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НАК „НАФТОГАЗ УКРАЇНИ“. Річний звіт англійською (2018 рік) - 12

187

186

FINANCIAL STATEMENTS

ANNUAL REPORT 2018

2018

19. FINANCE COSTS

In millions of Ukrainian hryvnias

2018

2017

Interest expense on bank borrowings (Note 13)

5,016

7,308

Unwinding of discount on employee benefit obligations (Note 14)

597

521

Unwinding of discount of decommissioning provision (Note 14)

224

152

Other

364

321

Total

6,201

8,302

20. FINANCE INCOME

In millions of Ukrainian hryvnias

2018

2017

Interest income on bank deposits and bank balances

1,691

1,244

Unwinding of discount on long-term accounts receivable

192

213

Other

245

141

Total

2,128

1,598

21. INCOME TAX

The components of income tax expense for the years ended 31 December were as follows:

In millions of Ukrainian hryvnias

2018

2017

Current tax expense

19,535

22,426

Deferred tax benefit

(10,565)

(9,124)

Income tax expenses

8,970

13,302

The Group is subject to taxation in Ukraine. In 2018 and 2017, Ukrainian corporate income tax was levied on taxable income less

allowable expenses at the rate of 18%.

Reconciliation between the expected and the actual taxation charge is provided below:

In millions of Ukrainian hryvnias

2018

2017

Profit before income tax

20,537

52,751

Income tax at statutory rate of 18%

3,697

9,495

Tax effect of items not deductible or taxable for taxation purposes:
- Non-deductible expenses

5,375

2,964

- Non-taxable income

(188)

(1,895)

Change in unrecognised deferred tax asset

2,738

Income tax expenses

8,970

13,302

The Parent and its subsidiaries are separate tax payers and, therefore, their deferred tax assets and liabilities are presented on an

individual basis. The deferred tax liabilities and assets reflected in the consolidated statement of financial position after appropriate set

off are as follows:

In millions of Ukrainian hryvnias

31 December

2018

31 December

2017

Deferred tax assets

5,119

4,204

Deferred tax liabilities

(50,544)

(67,304)

Net deferred tax liability

(45,425)

(63,100)

Net deferred tax liabilities as at 31 December 2018 related to the following:

In millions of Ukrainian hryvnias

31 December

2017

Recognised in profit

or loss

Recognised in other

comprehensive

income

31 December

2018

Property, plant and equipment

(70,334)

7,704

7,110

(55,520)

Trade accounts receivable

364

386

Advances received and other current liabilities

Provisions

4,613

2,587

7,200

Inventories

1,675

185

1,860

Prepayments made and other current assets

526

564

Other non-current assets

(1)

Net deferred tax liability

(63,100)

10,565

7,110

(45,425)

Net deferred tax liabilities as at 31 December 2017 related to the following:

In millions of Ukrainian hryvnias

31 December

2016

Recognised in profit

or loss

Recognised in other

comprehensive

income

31 December

2017

Property, plant and equipment

(84,890)

9,068

5,488

(70,334)

Trade accounts receivable

300

364

Advances received and other current liabilities

Provisions

3,588

933

4,613

Inventories

125

1,550

1,675

Prepayments made and other current assets

418

108

526

Trade accounts payable

(27)

Other non-current assets

(2)

(1)

Unused tax losses

2,630

(2,630)

Net deferred tax liability

(77,804)

9,124

5,580

(63,100)

As at 31 December 2018 and 2017, unrecognised deductible temporary differences and unused tax losses are as follows:

In millions of Ukrainian hryvnias

31 December

2018

31 December

2017

Provisions

45,529

Trade accounts receivable, prepayments made and other current assets

14,387

Inventories

9,327

Tax losses carried forward

1,104

628

Total

70,347

69,871

22. CONTINGENCIES, COMMITMENTS AND OPERATING RISKS

Tax legislation. Ukraine’s tax

environment is characterised by

complexity in tax administering,

arbitrary interpretation by tax

authorities of tax laws and regulations

that, inter alia, can increase fiscal

pressure on tax payers. Inconsistent

application, interpretation, and

enforcement of tax laws can lead to

litigation which, as a consequence, may

result in the imposition of additional

taxes, penalties, and interest, and these

amounts could be material.

