group’s entities are registered and operate in jurisdictions outside of the Russian Federation which are not subject to Russian taxes. These non-Russian entities contribute a significant proportion of the Group's operating results. The Management of the Group is of the opinion that the operations of the Group are conducted in a manner that does not give rise to any material tax liabilities other than those provided for in these combined financial statements. As stated in Note 2 the tax legislation in the Russian Federation is subject to varying interpretations which can change frequently and as such an unquantifiable risk remains that the tax authorities could seek to challenge this position in the future and levy additional tax on the Group.
The Group’s Management believes that its interpretation of the relevant legislation is appropriate and the Group’s tax, currency and customs positions will be sustained. The Group estimates that it has potential liabilities from exposure to other than remote tax risks of USD 31,196 thousand. The Group has recorded provisions of USD 2,000 thousand in these combined financial statements as its best estimate of potential liabilities arising from such tax contingencies. Separately, refer to Note 5 for details of tax audits related to the operations of TNK-BP.
Insurance
The Group is subject to political, legislative, fiscal and regulatory developments and risks, which are not covered by insurance. No provisions for self-insurance are included in these combined financial statements and the occurrence of significant losses and impairments associated with facilities could have a material effect on the Group’s operations.
51 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
31 Contingent Liabilities (Continued)
Formation of TNK-BP
Refer to Note 5 for information on contingencies and commitments related to the formation of TNK-BP.
Contingencies related to the Group’s investments in the joint venture and the associated companies.
The joint venture (Note 5) and the associated companies of the Group (Note 6) are involved in certain legal, regulatory, tax and shareholder disputes. Also, these companies’ future revenues are dependent upon these companies’ ability to retain and renew necessary licenses and permits. Management of the Group is currently unable to estimate the potential losses, which the Group may incur in the future if the resolution of these contingencies is adverse to the Group and its investees.
Assets pledged and restricted in use
Notes 2004 2003
Property, plant and equipment 4, 14 99,079 33,702 Investments available for sale 7, 30 209,870 95,754 Loans and advances to customers 8, 16 78,624 23,765 Receivables and other assets 10, 16 21,432 19,943 Trading securities 11, 16 83,594 319,126
Total 492,599 492,290
At 31 December 2004 all shares of CJSC TD Perekriostok were pledged in relation to borrowings (Note 14).
In addition, at 31 December 2004, securities purchased by the Group under reverse sale and repurchase agreements with banks with a fair value of USD nil thousand (2003: USD 13,775 thousand) were sold by the Group under sale and repurchase agreements with banks (Notes 9 and 16).
Mandatory cash balances with the central banks in the amount of USD 139,549 thousand (2003: USD 293,294 thousand) represent mandatory reserve deposits which are not available to finance the Group’s day to day operations.
Additionally, at 31 December 2004, shares representing a 25% +1 interest (2003: 25% +1 interest) in MegaFon were blocked due to pending litigation (Note 7).
Share options
Put option for shares in ABHH. In accordance with the Articles of Association of ABHH (the “ABHH Articles”) the shareholders of ABHH have a right to request redemption of their shares in ABHH for cash in the event of death or incapacity of the respective shareholder. The option is exercisable for a period of two years commencing from the date of death of a respective shareholder or for a period of two years commencing after one year of continued incapacity of the respective shareholder.
The redemption price of the shares in ABHH is 110% of the net assets of ABHH in accordance with most recently approved annual (or, at the request of the optionholder, as at the end of the previous quarter) IFRS consolidated financial statements of ABHH. Classification of redeemable capital as the liability results from amendments to IFRS which were effective from 1 January 2005 and was not contemplated explicitly in the ABHH Articles or considered by the parties when the ABHH Articles were negotiated. Therefore, the Management of the Group has not included redeemable capital itself in the calculation of net assets of ABHH for the purposes of calculation of the redeemable capital of ABHH arising from this option.
