The Consolidated financial statements are prepared in accordance with IFRS which require the use of estimates, judgments and assumptions that affect the carrying amount of assets and liabilities, the disclosures relating to contingent liabilities and the amounts of income and expenses recognized. The estimates and associated assumptions are based on elements that are known when the financial statements are prepared, on historical experience and on any other factors that are considered to be relevant.
The estimates and underlying assumptions are reviewed periodically and continuously by the Group. If the items subject to estimates do not perform as assumed, then the actual results could differ from the estimates, which would require adjustment accordingly. The effects of any changes in estimate are recognized in the Income statement in the period in which the adjustment is made, or in future periods.
The main items affected by these uses of estimates are non-current assets (Tangible and Intangible assets), Deferred tax assets, Provision for employee benefits and Inventories. Following are the items requiring estimates for which there is a risk that a significant difference may arise in respect of the carrying amounts of assets and liabilities in the future.
Recoverability of non-current assets
Non-current assets include Property, plant and equipment, Goodwill and Intangible assets with definite and indefinite useful lives. The Group periodically reviews the carrying amount of non-current assets and that of assets held for sale when events and circumstances warrant such a review. Impairment testing is performed by comparing the carrying amount and the recoverable amount of each cash-generating unit (“CGU”). The recoverable amount is the higher of the CGUs fair value less costs of disposal and their value in use. In assessing the value in use, the pre-tax estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the CGU.
The analysis of the recoverable amount of non-current assets is performed at least annually for CGUs to which Goodwill or Intangible assets with indefinite useful lives have been allocated. For a discussion on impairment testing on Goodwill arising from the Chrysler acquisition and Intangible assets with an indefinite useful life, reference should be made to Note 13.
For other CGUs, the same analysis is performed when events and circumstances indicate that an asset may be impaired. At 31 December 2012 and 2013, due to the continued decline in car demand on the European market (primarily in Italy) and to the streamlining of architectures(1) and related production platforms associated with the region’s refocused product strategy, impairment tests relating to EMEA net assets were performed on two levels.
Firstly, the recoverable amounts of the assets of specific EMEA CGUs were tested, identified as plants, machinery and equipment as well as the associated intangible assets dedicated to the production of specific platforms and powertrains. This impairment analysis led to the recognition of impairment on Development costs of €66 million and on Other tangible assets of €37 million (€108 million in 2012 mainly related to Development costs and Other tangible assets). These impairment losses were recognized under Other unusual expenses (€93 million) and under Operating costs (€10 million). A similar process was carried out also for specific CGUs within the Components operating segment and for the Maserati CGU, leading to the recognition of an impairment of Property, plant and equipment for €30 million and an impairment of Development costs of €65 million, respectively.
Secondly, following the above mentioned decline in demand, at 31 December 2012 and 2013, the Group deemed necessary to test the recoverable amount of the Net Capital Employed pertaining to the EMEA operating segment as a whole, by determining its value in use with the following assumptions:
- reference scenario was based on 2014 budget, the expected trading conditions and the automotive market trends for the 2015-2019 period, based on analysis and studies carried out by primary independent analysts (IHS-Global Insight), in line with the announced strategic decision to leverage historical premium brand heritage (Alfa Romeo) and the success of the new 500 family;
- the six year period has been deemed necessary to take into account the full cycle of new vehicles introduced reflecting the benefits arising from the capital expenditure devoted to the product portfolio enrichment and renewal, largely concentrated in 2015-2016;
- the expected future cash flows, represented by the projected trading profit plus depreciation and amortization and reduced by expected capital expenditure, include a normalized terminal period used to estimate the future results beyond the time period explicitly considered. This terminal period was assumed substantially in line with 2017-2019 amounts. The long-term growth rate was set at zero;
- the expected future cash flows have been discounted using a pre-tax Weighted Average Cost of Capital (“WACC”) of 12.20% (13.14% in 2012). This WACC reflects the current market assessment of the time value of money for the period being considered and the risks specific to the EMEA region. The WACC was calculated by referring among others to the yield curve of 10 years European government bonds and to Fiat cost of debt.
The recoverable amount of the net assets of the EMEA operating segment was higher than the corresponding book value. In addition, sensitivity analysis were performed by simulating two different scenarios: a) WACC was increased by 1% for 2017, 2% for 2018 and 3% for 2019 and for Terminal Value; b) cash-flows were reduced by estimating the impact of a 5% decrease in the European car market demand for 2015, 7.5% for 2016 and 10% for 2017-2019 as compared to the base assumptions. In all cases the recoverable amount of the net assets continued to be higher than their book value.
The estimates and assumptions described reflect the Group’s current available knowledge as to the expected future development of the businesses and are based on an assessment of the future development of the markets and the car industry, which remain subject to a high degree of uncertainty due to the continuation of the economic difficulties in most countries of the Eurozone and its effects on the industry. More specifically, considering the uncertainty, a future worsening in the economic environment in the Eurozone that is not reflected in these Group assumptions, could result in actual performance that differs from the original estimates, and might therefore require adjustments to the carrying amounts of certain non-current assets in future periods.
Recoverability of deferred tax assets
The carrying amount of deferred tax assets is reduced to the extent that it is not probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax assets to be utilized.
