6. FINANCIAL STATEMENTS 6.2. INTRODUCTION TO THE NOTES AND ACCOUNTING POLICIES Introduction Euronext N.V. is a company domiciled in the Netherlands and was incorporated by Société de Bourses Françaises S.A. (SBF), Amsterdam Exchanges N.V. (AEX) and Société des Bourses de Valeurs Mobilières de Bruxelles S.A./Effectenbeursvennootschap van Brussel N.V. (BXS). These three constituting companies merged into Euronext N.V. (hereafter: the Group) as at 22nd September 2000 and were renamed Euronext Paris S.A., Euronext Amsterdam N.V. and Euronext Brussels S.A./N.V. as from that date. The Group operates stock and derivative exchanges through subsidiaries in Paris, Brussels, Amsterdam and as from January 2002 also in London and Lisbon. The range of services originally included listing of financial instruments, the organisation of trading in such instruments, clearing, settlement, custody and the sale of related information and services. The Group disposed of its clearing activities in December 2003 (see note 6.3.5: "Discontinued operation") and became minority shareholder of the new clearing entity LCH.Clearnet Group Ltd for 24,9% of the ordinary shares and 16,6% of the Redeemable Convertible Preference Shares. Statement of compliance The consolidated financial statements for the year ended 31st December 2003 have been prepared in accordance with International Financial Repor ting Standards/International Accounting Standards and interpretations issued by the International Financial Reporting Interpretations Committee/Standing Interpretations Committee as adopted by the International Accounting Standards Board. The consolidated financial statements for the year ended 31st December 2003 have also been prepared in accordance with accounting principles generally accepted in the Netherlands and comply with the financial reporting requirements included in Part 9 of Book II of the Dutch Civil Code. The financial statements deviate from Part 9, Book II of the Dutch Civil Codes on three aspects: - the application of standard models for the balance sheet and income statements; - goodwill amortisation is presented separately on the face of the consolidated income statement as component part of profit from operations rather than as part of depreciation; - goodwill related to investments in associates/joint ventures is presented as part of the respective balance sheet caption (as required under IFRS) rather than presented under intangible assets. These departures from Dutch legal requirements are done on the basis of the international character of the Group, as it is considered that this improves the insight of the international user (as required by Article 362-4 of the Dutch Civil Code). This presentation does not affect equity or net results. Changes in the scope of the consolidation The Group disposed of the shares it held in BCC/Clearnet on 22nd December 2003. As from that date, assets, liabilities, results and cash-flows of BCC/Clearnet have been deconsolidated. On 24th July 2003 the remaining 50% of shares in joint venture NQLX LLC held by Nasdaq were withdrawn, the Group thus becoming sole shareholder. From that date onwards the assets, liabilities, results and cash-flows of NQLX LLC are fully consolidated in the Group's consolidated financial statements. The assets, liabilities, results and cash-flows of three entities acquired by GL Trade S.A. are included in the Group's consolidated financial statements since 4th November 2003, the date of their acquisition. Assets, liabilities, results and cash-flows of 4D Trading (also acquired by GL Trade S.A.) were acquired in April 2003 and have been included in the consolidated financial statements since that date. Further reference is made to note 6.3.7, "Effect of acquisitions and disposals". Significant accounting policies a) Basis of preparation and measurement The financial statements are presented in thousands of euros. The consolidated financial statements have been prepared on an historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, investments held-for-trading and investments available-for-sale. Recognised assets and liabilities that are hedged are stated at fair value in respect of the risk that is hedged. b) Use of estimates in the preparation of the financial statements In preparation of the financial statements management is required to make estimates and assumptions that affect reported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available information and application of judgement are inherent in the assessment of estimates. c) Basis of consolidation (i) Subsidiaries Subsidiaries are those enterprises that are controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control effectively commences until the date that control effectively ceases. Acquisitions of subsidiaries are accounted for using the purchase method of accounting. The fair value of the assets and liabilities of newly acquired subsidiaries is the cost price of these assets and liabilities for the Group. Not included in the consolidation are the assets, liabilities, cash-flows and result of Group companies that are considered immaterial. Only the subsidiaries where restated contribution would increase the consolidated balance sheet by more than €100,000 are included in the scope of consolidation. (ii) Joint ventures and associates Joint ventures are those enterprises over whose activities the Group has joint control, established by contractual agreement. They are stated at net equity value using the alternative treatment allowed under IFRS. Associates are those enterprises in which the Group has significant influence, but not control, over the financial and operating policies. The consolidated financial statements include the Group's share of the total recognised gains and losses of joint ventures and associates on an equity accounted basis, from the date that significant influence effectively commences until the date that significant influence effectively ceases. (iii) Transactions eliminated upon consolidation Intra-Group balances and transactions, and any (un)realised gains or losses arising from intra-Group transactions, are eliminated in preparing the consolidated financial statements. (Un)realised gains or losses arising