At 31 December 2004 the amount of redeemable capital of ABHH was nil. No amounts have been recorded in these combined financial statements in respect of the option.
52 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
31 Contingent Liabilities (Continued)
Put option for shares in Alfa Finance Holdings S.A. In accordance with the Shareholders Agreement of Alfa Finance Holdings S.A. dated 15 September 2004 (the “AFH Agreement”) the shareholders of Alfa Finance Holdings S.A. have a right to request redemption of their shares in Alfa Finance Holdings S.A. for cash in the event of death or incapacity of the respective ultimate shareholder. The option is exercisable for a period of two years commencing from the date of death of the respective ultimate shareholder or for a period of two years commencing after one year of continued incapacity of the respective ultimate shareholder.
The redemption price of the shares in Alfa Finance Holdings S.A. is 110% of the net assets of Alfa Finance Holdings S.A. in accordance with most recently approved annual (or, at the request of the optionholder, as at the end of the previous quarter) IFRS consolidated financial statements of Alfa Finance Holdings S.A. Classification of redeemable capital as a liability results from amendments to IFRS which were effective from 1 January 2005 and was not contemplated explicitly in the AFH Agreement or considered by the parties when the AFH Agreement was negotiated. Therefore, the Management has not included the amount of redeemable capital itself in the calculation of net assets of Alfa Finance Holdings S.A. for the purposes of calculation of the redeemable capital of Alfa Finance Holdings S.A. arising from this option.
The Group’s interest in Alfa Finance Holdings S.A. is held through subsidiaries of CTFH. Currently there are no arrangements in place for direct transfer to the incapacitated Controlling Shareholders or their heirs of proceeds from sale by those subsidiaries of shares in Alfa Finance Holdings S.A. As a result, part of the redeemable capital of Alfa Finance Holdings S.A. is attributable to those subsidiaries of CTFH. At 31 December 2004 the amount of redeemable capital of Alfa Finance Holdings S.A. attributable to minority interest was USD 1,323,704 thousand. No amounts have been recorded in these combined financial statements in respect of the option.
Put option for shares in Alfa Telecom Limited. In accordance with the 2004 Shareholders’ Agreement of Alfa Telecom Limited (the “ATL Agreement”) the shareholders of Alfa Telecom Limited have a right to request redemption of their interests in Alfa Telecom Limited for cash in the event of death or incapacity of the respective ultimate shareholder. The option is exercisable for a period of two years commencing from the date of death of a respective shareholder or for a period of two years commencing after one year of continued incapacity of the respective ultimate shareholder.
In arriving at redemption price for the shares subject to the put option, and, as defined in the ATL Agreement, the Alfa Telecom Limited’s assets and liabilities are separated into those that are quoted on a recognised stock exchange or market or the quotation of such asset or liability is determined on an over-the-counter market, referred to hereinafter as “Quoted assets” and those assets and liabilities that are not quoted on such an exchange or market, referred to hereinafter as “Unquoted assets”. The total redemption value of the redeemable capital is the sum of the values determined for the Quoted and Unquoted assets.
With regards to the Quoted assets, the ATL Agreement provides that the value is calculated as 90% of the average of the closing sales prices quoted on the recognised stock exchange or over-the-counter market over the period of three months immediately before the relevant valuation date. The Group has applied this valuation approach to determine the redemption value of the liability attributable to the Group’s shareholdings in VimpelCom and Golden Telecom which are traded on the NYSE and the NASDAQ, respectively.
With regards to the Unquoted assets, the ATL Agreement states that the value of such assets shall be the book value of the asset, and is subject to the application of a liquidity discount or premium if considered relevant and taking into account any other factors. Although Management has included all liabilities into the calculation of its estimate for the redemption price, Management has not included the redeemable capital itself in the calculation of the redemption price as this was not contemplated explicitly in the ATL Agreement. As such a liability results from amendments to IFRS which were effective from 1 January 2005 and was not considered by the parties when the Agreement was negotiated, Management did not deduct the redeemable capital from the redemption price. In order to determine the redemption value attributable to the remaining Unquoted assets and liabilities, the Group has used the book value of the related assets and liabilities as recorded in the consolidated financial statements of Alfa Telecom Limited prepared in accordance with IFRS at the respective balance sheet dates, except for the investment in MegaFon as discussed below.