At 31 December 2013, the Group had deferred tax assets on deductible temporary differences of €6,173 million (€6,353 million at 31 December 2012), of which €435 million was not recognized (€2,445 million at 31 December 2012). At the same date the Group had also theoretical tax benefit of losses carried forward of €3,810 million (€3,399 million at 31 December 2012), of which €2,891 million was unrecognized (€2,473 million at 31 December 2012). In addition, at 31 December 2013, in view of the results achieved by Chrysler, of the continuous improvement of its product mix, its trends in international sales and its implementation of new vehicles, together with the consolidation of the alliance between Fiat and Chrysler, following Fiat’s acquisition of the remaining shareholding at the beginning of 2014, the Group recognized previously unrecognized deferred tax assets for a total of €1,734 million, of which €1,500 million recognized in Income taxes and €234 million in Other comprehensive income/(losses).
The recoverability of deferred tax assets is dependent on the Group's ability to generate sufficient future taxable income in the period in which it is assumed that the deductible temporary differences reverse and tax losses carried forward can be utilized. In making this assessment, the Group considers future taxable income arising on the most recent budgets and plans, prepared by using the same criteria described for testing the impairment of assets and goodwill, moreover, it estimates the impact of the reversal of taxable temporary differences on earnings and it also considers the period over which these assets could be recovered.
These estimates and assumptions are subject to a high degree of uncertainty, in particular with regard to the future performance in the Eurozone, therefore changes in current estimates due to unanticipated events could have a significant impact on the Group’s Consolidated financial statements.
Pension plans and other post-retirement benefits
At 31 December 2013 net liabilities and net assets for employee benefit, amounting to €7,181 million and to €95 million, respectively (€10,256 million and €83 million, respectively at 31 December 2012), are measured on an actuarial basis which requires the use of estimates and assumptions to determine the net liability or net asset. The actuarial method takes into consideration parameters of a financial nature such as the discount rate and the return on plan assets, the rates of salary increases and the rates of health care cost increases and the likelihood of potential future events estimated by using demographic assumptions such as mortality rates, dismissal and retirement rates.
In particular, the discount rates selected are based on high quality corporate bonds in the relevant market. The return on plan assets is interest, dividends and other revenue derived from the plan assets, together with realized and unrealized gains or losses on the plan assets, less any costs of administering the plan and less any tax payable by the plan itself (other than those included in the actuarial assumptions used to measure the defined benefit obligation). Rates of salary increases reflect the Group’s long-term actual expectation in the reference market and inflation trends. Trends in health care costs are developed on the basis of historical experience, the near-term outlook for costs and likely long-term trends. Changes in any of these assumptions are recognized in Other comprehensive income/(losses) when they occur and may have an effect on future contributions to the plans.
Net realizable value of Inventories
At 31 December 2013 the Group had Inventories of €10,230 million (€9,295 million at 31 December 2012), measured at the lower of cost and their net realizable value. Net realizable value is based on the most reliable evidence of the amount the Group expects to realize from vehicles and components, on future sales trends or needs (for components) and also takes into account items that are wholly or partially obsolete. A future unexpected worsening in market conditions could result in an adjustment in future expected sales, requirements and in estimated selling prices assumptions which may require an adjustment to the carrying amount of Inventories.
The Group offers a variety of sales incentive programs, including: cash offers to dealers primarily on the basis of their cumulative level of sales during a specified period, cash offers to retail customers and subvention programs offered to retail customers or lease subsidies. Incentive programs are generally brand, model and region specific for a defined period of time, which may be extended. The Group recognizes the estimated cost of these incentive programs at the time of sale. The estimated cost represents the incentive programs offered to dealers and retail customers, as well as the expected modifications to these programs in order to facilitate sales of the dealer inventory. Subsequent adjustments to incentive programs and new incentive programs offered by the Group on vehicles previously sold to dealers are recognized as an adjustment to Net revenue in the period the adjustment is determined.
Product warranties and liabilities
At 31 December 2013 the Group had provisions for estimated expenses related to product warranties of €3,656 million (€3,617 million at 31 December 2012). Estimates of warranty costs are principally based on assumptions regarding the lifetime of warranty costs of each vehicle, as well as historical claims experience. Estimates of the future costs of these actions are inevitably imprecise and may result in adjustments to the established provisions due to numerous uncertainties, including new laws and regulations, the number of vehicles affected and the nature of the corrective action.
Moreover, the Group makes provisions for estimated product liability costs arising from personal injuries alleged to be the result of product defects. The valuation of the reserve is actuarially determined on an annual basis based on, among other factors, the number of vehicles sold and product liability claims incurred. Costs associated with these provisions are recorded in Cost of Sales and any subsequent adjustments are recorded in the period in which the adjustment is determined.
The Group makes provision in connection with pending or threatened disputes or legal proceedings when it is considered probable that there will be an outflow of funds and when the amount can be reasonably estimated. If an outflow of funds becomes possible but the amount cannot be estimated, the matter is disclosed in the notes to the financial statements. The Group is the subject of legal and tax proceedings covering a wide range of matters in various jurisdictions. Due to the uncertainty inherent in such matters, it is difficult to predict the outflow of funds which will result from such disputes with any certainty. Moreover, the cases and claims against the Group often derive from complex legal issues which are subject to a differing degree of uncertainty, including the facts and circumstances of each particular case and the manner in which applicable law is likely to be interpreted and applied to such fact and circumstances, and the jurisdiction and the different laws involved. The Group monitors the status of pending legal procedures and consults with experts on legal and tax matters on a regular basis. It is therefore possible that the provisions for the Group’s legal proceedings and litigation may vary as the result of future developments in pending matters.
(1)The “vehicle architecture” is the combination of systems that enables the generation of specific vehicle platforms for the different models in a certain segment.