from transactions with associates (and jointly controlled entities) are eliminated to the extent of the Group's interest in the enterprise. (Un)realised gains or losses resulting from transactions with associates and joint ventures are eliminated against the investment in the associate or joint venture. d) Foreign currency translation Transactions in foreign currencies are translated to euro at the foreign exchange rate prevailing at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to euro at the foreign exchange rate prevailing at that date. Foreign exchange differences arising on translation are recognised in the income statement. The assets and liabilities of foreign (non euro) operations are translated to euro at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated to euro at rates approximating the foreign exchange rates ruling at the date of the transaction. Foreign exchange differences arising on translation are recognised directly in equity. e) Financial instruments (i) Classification Originated loans and receivables are loans and receivables created by the Group providing money to a debtor other than those created with the intention of short-term profit taking. Originated loans and receivables comprise loans and advances to banks and customers. Held-to-maturity assets are financial assets with fixed or determinable payments and fixed maturity that the Group has the intent and ability to hold to maturity. Held-for-trading assets are financial assets that are acquired or incurred principally for the purpose of generating a profit from short-term fluctuations in price. Available-for-sale assets are financial assets that are not held-for-trading purposes, originated by the Group, or held-to-maturity. Available-for-sale instruments include money market placements, and certain equity investments. (ii) Recognition The Group recognises held-for-trading/available-for-sale assets on the date it commits to purchase the assets. From this date any gains and losses arising from changes in fair value of the assets are recognised in the income statement under "net financing income". Held-to-maturity loans and originated loans and receivables are recognised in the balance sheet on the day they are originated by or transferred to the Group. (iii) Measurement Financial instruments are measured initially at cost, including transaction costs. Subsequent to initial recognition all held-for-trading and available-for-sale assets are measured at fair value, except that any instrument that does not have a quoted market price in an active market and whose fair value cannot be reliably measured is stated at cost, including transaction costs, less impairment losses. All non-trading financial liabilities, originated loans and receivables and held-to-maturity assets are measured at amortised cost less impairment losses. Amortised cost is calculated using the effective interest rate method. Premiums and discounts, including initial transaction costs, are included in the carrying amount of the related instrument and amortised based on the effective interest rate of the instrument. (iv) Fair value measurement principles The fair value of financial instruments is based on their quoted market price at the balance sheet date without any deduction for transaction costs. If a quoted market price is not available, the fair value of the instrument is estimated using pricing models or discounted cash-flow techniques. (v) Gains or losses on subsequent measurement Gains or losses arising from a change in the fair value of available-for-sale assets are recognised directly in equity. When the financial assets are sold, collected or otherwise disposed of, the cumulative gain or loss previously recognised in equity is transferred to the income statement. A decline in the fair value of an available-for-sale asset that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment is charged to the income statement as part of "net financing income" and a new cost basis for the asset is established. Gains or losses on investments held-for-trading are recognised in income. (vi) Derivative financial instruments The Group uses interest rate swaps to manage its exposure to interest rate risks arising from operational and financing activities. In accordance with its treasury policy, the Group does not hold or issue such derivative financial instruments for trading purposes. Derivative financial instruments are recognised initially at cost. Subsequent to initial recognition, derivative financial instruments are stated at fair value. The fair value of interest rate swaps is the amount that the Group would receive or pay to terminate the swap at the balance sheet date, taking into account current interest rates and the current creditworthiness of the swap counterparties. f) Hedging Hedge of recognised assets and liabilities Any resultant gain or loss arising from measurement at fair value on the derivative financial instrument is recognised in the income statement. Where a derivative financial instrument hedges a recognised receivable or payable, the hedged item is also adjusted for the fair value in respect of the risk being hedged, with any resultant gain or loss being recognised in the income statement. The carrying amount at the balance sheet date of the hedged items is the valuation basis of the investment translated to Euros at the foreign exchange rate ruling at that date and adjusted for the fair value movement in respect of the risk being hedged. g) Property and equipment (i) Owned assets Items of property and equipment are stated at cost less accumulated depreciation and impairment losses (see accounting policies under [l]). Where an item of property and equipment comprises major components having different useful lives, they are accounted for as separate items of property and equipment. (ii) Leased assets Leases in terms of which the Group assumes substantially all the risks and rewards of ownership are classified as financial leases. Equipment acquired by way of financial leases are stated at an amount equal to the lower of fair value and the present value of the minimum lease payments at inception of the lease, less accumulated depreciation and impairment losses. (iii) Subsequent