Management believes that the

Group has been in compliance with

all requirements of the effective tax

legislation. In the ordinary course

of business the Group is engaged in

transactions that may be interpreted

differently by the Group and tax

authorities. Where the risk of outflow

of financial resources associated with

this is deemed to be probable and the

amount is measured with sufficient

reliability, the Group provides for those

liabilities. Where management of the

Group estimates the risk of financial

resources outflow as possible, the

Group makes a disclosure of these

contingent liabilities.

As at 31 December 2018, management

estimated possible tax exposures in

total amount of UAH 13,516 million (31

December 2017: UAH 6,374 million).

Management believes that it is not

likely that any significant settlement

will arise from the above cases and,

therefore, the Group’s consolidated

financial statements do not include any

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FINANCIAL STATEMENTS

ANNUAL REPORT 2018

2018

amount of provision in this respect.

During 2015 “Ukrnafta” PJSC was

engaged in transactions for petroleum

products and crude oil sales, and made

prepayments in respect of future supply

of petroleum products. In 2017 National

Anti-corruption Bureau of Ukraine

initiated a claim in the court to declare

such transactions invalid. The Group’s

management believes that there is

likelihood that certain transactions

performed by “Ukrnafta” PJSC can be

challenged or declared invalid in future,

leading to additional tax obligations. The

Group’s management cannot estimate

impact of such potential obligations to

the consolidated financial statements

reliably, and does not recognise any

provision in this respect as at 31

December 2018.

The Group conducts transactions with its

subsidiaries. It is possible with evolution

of the interpretation of tax law in Ukraine

and changes in the approach of tax

authorities under the Tax Code, that

such transactions could be challenged

in the future. The impact of any such

challenge cannot be estimated, however,

management believes that it should not

be significant.

The Group exports refinery products

and transportation services, performs

intercompany transactions and is

involved in transactions with related

parties, which may potentially be in the

scope of the new Ukrainian transfer

pricing (“TP”) regulations. The Group’s

companies have submitted the controlled

transaction report for the year ended

31 December 2017 within the required

deadline. The report on controlled

transactions for the year ended 31

December 2018 shall be prepared by the

Group’s companies by 1 October 2019.

Management believes that the Group is

in compliance with TP requirements. As

the practice of implementation of the

new transfer pricing rules has not yet

developed and wording of some clauses

of the rules may be subject to various

interpretations, the impact of challenge

of the Group’s companies transfer pricing

positions by the tax authorities cannot be

reliably estimated.

Arbitration with Gazprom. On 28

February 2018, the Tribunal rendered the

Final Award in respect of the Gas Transit

Arbitration, and supported Naftogaz’s

position in respect of Gazprom failure

to deliver minimum contractual volume

of gas transit (underdeliveries) during

2009-2017. As a result, the Tribunal

awarded USD 4,674 million to be paid

in favour of Naftogaz by Gazprom as a

compensation of losses in this respect.

Further, the Tribunal performed a set-off

in respect of amounts owing between

the parties pursuant to the Gas Sales

Arbitration and Gas Transit Arbitration,

supporting a respective Naftogaz

request. Consequently, the Tribunal

ordered a single amount of USD 2,560

million payable by Gazprom in favour of

Naftogaz. This amount also bears a late

payment interest. As at 31 December

2018, amount due from Gazprom after

the set-off comprises USD 2,721 million

including interest.

There was no settlement of this

amount performed by the date of these

consolidated financial statements. Taking

that Gazprom has appealed the final

award in the Gas Transit Arbitration,

and the fact that the amount was not

settled by the date of these consolidated

financial statements, management

follows a prudent approach and does not

recognise the amount owed by Gazprom

after the set-off, as decided by the

Tribunal, as receivable as at 31 December

2018 and 2017.

Despite the fact that the Tribunal

has rejected Naftogaz’s claim on

reimbursement of VAT payable

on compensation of losses for

underdeliveries after 1 January 2016

in the Gas Transit Arbitration, Naftogaz

treats the amount awarded as a

contractual service price adjustment

that is subject to VAT under the Tax

Code of Ukraine. As a result, Naftogaz

has recognised respective VAT liabilities

amounting to UAH 4,751 million in March

2018, which were paid by 30 April 2018.