53 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
31 Contingent Liabilities (Continued)
Alfa Telecom Limited and the Group account for its investment in MegaFon at fair value. As further discussed above, the investment is subject to an ongoing dispute with IPOC that involves a number of legal proceedings. Although the Management believes at 31 December 2004 and 2003 that it is more likely than not that the Group would not have an outflow of cash or assets due to the litigation as it makes significant efforts to defend the Group’s ownership, it has also considered several other factors in assessing whether a discount should be applied on its investment in MegaFon for purposes of estimating the amount of redeemable capital. In addition to the litigation, including pending legal proceedings in which the Group is not named as a defendant, Management considered the overall general uncertainty of the business and political environment in the Russian Federation which has the potential to impact the value that could be realised from the investment. Additionally, Management has considered the fact that it currently has no ability to exercise significant influence on MegaFon, its management or operations, despite the percentage interest held and that it will have to continue to defend the Group’s ownership in courts in the foreseeable future. When assessed in the aggregate, the various factors considered by Management result in the conclusion that, in their best estimate and reasonable interpretation of the relevant provisions of the ATL Agreement, a 50% discount on MegaFon is appropriate as at 31 December 2004 for purposes of estimating the amount of redeemable capital.
In calculating its estimate of the redemption price, with the exception of MegaFon as stated above, the Group has included all other Unquoted assets into the calculation at their book value.
The Group’s interest in Alfa Telecom Limited is held through subsidiaries of CTFH. Currently there are no arrangements in place for direct transfer to the incapacitated Controlling Shareholders or their heirs of proceeds from sale by those subsidiaries of shares in Alfa Telecom Limited. As a result, part of the redeemable capital of Alfa Telecom Limited is attributable to those subsidiaries of CTFH. At 31 December 2004 the amount of redeemable capital of Alfa Telecom Limited attributable to minority interest was USD 557,085 thousand. No amounts have been recorded in these combined financial statements in respect of the option.
Put option for shares in Eco Holdings Limited. Under the terms of the Eco Holdings Limited’s Shareholders agreement, a minority shareholder, which owns 30% of Eco Holdings Limited, had an option to sell, at anytime, its shares in Eco Holdings Limited to CTFH or, at CTFH’s option, to Eco Holdings Limited for its share in book net assets of Eco Holdings Limited at the date of the last financial statement adjusted for fair valuation of certain assets. In November 2005 the option holder exercised its shareholder rights for resolution of deadlock issues and sold its entire interest in Eco Holdings Limited to the Group for an amount of its share in the book net assets of Eco Holdings Limited. At 31 December 2004 the amount of redeemable capital of Eco Holdings Limited was USD 77,879 thousand. No amounts have been recorded in these combined financial statements in respect of the option.
Call options for shares in the Group companies held by the Group. The Group has the right to require individual shareholders of certain Group companies to sell their shares in those companies to the Group for the calculatable amount of cash in the event of death or incapacity of the respective shareholder or in case the respective shareholder does not satisfy the test for significant contribution to the Group. The Group has not recorded any amounts in respect of such call options since these options are contingent upon future events and their exercise is under control of the Group.
Call options for the shares in Alfa Finance Holdings S.A., ABH Holdings Corp. and Alfa Telecom Limited. At 31 December 2004, a member of Management of the Group was the holder of two call options which expire on 31 December 2006. Under the terms of the option agreements, the holder may purchase for USD 37,078 thousand shares representing a 2.01% interest in Alfa Finance Holdings S.A., a 2.01% interest in ABH Holdings Corp. and a 1.05% interest in Alfa Telecom Limited. At the date of grant, shares subject to these call options were reclassified into minority interest. Dividends declared in relation to the shares subject to the option agreements are accrued for the benefit of the option holder. The shares subject to the option agreements do not have voting rights until the date of the option exercise or expiry. The options were exercised and settled in 2006.