expenditure Expenditure incurred to replace a component of an item of property, plant and equipment that is accounted for separately, is capitalised with the carrying amount of the component being written off. Other subsequent expenditure is capitalised only when it increases the future economic benefits embodied in the item of property and equipment. All other expenditure is recognised in the income statement as an expense as incurred. (iv) Depreciation Depreciation is charged to the income statement generally on a straight-line basis over the estimated useful lives of items of property and equipment. Land is not depreciated. The estimated useful lives are as follows: Buildings: 5-40 years IT equipment: 2-3 years Other equipment: 5-12 years Vehicles: 3-4 years Fixtures and fittings: 4-10 years h) Intangible assets (i) Goodwill Goodwill arising on an acquisition represents the excess of the cost of the acquisition over the fair value of the net identifiable assets acquired. Goodwill is stated at cost less accumulated amortisation and impairment losses (see accounting policies under (l: "impairment")). In respect of associates/joint ventures, the carrying amount of goodwill is included in the amount of the investment in the associates/joint ventures. Negative goodwill arising on an acquisition represents the excess of the fair value of the net identifiable asset acquired over the cost of acquisition. To the extend that negative goodwill relates to an expectation of future losses and expenses that are identified in the plan of acquisition and can be measured reliably, but which have not yet been recognised, it is recognised in the income statement when the future losses and expenses are recognised. Any remaining negative goodwill, not exceeding the fair values of the non-monetary assets acquired, is recognised in the income statement over the weighted average useful life of those assets that are depreciable/amortisable. (ii) Research and development Expenditure on research activities, undertaken with the prospect of gaining technical knowledge and understanding, is recognised in the income statement as an expense as incurred. Expenditure on development activities, whereby research findings are applied to a plan or design for the production of new or substantially improved products and processes, is capitalised if the product or process is technically and commercially feasible and the Group has sufficient resources to complete development. The expenditure capitalised includes the cost of materials and direct labour. Other development expenditure is recognised in the income statement as an expense as incurred. Capitalised development expenditure is stated at cost less accumulated amortisation and impairment losses. (iii) Other intangible assets Other intangible assets, which are acquired by the Group, are stated at cost less accumulated amortisation and impairment losses. (iv) Subsequent expenditure Subsequent expenditure on capitalised intangible assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed as incurred. (v) Amortisation Amortisation is charged to the income statement on a straight-line basis over the estimated useful lives of intangible assets. Goodwill is amortised from the date of initial recognition; other intangible assets are amortised from the date the asset is available for use. The estimated useful lives are as follows: Goodwill: 20 years Capitalised development costs: 2-3 years Patents and trademarks: 5 years i) Investments in debt and equity securities Investments held-for-trading are classified as current assets and are stated at fair value, with any resultant gain or loss recognised in the income statement. Investments held-for-trading include deposits held for over three months and equity investments. Where the Group has the positive intent and ability to hold bonds to maturity, they are stated at amortised costs. Other investments held by the Group are classified as being available-for-sale and are stated at fair value, with any resultant gain or loss recognised in equity. Realised gains or losses are recognised in the income statement with a reversal of any revaluation recorded in equity. The fair value of investments held-for-trading and investments available-for-sale is their market price, excluding disposal costs, at the balance sheet date. j) Trade and other receivables Trade and other receivables are stated at cost less impairment losses. k) Cash and cash equivalents Cash comprise cash balances, deposits and cash deposits from third parties arising from the compulsory maintenance of a clearing fund and/or margin requirement. Cash equivalents include current investments that are readily convertible to cash and which are subject to an insignificant risk of changes in value. Deposits and other fixed interest instruments with an original maturity of less than three months are considered cash equivalents. l) Impairment The carrying amounts of the Group's assets are reviewed at each balance sheet date to determine whether there is any indication of impairment. If any such indication exists, the asset's recoverable amount is estimated. For intangible assets that are not yet available for use, the recoverable amount is estimated at each balance sheet date. An impairment loss is recognised whenever the carrying amount of an asset or its cash-generating unit exceeds its recoverable amount. In the assessment of any impairment the Group applies the best available information bases on market prices. If such information is not available the Group uses discounted cash-flow methods to approximate the recoverable amount. m) Share capital and reserves (i) Repurchase of share capital When share capital recognised as equity is repurchased, the amount of the consideration paid, including directly attributable costs, is recognised as a change in equity. Repurchased shares are presented as a deduction from total equity. Purchased shares subsequently sold are added at equity for the amount of the consideration received. (ii) Dividends Dividends are recognised as a liability in the period in which they are declared. (iii) Costs of other equity transactions Transaction costs related to the issuance of new shares are directly charged to equity, net