Additionally, according to the Final

Award of the Tribunal in the Gas Sales

Arbitration rendered on 22 December

2017, Gazprom is obliged to resume

gas supplies to Naftogaz according to

the effective Gas Sales Contract for

2009-2019 as amended by the Final

Award. Following the Final Award in

this case, in February 2018 Naftogaz

made a prepayment of USD 128 million

for gas deliveries to be made in March

2018. However, Gazprom returned

this payment and refused to make gas

supplies in March 2018. There were no

gas supplies during 2018 from Gazprom

to the Company up to the date of these

consolidated financial statements. Such

actions from Gazprom currently prevent

Naftogaz from fulfilling the Final Award

requirements in respect of offtaking

minimum annual quantities according to

Gas Sales Contract in 2018.

As stated above, after both Final Awards

were rendered, Gazprom representatives

officially declared a refusal to resume

deliveries to Ukraine as ordered by the

Tribunal in the Gas Sales Arbitration.

Additionally, Gazprom refused to confirm

its intention to settle outstanding

amount as decided by the Tribunal in the

Gas Transit Arbitration. Instead, on 20

April 2018 Gazprom filed a Request for

Arbitration to the Arbitration Institute of

the Stockholm Chamber of Commerce

requesting revision or, alternatively,

setting aside of the specific provisions of

the Gas Transit and Gas Sales Contracts

effective for 2009-2019 because of

alleged imbalance between the parties’

obligations under the Contracts following

Final Awards in both Gas Transit and Gas

Sales Arbitration.

Naftogaz rejected Gazprom’s claims

and presented its counterclaims, the

monetary value of which should be

specified later. Naftogaz is also taking

measures to enforce the Final Award in

the Gas Transit Arbitration.

Gazprom has also brought a challenge

against the Separate and Final Awards on

Gas Sales Arbitration and the Final Award

in Gas Transit Arbitration.

Based on the final awards and in view of

the Gazprom’s failure to comply with the

awards Naftogaz has moved to attach

Gazprom’s assets in several jurisdictions,

including the shares of Gazprom’s

subsidiaries Nord Stream AG and Nord

Stream 2 AG in Switzerland.

Additionally, on 6 July 2018, Naftogaz

submitted a Request for Arbitration to

the Arbitration Institute of the Stockholm

Chamber of Commerce seeking for tariff

revision in the Gas Transit Contract for the

period 2009-2019. Preliminary monetary

claim is estimated at USD 11,580 million.

Gazprom has submitted its answer on

14 August 2018, rejecting Naftogaz’s

claim. Upon request from Gazprom, on 6

September 2018 the Stockholm Chamber

of Commerce Board made a decision to

consolidate both cases to the consolidated

arbitration case. According to the agreed

procedural schedule, the final award in the

consolidated arbitration shall be rendered

by 1 November 2021.

Claim to the Russian Federation regarding

assets in Crimea. In October 2016,

Naftogaz and its subsidiaries initiated

arbitration proceeding against the Russian

Federation seeking for reimbursement of

losses caused by unlawful expropriation

of Group’s assets in Crimea by the Russian

Federation. This arbitration proceeding was

initiated under the Agreement between

the Cabinet of Ministers of Ukraine and the

Government of the Russian Federation on

mutual encouragement and protection of

investments.

On 15 September 2017, Naftogaz and its

subsidiaries have submitted the Statement

of Claim to the Tribunal under the auspices

of the Permanent Court of Arbitration in

The Hague. The amount of claim will be

estimated following the Tribunals’ Partial

Final Award.

On 22 February 2019, the Tribunal issued

Partial Final Award on jurisdiction and

responsibility in favour of the Group. The

Tribunal acknowledged its jurisdiction

over the claims and ruled that the Russian

Federation is responsible for violation of

the particular articles of the Agreement

between the Cabinet of Ministers of

Ukraine and the Government of the Russian

Federation on mutual encouragement and

protection of investments, including article

on prohibition of expropriation.

Legal proceedings. In the normal

course of business, the Group is subject

to claims. Where the risk of outflow

of financial resources associated with

such claims is assumed as probable, a

respective liability is recognised as a

component of provision for litigations

(Note 14). Where management

estimates the risk of outflow of financial

resources associated with such claims as

possible, or amount of outflow cannot

be measured reliably, no provision is

recognised, and respective amount is

disclosed in the consolidated financial

statements. Management believes that

it has provided for all material losses in

these consolidated financial statements

Joint operations with Misen

Enterprises AB, and “Karpatygaz” LLC.