Put options for the shares in Alfa Telecom Limited. A minority shareholder, which owns 14.35% of Alfa Telecom Limited, has the right at any time until August 2007 to sell to CTFH shares representing a 4.6% interest in Alfa Telecom Limited for USD 95,000 thousand. No amounts have been recorded in these combined financial statements in respect of the option.
54 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
31 Contingent Liabilities (Continued)
Compliance with Covenants.
The Group is subject to certain covenants related primarily to its borrowings. Non-compliance with such covenants may result in negative consequences for the Group including increased cost of borrowings and/or declaration of default.
32 Fiduciary Assets
These assets are not included in the Group’s balance sheet as they are not assets of the Group. Nominal values disclosed below may be different from the fair values of certain securities. The fiduciary assets are held in the name of a Group entity on behalf of its customers and fall into the following categories:
2004 2003 Nominal value Nominal value
Corporate bonds 143,833 153,355 Shares 132,506 225,694 Bills of exchange 69,535 103,425 OVGVZ 31,595 31,162 OFZ 19,302 15,131 Eurobonds 3,659 43,151 Other 7,951 200
33 Related Party Transactions
For the purposes of these combined financial statements, parties are considered to be related if one party has the ability to control the other party, is under common control or can exercise significant influence over the other party in making financial or operational decisions as defined by IAS 24 “Related Party Disclosures”. In considering each possible related party relationship, attention is directed to the substance of the relationship, not merely the legal form.
The combined financial statements of the Group include the following significant transactions and balances with related parties. All related party transactions were priced on an arm’s length basis using market prices.
Note 2004 2003
Loans and advances to customers outstanding with related parties 8 CTC Media Inc 24,000 - TNK-BP 12,785 52,371 Management 8,146 2,424 Other related parties 1,919 851
Total loans and advances to customers outstanding with
related parties 46,850 55,646
Receivables outstanding from related parties 10 Management 6,768 37,078 VimpelCom Group 3,507 - Golden Telecom 2,062 - TNK-BP 9 117,500 Other related parties 6,226 3,856
Total receivables outstanding from related parties 18,572 158,434
55 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
33 Related Party Transactions (Continued)
Note 2004 2003
Trading securities issued by related parties 11 VimpelCom Group 12,545 - TNK –BP 58 7,180
Total trading securities issued by related parties 12,603 7,180
Borrowings from related parties 14 Loans from shareholders 5,441 5,126 TNK-BP 1,296 5,684 Other related parties - 470
Total borrowings from related parties 6,737 11,280
Customer accounts outstanding to related parties 15 Shareholders 236,979 - TNK-BP 165,598 163,515 VimpelCom Group 22,143 22,186 Other related parties 28,031 11,120
Total customer accounts outstanding to related parties 452,751 196,821
Payables outstanding to related parties 17 Accrued compensation expense to Management 159,043 556,932 Other related parties 1,536 8,377
Total payables outstanding to related parties 160,579 565,309
Cost of sales of transactions with related parties Other related parties 4,569 -
Total cost of sales of transactions with related parties 4,569 -
56 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
33 Related Party Transactions (Continued)
Note 2004 2003
Fee and other income on banking activities received from related parties 21 TNK-BP 4,518 14,885 Other related parties 3,525 942
Total fee and other income on banking activities received
from related parties 8,043 15,827
Interest income received from related parties 21 TNK-BP 2,775 3,872 Other related parties 1,413 -
Total interest income received from related parties 4,188 3,872
Interest expense paid to related parties 21 Management 4,568 - TNK –BP 1,914 3,822 Other related parties 1,174 -
Total interest expense paid to related parties 7,656 3,822
Commission income on trading operations from related
parties VimpelCom Group 2,348 3,500
Total commission income on trading operations from related
parties 2,348 3,500
Operating expenses paid to related parties VimpelCom Group 343 - Other related parties 342 -
Total operating expenses paid to related parties 685 -
Guarantees issued to related parties 30 TNK-BP 96,883 45,120 Akrikhin - 884
Total guarantees issued to related parties 96,883 46,004
Import letters of credit with related parties 30 Other related parties 6,101 -
Total import letters of credit with related parties 6,101 -
57 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
33 Related Party Transactions (Continued)
For 2004 the compensation of key management, comprising salaries, bonuses and other short-term benefits amounted to USD 169,360 thousand (2003: USD 561,712 thousand) and was included in operating expenses.