of any related tax benefits. These expenses are restricted to incremental external expenses such as legal and bank fees. Expenses related to the listing of new or already existing shares are expensed. n) Interest-bearing borrowings Interest-bearing borrowings are recognised initially at cost, net of any transaction costs incurred. Subsequent to initial recognition, interest-bearing borrowings are stated at amortised cost with any difference between cost and redemption value being recognised in the income statement over the period of the borrowings. When borrowings are repurchased or settled before maturity, any difference between the amount repaid and the carrying amount is recognised immediately in the income statement. o) Employee benefits (i) Defined contribution plans Contributions to defined contribution pension plans are recognised as an expense in the income statement as incurred. (ii) Defined benefit plans The Group's net obligation in respect of defined benefit pensions, early retirements and healthcare plans is calculated separately for each defined benefit plan by estimating the amount of future benefit that employees have earned in return for their service in the current and prior periods. That benefit is discounted to determine the present value and the fair value of any plan assets is deducted. The discount rate is the yield at balance sheet date on AAA credit rated bonds that have maturity dates approximating the terms of the Group's obligations. The calculation is performed by a qualified actuary using the projected unit credit method. When the benefits of a plan change, the portion of the increased benefit relating to past service by employees is recognised as an expense in the income statement on a straight-line basis over the average period until the benefits become vested. To the extent that the benefits vest immediately, the expense is recognised immediately in the income statement. In calculating the Group's obligation in respect of a plan, to the extent that any cumulative unrecognised actuarial gain or loss exceeds ten percent of the greater of the present value of the defined benefit obligation and the fair value of plan assets, that portion is recognised in the income statement over the average remaining service period of the employees. Where the calculation results in a benefit to the Group, the recognised asset is limited to the net total of any unrecognised actuarial losses and past service costs and the present value of any future refunds from the plan or reductions in future contributions to the plan. (iii) Equity and equity-related compensation benefits Several stock option programmes allow certain Group employees to acquire shares of the Group. When the options are exercised, equity is increased by the amount of the proceeds received. p) Provisions A provision is recognised in the balance sheet when the Group has a legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation. If the effect is material, provisions are determined by discounting the expected future cash-flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. A provision for restructuring is recognised when the Group has approved a detailed and formal restructuring plan, and the restructuring has either commenced or has been announced publicly. Costs relating to the ongoing activities of the Group are not provided for. q) Trade and other payables Trade and other payables are stated at their cost. r) Revenues Revenues are attributed to the period to which they relate. Operating income consists mainly of fees for executing, clearing and settlement of transactions in shares, bonds, options and futures, fees for custody, fees for providing technical infrastructure related to these activities, proceeds from the sale of exchange information and listing fees. Sales of software comprises revenues from fees received for the sale of software licenses. These revenues are recognised in accordance with the substance of the licensing agreements. Revenues from licensing agreements with a specified period of time are amortised on a straight-line basis over the life of the agreements. Fees received under licensing agreements for which the Group has no remaining obligations to perform or to deliver are recognised immediately. s) Expenses Expenses are attributed to the period to which they relate. (i) Operating lease payments Payments made under operating leases are recognised in the income statement on a straight-line basis over the term of the lease. Lease incentives received are recognised in the income statement as an integral part of the total lease payments made. (ii) Net financing income Net financing costs comprise interest payable on borrowings, interest receivable on funds invested, dividend income, foreign exchange gains and losses, gains on disposal, revaluations to fair value of held-for-trading financial instruments, gains and losses on hedging instruments that are recognised in the income statement as well as impairment adjustments related to available-for-sale financial instruments. Interest income is recognised in the income statement as it accrues, taking into account the effective yield on the asset. Dividend income is recognised in the income statement on the date that the dividend is declared. All interest and other costs incurred in connection with borrowings are expensed as incurred as part of net financing costs. The interest expense component of financial lease payments is recognised in the income statement using the effective interest rate method. t) Income tax expense Income tax on the profit or loss for the year comprises current and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised directly in equity, in which case it is recognised in equity. Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantially enacted at the balance sheet date, and any adjustment to tax payable in respect of previous periods. Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Goodwill not deductible for tax purposes is not provided for. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the unused tax losses and credits can be utilised. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realised. u) 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.