As a part of determining the validity of

the joint arrangement, in July 2016, the

Group initiated legal proceedings in the

Stockholm Arbitration on termination or

recognition as invalid of this agreement.

In July 2018, the Arbitration Institute of

the Stockholm Chamber of Commerce

has issued a Partial Final Award regarding

termination of the joint arrangement

agreement. The Arbitral Tribunal

found that the joint arrangement

agreement had been violated by both

Misen Enterprises AB and “Karpatygaz”

LLC and is therefore terminated due

to the change in circumstances and

impossibility to continue the joint

operation arrangement.

Dispute with the non-controlling

shareholders of “Ukrnafta” PJSC in

respect of the validity and subsistence

of shareholders agreement. In January

2010 Naftogaz and the non-controlling

shareholders of “Ukrnafta” PJSC

(“Ukrnafta”) signed a shareholders

agreement that included, among other,

setting the procedure of electing the

Chairman of the Board, appointment of

the Executive Board and the Supervisory

board members. Under the shareholders

agreement the Chairman of the Board

is to be elected from among the

candidates nominated by the non-

controlling shareholders, 6 of 11 Ukrnafta

Supervisory board members, including

Chairman, are to be nominated by

Naftogaz, and remaining 5 members by

the non-controlling shareholders.

Under the shareholders agreement, any

dispute arising in connection with it is

to be resolved exclusively by the London

Court of International Arbitration and the

shareholder agreement is governed by

the English law.

In April 2018 Tribunal rendered the

Partial Final Award by which it (i)

acknowledged its jurisdiction over

the claims, and declared that (ii)

specific provisions of the shareholders

agreement are unenforceable as a

matter of English law by reason of their

conflict with mandatory provisions of

Ukrainian corporate law, but (iii) any

such non-enforceability does not affect

the enforceability of the shareholders

agreement as a whole.

Uncertainty as to the ability of “Ukrnafta”

PJSC to continue as a going concern.

Following accumulated debts to the State

Budget of UAH 28,553 million as at 31

December 2018 (31 December 2017:

UAH 26,920 million), limited ability to

collect accounts receivable and recover

prepayments made to suppliers with gross

amount of UAH 29,374 million as at 31

December 2018 (31 December 2017: UAH

22,525 million), Ukrnafta had insufficient

funds to satisfy its working capital needs

and settle its tax payments as they fall due.

Consequently, as at 31 December 2018

and 2017 Ukrnafta had a negative working

capital and incurred a negative cash flow

for the year ended 31 December 2018.

If Ukrnafta fails to restructure or otherwise

ensure settlement of overdue accounts

receivable, prepayments made, extend

production licenses and perform other

measures to minimise amount of net

current liabilities, this could lead to

insufficient funds to settle accumulated tax

liabilities in the short run, and this will lead

to additional measures to ensure the going

concern assumption, including negotiations

in respect of export operations or partial

sale of assets.

Despite the material uncertainties

described above, and taking into account

Ukrnafta’s positive financial results for the

years 2018 and 2017 and management

actions in improving its liquidity, production

and sales activities, management of the

Group believes that application of the going

concern assumption in respect of Ukrnafta

is appropriate for the purpose of these

consolidated financial statements.

Possible transfer of the Company’s

equity interest in the subsidiaries

to the State. In 1998, upon creation

of the Company, the Government of

Ukraine contributed shares of joint

stock companies to the share capital

of the Company, including “Long-

Distance Pipelines “Druzhba” JSC

and “Prydniprovskyi Long-Distance

Pipeline” JSC (that were subsequently

contributed to “Ukrtransnafta” JSC

share capital), “Ukrspetstransgaz” SE,

“Chornomornaftogaz” SE, “Ukrnafta”

OJSC, and fifty four regional gas

distribution entities. The Government of

Ukraine may decide to transfer shares

(stakes) or ownership or control over all

or part of the Company’s equity interest

in those joint stock companies and/

or companies, and those actions could

have a material adverse effect on the

Company’s operations.

State property not subject to

privatisation. In 1998, the Company

entered into an agreement “On use of

the State owned property not subject

to privatisation” (“Agreement”) with

the State Property Fund of Ukraine,

and received oil and gas transportation

system into the operational control. The

Agreement was signed for one year, and

its term is prolonged automatically for

one year, unless terminated by notice

from either party, and is binding on the

legal successor of each party. Historically,

the agreement has been prolonged

automatically, as neither party initiated

its termination. As the State property not

subject to privatisation forms an essential

part of the Group’s business, the future

operations and financial performance of

the Group depends on the prolongation

of the Agreement. The Group’s

management believes that the Group will

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FINANCIAL STATEMENTS

ANNUAL REPORT 2018

2018

continue to operate with this property in

the foreseeable future.

