Note 3 - Critical Accounting Estimates and Judgements

IFRS requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, as well as income and expenses in the financial statements. The final reported outcomes may deviate from the original estimates.

Certain amounts included in, or that have an effect on, the accounts and the associated notes require estimation, which in turn entails that the Company must make assessments related to values and circumstances that are not known at the point in time when the accounts are prepared.

A significant accounting estimate is an estimate that is important to provide a complete picture of the Company’s financial position, which at the same time is the result of difficult, subjective and complex assessments performed by the management. Such estimates are often uncertain by nature.

Management evaluates such estimates continuously based on historical data and experience, consultation with experts, trend analysis and other factors that are relevant for the individual estimate, including expectations of future events that are believed to be reasonable under the circumstances.

Estimates and assumptions that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, as well as judgments made by management, in the process of applying the Company’s accounting policies, that have the most significant effect on the amounts recognized in the financial statements, are discussed below.

Revenue recognition percentage-of-completion off-shore cable contracts

The Company uses the percentage-of-completion method in accounting for its fixed price construction contracts related to the segment Submarine Power Cable Installation.

One significant estimate is an estimate of the percent complete. Management estimates completion based on an assessment of certain technical criteria in the project execution plan that have to be met in order to achieve a certain level of percentage of completion, as opposed to using costs incurred as a measure of completion.

The primary risk in the execution of projects relates to the offshore installation phase. Hence, profit margin is not recorded until the progress of the project has reached a stage of minimum 25 percent technical completion.

The project shall need to progress into the cable-laying phase before the minimum 25 percent age of technical completion is reached. Prior to reaching a progress of minimum 25 percent technical completion, and subject to a foreseen positive project margin, project revenue is accrued to match the actual costs incurred at the estimated stage.

Periodic project margin is only recorded when the overall project margin is forecasted to be positive, and when the execution of the project has reached such level of technical completion beyond 25 percent that the management is comfortable to assess the financial outcome of the project.

The sensitivity of the recorded revenue on long-term construction contracts would be +/- USD 8.9 million in 2015 (2014: USD 14.9 million) if management had estimated a 10% better/worse progress on the contracts ongoing at year-end 2015.

Vessels

Economic useful life
The level of depreciation expense is dependent, in part, upon the estimated useful life of the vessel. The useful life is estimated based on historical data, experience related to the vessel and similar vessels. The estimate is reviewed and updated annually. A change in the estimate will affect depreciation prospectively in current and future reporting periods.

Residual value
The level of depreciation expense is dependent, in part, upon the estimated residual value. Management estimates a vessel’s residual value using their knowledge of the scrap value of vessels.

The scrap value estimates are dependent on the price of steel. The scrap value estimate is based on the expected value at the end of the useful life of the vessel. Management performs an annual review and assessment of the vessel scrap value estimates. Residual value is subject to an annual reassessment.

Impairment of vessels
On the reporting date, the Company has assessed whether there are any indications that it may be necessary to write down a vessel. Indicators include external broker estimates, significant changes in charter hire contracts, day rates, operating costs or adverse market conditions.

When such indications exist, an impairment test is performed in accordance with Company policy.

The recoverable value of the vessel is estimated, and if the recoverable amount is less than the current carrying value, an impairment loss is recognized in the amount of the difference between carrying value and net realizable value.

The recoverable amount for vessels is estimated by means of broker estimates and value in use calculations based on projected discounted cash flows for the remaining charter hire period or over the next four years if no charter contract exists, together with an assumption of a terminal value of the vessel.

The value in use calculation for tangible assets and goodwill are based on a Discounted Cash Flow model (DCF-model), using a pre-tax discount rate that reflects current market assessments of the time value of money and the risk specific to the asset. The cash flows are derived from the budget for the next four years. The recoverable amount is sensitive to the discount rate used for the DCF-model as well as the expected future cash-inflows and the principles used for calculating the terminal value. These estimates are most relevant to goodwill and value in use calculations for vessels.

The market for offshore service vessels is expected to remain weak for several years. For vessels fixed on firm contracts during the period from 2016 until 2019, the assumption is that the contract remains unchanged during the remaining contract period, and that the rate level is reduced thereafter until the end of 2019. Options included in charter hire agreements are not considered in the value in use calculations.

The key assumptions used to determine the recoverable amount for the different CGUs, including a sensitivity analysis, are disclosed and further explained in Note 5.

Impairment of goodwill
The Company tests whether goodwill and intangible assets have suffered any impairment in accordance with the accounting policy stated in note 1.11. The recoverable amounts of cash-generating unit have been determined based on value-in-use calculation. This calculation requires the use of estimates (Note 5).

Impairment of intangible assets
The Company tests whether intangible assets have suffered any impairment in accordance with the accounting policy stated in note 1.11. The recoverable amounts of a cash-generating unit have been determined based on an estimate of fair value less cost of disposal under level 3 in the fair value hierarchi of IFRS. The calculation require the use of estimates.

Hedge accounting
The Company uses hedge accounting for the Brazilian subsidiary, which has a functional currency of BRL. The designated cash-flow hedge is a foreign currency exposure of future USD charter hire revenue as the hedged item and USD long-term debt the designated hedging instrument.

Designation of the hedged item requires significant judgment in defining the future charter contract revenue as highly probable. Contracts have been written for vessels still under construction, and sometimes the delivery date of the vessel is delayed. Contracts have been agreed for a specific time period (e.g. four to five years) and have a renewal option.

Highly probable future charter revenue has been determined by management to include the renewal option period, based on the frequency of similar past transactions and for the contracts to be included in the designated hedge from the date of signing, even though the vessels are under construction.

Siem Offshore has defined an effective hedge to be when the cash flows of the highly probable future transactions are higher than the cash flows of the hedging instrument for the same period. Effectiveness testing is performed using the Dollar Offset Method. See note 12 for additional information.