Refer to Note 31 for details of option agreements with the shareholders of the Group and its subsidiaries.
34 Principal Subsidiaries, Joint Ventures and Associated Companies
Country of Percentage of ownership and control incorporation
Financial Services Alfa Finance Holdings S.A. Luxemburg 77.07% owned and controlled by CTF Holdings Limited ABH Financial Limited BVI 100% owned and controlled by ABH Holdings Corp. OJSC Alfa-Bank Russian 100% owned and controlled by ABH Financial Limited Federation Alfa Capital Holdings (Cyprus) Limited Cyprus 100% owned and controlled by ABH Financial Limited Alfastrakhovanie Holdings Limited BVI 100% owned and controlled by ABH Holdings Corp.
Investment Group Eco Holdings Limited Gibraltar 70% owned and controlled by CTF Holdings Limited LLC Alfa Eco Russian 100% owned and controlled by Eco Holdings Limited Federation LLC Alfa Eco M Russian 100% owned and controlled by Eco Holdings Limited Federation Westvector Limited BVI 100% owned and controlled by Eco Holdings Limited OJSC CBK Kama Russian 100% owned and controlled by Eco Holdings Limited Federation TDS Holdings Limited Gibraltar 84.21% owned and controlled by Eco Holdings Limited Russian Technologies Limited Gibraltar 75% owned and controlled by CTF Holdings Limited
Retail Trade Perekrestok Holdings Limited Gibraltar 80.55% owned and controlled by CTF Holdings Limited CJSC TD Perekriostok Russian 100% owned and controlled by Perekrestok Holdings Limited Federation LLC Perekriostok 2000 Russian 100% owned and controlled by Perekrestok Holdings Limited Federation Rathmine Holdings Limited Gibraltar 85.50% owned and controlled by Perekrestok Holdings Limited
Oil and Gas Alfa Petroleum Holdings Limited BVI 100% owned and controlled by Alfa Finance Holdings S.A. TNK-BP Limited BVI 25% joint venture of Alfa Petroleum Holdings Limited
Telecommunications Alfa Telecom Limited BVI 73.69% owned and controlled by CTF Holdings Limited Golden Telecom Inc. USA 29.58% owned by Alfa Telecom Limited CJSC Kyivstar GSM Ukraine 43.48% owned by Alfa Telecom Limited Eco Telecom Limited Gibraltar 100% owned and controlled by Alfa Telecom Limited OJSC Vimpel-Communications Russian 24.5% owned by Eco Telecom Limited Federation
58 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
35 Subsequent Events
During 2005 TNK-BP (Note 5) declared dividends in the amount of USD 3,854,000 thousand which were paid during 2005 and 2006. The Group’s share was USD 963,500 thousand.