Pursuant to the Agreement, the Company

is required, inter alia, to handle oil and gas

transmission and distribution pipelines

owned by the State of Ukraine, keep the

state property in adequate operational

condition, and transfer 50% share of

profits received from using those assets

to the State. The amount of such transfer

could be reduced by the amount of

capital investments in those assets. The

Agreement does not provide a mechanism

of such calculations, and historically there

were no payments from the Company

to the State in respect of using such

assets. The Company believes that had

the mechanism for calculating the state

share in profits from using the assets

been determined by the State, the capital

investments performed by the Company

would be greater, and no payment in favour

of the State would occur. Accordingly, no

liability for such payment was recognised in

these consolidated financial statements.

Capital commitments. Capital commit-

ments for purchase of property, plant and

equipment, and exploration and develop-

ment of oil and gas fields comprise UAH

15,915 million as at 31 December 2018 (31

December 2017: UAH 11,573 million).

23. FINANCIAL

RISK MANAGEMENT

The Group is exposed to a variety of

financial risks: market risk (including

currency risk and interest rate risk),

concentration risk (Note 3), credit risk

and liquidity risk. According to its risk

management policy the Group identifies,

assessed and develops actions to

minimise the potential adverse effects

on the Group’s financial performance for

those risks.

Major categories of financial instruments:

In millions of Ukrainian hryvnias

Note

31 December

2018

31 December

2017

Other non-current assets

4,594

6,118

Trade accounts receivable

65,942

58,988

Prepayments made and other current assets

1,189

1,531

Сash and bank balances

14,224

23,093

Restricted cash

1,338

1,591

Total financial assets

87,287

91,321

In millions of Ukrainian hryvnias

Note

31 December

2018

31 December

2017

Borrowings

(55,999)

(59,315)

Trade accounts payable

(5,500)

(8,137)

Advances received and other current liabilities

(5,441)

(3,381)

Other long-term liabilities

(216)

Total financial liabilities

(67,156)

(70,833)

Market risk. The Group is exposed to

market risks. Market risks arise from

open positions in (a) foreign currencies,

(b) interest bearing assets and liabilities,

and (с) assets and liabilities that are

exposed to other price risk.

Currency risk. The Group operates within

Ukraine and its exposure to foreign

currency risk is determined mainly by

purchases of natural gas from foreign

suppliers, which are denominated in USD.

The Group also receives borrowings in

foreign currencies. The Group does not

hedge its foreign currency positions.

The Group’s exposure to foreign currency

risk is as follows, based on carrying

amounts of respective currency assets

and liabilities:

In millions of Ukrainian

hryvnias

31 December 2018

31 December 2017

USD

EUR

Others

USD

EUR

Others

Restricted cash

828

539

951

Cash and bank balances

4,084

3,960

18,246

2,718

Trade accounts receivable

6,454

7,086

Prepayments made and other

current assets

2,191

983

Other non-current assets

3,000

308

4,866

307

Borrowings

(17,829)

(13,355)

(26,706)

(11,447)

Trade accounts payable

(173)

(380)

(9)

(356)

(4,133)

(4)

Advances received and other

current liabilities

(954)

(378)

(3)

(139)

(67)

Other long-term liabilities

(193)

Net (short)/long currency

position

(2,592)

(9,791)

4,519

(11,671)

The following table presents sensitivities of profit or loss and equity to reasonably possible changes in exchange rates applied at the

reporting date, with all other variables held constant.

The exposure was calculated only for monetary balances denominated in currencies other than the functional currency of the Group’s

entities.

In millions of Ukrainian hryvnias

At 31 December 2018

At 31 December 2017

Impact on profit

or loss

Impact on equity

Impact on profit

or loss

Impact on equity

USD strengthening by 10%

(259)

452

USD weakening by 10%

259

(452)

EUR strengthening by 10%

(979)

(1,167)

EUR weakening by 10%

979

1,167

Interest rate risk. The Group normally

has no significant interest bearing assets,

and its income and operating cash flows

are substantially independent of changes

in market interest rate. The Group’s

interest rate risk exposure arises from

borrowings at variable interest rates.

Borrowings at fixed rate expose the

Group to the risk of fair value change of

the interest rate.

The Group attracts borrowings at both

fixed and floating interest rates. As at

31 December 2018 almost 24% of the

Group’s borrowings were provided at

floating rates (31 December 2017: 34%).

The risk of increase in market interest

rates is monitored by the Treasury

department of the Company. The key

objective of managing interest rate risk

is to get financing at a minimum costs,

and match the liquidity needs with the

proceeds from borrowings.

The borrowing activities are reviewed

on an annual basis. Long-term investing

activities and associated funding are

considered separately, and are subject to

the Government of Ukraine approval. The

maturity dates of financial liabilities are

further disclosed in this Note.

If floating interest rates on USD and EUR

denominated borrowings had been 100

basis points higher as at 31 December

2018 with all other variables remaining

constant, net profit for 2018 would have

been UAH 118 million lower (2017: UAH

149 million lower).

Other price risk. The Group determines

other price risk as risk of possible future

losses as a result of price volatility during

purchase and sale transactions. Both

volatility in gas prices at the European gas

hubs that impacts gas purchase prices,

and gas sale and supply to customers

at prices set by the NCREU within PSO

imposed on the Company (Note 2)

expose the Group to the price risk. To

manage this risk and offset its negative

impact on the Group’s financial position,

the Group, amongst other measures, is

actively taking part in gas market reform

in Ukraine and introduce the principle of

free pricing for all groups of customers.

In gas supply for groups of customers

at prices established independently by

Naftogaz on a monthly basis price risk is

not considered to be significant.

Credit risk. The Group is exposed to

credit risk, which is the risk that one

party to a financial instrument will

cause a financial loss for the other party

by failing to discharge an obligation.

Exposure to credit risk arises as a result

of the Group’s sales of products on

credit terms and other transactions with

counterparties giving rise to financial

assets. The Group’s policy is that the

customers that wish to pay on credit

terms are subject to the solvency check.

Significant outstanding balances are

also reviewed on an ongoing basis. At

the same time, the Group must follow

the state regulations within public

service obligations in respect of gas

sales to certain gas market participants

irrespective of whether they are

delinquent or not.

The Group makes a provision for

impairment that represents its

estimate of incurred losses in respect

of trade accounts receivable. The main

component of this provision relates to

specific individually significant exposures.

The maximum exposure to credit risk

as at 31 December 2018 is UAH 87,287

million (31 December 2017: UAH 91,321

million).

The following table presents credit

quality analysis for cash and cash

equivalents and cash collateral for

participation in the State procurement

procedures as at 31 December based on

Fitch ratings:

In millions of Ukrainian

hryvnias

31 December 2018

31 December 2017

Cash and bank balances

Restricted cash

Cash and bank

balances

Restricted cash

A rating

141

В rating

В- rating

7,849

131

12,431

596

No rating

6,196

1,207

10,576

995

Total

14,224

1,338

23,093

1,591

The Group does not hold any collateral

as a security for its credit risks related to

financial assets, except for guarantees

received in respect of restructured

accounts receivable of gas consumers

within the scope of the Law of Ukraine

“On measures to settle the debts for the

natural gas consumed by municipal heat

generating entities and distribution and

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FINANCIAL STATEMENTS

ANNUAL REPORT 2018

2018

water supplying companies” #1730 (Note

2). Amount of such collateral as at 31

December 2018 amounted to UAH 1,655

million (31 December 2017: UAH 400

million).

Liquidity risk. Prudent liquidity

management implies maintaining

sufficient cash and the availability of

funding to meet existing obligations

as they fall due. The Group’s objective

is to maintain a balance between the

continuity of funding and the use

of flexible credit terms provided by

suppliers and banks. Prepayments are

commonly used to manage both liquidity

and credit risks. The Group analyses

ageing of its assets and maturity of its

liabilities and plans liquidity depending

on their expected repayment. The

Group has capital construction programs

which are funded both through existing

business cash flows and borrowed funds.

Borrowed funds are also used to finance

the Group’s working capital needs.

The following table analyses the Group’s

financial liabilities by relevant maturity

groupings based on the remaining period

at the reporting date to the contractual

maturity date. The amounts disclosed in

the table are undiscounted cash flows of

principal and interest payments.