On 25 November 2005 the Group acquired from Cukurova Group for a cash consideration of USD 1,593,000 thousand, a 49% interest in Cukurova Telecom Holdings Limited (“CTH”). CTH indirectly owns a 26.98% interest in Turkcell Iletisim Hizmetleri Anonim Sirketi (“Turkcell”), a leading Turkish mobile telecommunications company operating in Turkey and neighbouring states. In the course of the acquisition the Group provided Cukurova Group with (i) a loan in the amount of USD 1,352,000 thousand secured by Cukurova Group’s 51% interest in CTH and (ii) an unsecured loan in the amount of USD 355,000 thousand. Both loans have principal repayable in four equal annual instalments starting from 25 November 2008 and interest at a rate of LIBOR plus 8% per annum payable annually on 25 November. In November 2006 Cukurova Group repaid the unsecured loan in full.
The option for the shares in Eco Holdings Limited (Note 31) was exercised in 2005.
In 2005 CTFH declared and paid dividends in the amount of USD 150,000 thousand.
During 2006 TNK-BP (Note 5) declared and paid dividends in the amount of USD 4,000,000 thousand. The Group’s share was USD 1,000,000 thousand.
The options for the shares in Alfa Finance Holdings S.A., ABH Holdings Corp. and Alfa Telecom Limited (Note 31) were exercised and settled in 2006.
In July 2006 CTFH declared and paid a cash dividend in the amount of USD 120,000 thousand.
Refer to Note 5 for the information on a significant payment made by TNK-BP to the Russian tax authorities in 2006.
In August 2006 TNK-BP completed disposal of a number of its subsidiaries in Udmurtia region of the Russian Federation for cash consideration of USD 3,525,000 thousand.
In August-September 2006 the Group acquired additional 2.9% voting interest in VimpelCom (Note 6) for USD 399,710 thousand.
Acquisition of Pyaterochka Group
In April - May 2006 the Group acquired effective interest of 48.7% in and control over Pyaterochka Holding N.V., parent company of Pyaterochka Group, Russia’s largest discount supermarket chain listed on London Stock Exchange, in exchange for (i) net cash payment of USD 907,350 thousand and (ii) contribution of its entire interest in Perekrestok Holdings Limited to Pyaterochka Holding N.V.
59 ALFA GROUP Notes to the Combined Financial Statements For the year ended 31 December 2004 (Expressed in thousands of US Dollars for presentational purposes only – see Note 3)
35 Subsequent Events (Continued)
Details of assets and liabilities acquired and the related goodwill are as follows:
IFRS carrying Provisional fair amount immediately value before business combination
Cash and cash equivalents 327,504 327,504 Inventory of goods for resale 58,750 58,750 Trade and other accounts receivable 73,514 73,514 Intangible assets (Note 13) 1,451 1,451 Property, plant and equipment 524,873 524,873 Long-term prepaid lease expenses 4,589 4,589 Deferred tax asset 1,633 1,633 Other assets 1,165 1,165 Short-term borrowings (37,295) (37,295) Trade and other accounts payable (257,307) (257,307) Long-term liability for share-based payments (42,288) (42,288) Long-term borrowings (544,034) (544,034) Non-current lease payable (3,714) (3,714) Deferred tax liability (9,110) (9,110)
Net assets of subsidiary 99,731 99,731 Less: minority interest (51 162)
Net assets acquired 48 569 Goodwill 1 332 627
Total acquisition consideration 1,381,196
Cash paid 907,350 Effective disposal of 28.9% of Perekrestok Holdings Limited 456,681 Directly attributable transaction costs 17,165
Total acquisition consideration 1,381,196
Goodwill arising on the transaction is primarily attributable to the profitability of the acquired business, the significant synergies and combined costs savings expected to arise. Fair value of assets and liabilities acquired are based on the values determined provisionally, adjustments to those provisional values will be recognized in the combined financial statements for the year ended 31 December 2006.
A maximum of an additional 3.04% interest in Pyaterochka Holding N.V. may be obtained by the Group from the previous majority sharehholders of Pyaterochka Holding N.V. and a maximum of 1.80% of Pyaterochka shares may be paid by the Group to previous majority sharehholders of Pyaterochka Holding N.V. depending on 2006 financial performance of Pyaterochka and Perekrestok.
60