The maturity analysis of financial

liabilities as at 31 December 2018 was as

follows:

In millions of Ukrainian hryvnias

Up to 6

months 6-12 months

1-2 years 2-5 years

Over 5 years

Total

Borrowings

31,432

19,792

8,627

230

60,081

Trade accounts payable

5,498

5,500

Advances received and other current

liabilities

5,420

5,441

Other long-term liabilities

272

295

Total

42,352

19,813

8,648

502

71,317

The maturity analysis of financial liabilities as at 31 December 2017 was as follows:

In millions of Ukrainian hryvnias

Up to 6

months 6-12 months

1-2 years

2-5 years

Over 5 years

Total

Borrowings

25,759

23,067

6,321

11,918

159

67,224

Trade accounts payable

8,131

8,137

Advances received and other current

liabilities

3,303

3,381

Total

37,193

23,151

6,321

11,918

159

78,742

Gearing ratio. Consistent with others

in the industry, the Group monitors

capital on the basis of gearing ratio. This

ratio is calculated as net debt divided

by total capital under management. Net

debt is calculated as total borrowings

(current and non-current as shown in

the consolidated statement of financial

position) less cash and cash equivalents.

Total capital under management equals

total equity as shown in the consolidated

statement of financial position.

The gearing ratio at the end of the

reporting period was as following:

In millions of Ukrainian hryvnias

31 December

2018

31 December

2017

Total borrowings (Note 13)

55,999

59,315

Less: cash and cash equivalents (Note 11)

(12,759)

(23,093)

Total Net Debt

43,240

36,222

Total Equity

413,858

440,519

Gearing ratio

0.10

0.08

24. FAIR VALUE

International Financial Reporting

Standards defines fair value as the price

that would be received to sell an asset

or paid to transfer a liability in an orderly

transaction between market participants

at the measurement date.

The estimated fair values have been

determined by the Group 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.

Management used all available market

information in estimating the fair value.

The estimates presented herein are not

necessarily indicative of the amounts

the Group could realise in a market

exchange from the sale of its full holdings

of a particular instrument or pay in the

transfer of liabilities.

Fair value of property, plant and

equipment

Property, plant and equipment are

measured at fair value at the end of each

reporting period. The following table

provides information about how the fair

values of these assets are determined (in

particular, the valuation techniques and

inputs used):

Assets

Fair value hierarchy Valuation techniques and key inputs

Property,

plant and

equipment

The Group engages professional independent appraisers to determine the fair value of its

property, plant and equipment by using a replacement cost method for the majority of groups.

The fair value is determined as the cost of construction of these items at current prices less the

economic obsolescence and physical tear and wear to date. The main parameter used in this

valuation technique are current prices on construction.

For items for which there are market analogues (mainly buildings), the sales comparison

method is used, the prices of market-based sales of comparable properties in the immediate

proximity are adjusted with reference to differences in main parameters (such as floor space

of the property). The main parameter used in this valuation technique is the price per square

meter of a property.

Property,

plant and

equipment

The fair value of cushion gas is determined by application of the market price of gas at the end

of the reporting date to the volume of cushion gas. The main parameter used in this valuation

technique is market price for gas at the end of the reporting period. The market value of the

cushion gas equals to the market price of gas less costs of its pumping and transportation to the

point of sale.

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FINANCIAL STATEMENTS

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2018

The following table summarises property, plant and equipment recognised at fair value after initial recognition using a fair value

hierarchy:

31 December 2018

In millions of Ukrainian hryvnias

Level 2

Level 3

Total

Property, plant and equipment

186,497

217,347

403,844

Total

186,497

217,347

403,844

Details of the Group’s property, plant and equipment and information about the fair value hierarchy as at 31 December 2017 are as follows:

Description

Group of assets Valuation technique

Unobservable inputs

Range of unobservable inputs

Interrelationship between key unobservable inputs and

fair value measurement

Gas transmission

system and gas

storages

Gas transmission

system

Undeground

gas storages

equipment

Cushion gas

Depreciated replacement cost

method using the income

approach for economic

obsolescence determination

Period when transit revenues are received

2018-2019

The longer the period of income generation from transit,

the higher the fair value

Applicable transit volumes

110 bcm p.a. (based on minimal contract volumes from transit contract

with Gazprom)

If Gazprom refuses to transit not less then 110 bcm

p.a. in 2018-2019, Naftogaz will have the right to claim

damages from Gazprom for underdeliveries. The longer

the period of potential arbitration regarding such

claims, the lower both the discounted value of such

underdeliveries and the fair value.

Date of implementation of incentive tariff regulation system

The RBA-based (Regulatory Asset Base) tariffs are valid for transportation

services for cross-border gas pipelines from 2016, but they are not

recognised by Gazprom. Domestic entry tariffs for local gas producers are

currently put on hold by a court decision, but will be launched starting

from 2019. The RBA-based tariffs for storage are expected from 2021

The later the introduction of incentive tariff / entry point

fees, the lower the fair value

The rate of return on the regulatory basis of assets for

storage

11.89% The higher the rate, the higher the fair value

Nominal WACC for USD-denominated cash flows

11.89% The higher the weighted average cost of capital, the

lower the fair value

Gas extraction

assets

Gas and oil

upstream

Depreciated replacement cost

method using the income

approach for economic

obsolescence determination

Remaining period for natural gas extraction, years (based

on proved and probable reserves determined by an

independent expert)

0-50 The shorter the period, the lower the fair value due to

lower remaining periods of the use of extraction assets

Natural gas selling price

Price for the period from 2018 to 2020 is regulated for the volume of

delivery under PSO. Market price for the volume of delivery to the market

is formed on the basis of forecast prices for natural gas in the German

virtual gas trading point, plus cost of transportation to the Ukrainian

western border and entrance fee. Market price for subsequent period

is formed on the basis of forecast prices for natural gas in the German

virtual gas trading point, less cost of transportation to the Ukrainian

western border.

The higher the selling price, the higher the fair value

Long-term forecast of royalty rates (estimated for selling

price)

Natural gas and crude oil deposits at depths up to 5000 m – 29%, over

5000 m – 14%

Oil and gas condensate deposits at depths up to 5000 m – 45%, over

5000 m – 21%

The higher the rate, the lower the fair value

Nominal weighted average cost of capital for UAH

denominated cash flows

18.70% The higher the weighted average cost of capital, the

lower the fair value

Oil transmission

system and

storages

Oil transmission

system

Depreciated replacement cost

method using the income

approach for economic

obsolescence determination

Cumulative factor of physical and functional depreciations

0.38-0.79

The higher the factor, the lower the fair value

Nominal WACC for UAH-denominated cash flows

17.38% The higher the weighted average cost of capital, the

lower the fair value

31 December 2017

In millions of Ukrainian hryvnias

Level 2

Level 3

Total

Property, plant and equipment

150,040

324,021

474,061

Total

150,040

324,021

474,061

There were no transfers between Level 2 and Level 3 during the year.

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FINANCIAL STATEMENTS

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2018

Fair value of financial assets and

financial liabilities that are not

measured at fair value on a recurring

basis (but fair value disclosures are

required)

The Group’s management believes that,

the carrying amounts of financial assets

and financial liabilities recognised in

the consolidated financial statements

approximate their fair values as at 31

December 2018 and 2017.

25. SUBSEQUENT EVENTS

Decision of the Permanent Court of

Arbitration in The Hague in the claim

against the Russian Federation in

respect of assets located in Crimea. In

February 2019 the Permanent Court of

Arbitration in The Hague found in favour

of Naftogaz and concluded that according

to the bilateral investment treaty

between Ukraine and Russia, the Russian

Federation responsible for the unlawful

seizure of assets owned by Naftogaz and

its subsidiaries in Crimea (Note 22).

Loans repayment. During January-March

2019 the Group repaid UAH 19,261

million of bank borrowings.

26. SUMMARY OF SIGNIFICANT

ACCOUNTING POLICIES

Statement of compliance. These

consolidated financial statements

have been prepared in accordance

with International Financial Reporting

Standards (“IFRSs”).

Basis of preparation of consolidated

financial statements. This consolidated

financial statements have been prepared

on the historical cost basis except for

property, plant and equipment that are

measured at revalued amounts at the end

of each reporting period, as explained in

the accounting policies below.

Historical cost is generally based on the

fair value of the consideration given in

exchange for goods and services.

Fair value is the price that would be

received to sell an asset or paid to transfer

a liability in an orderly transaction between

market participants at the measurement

date, regardless of whether that price is

directly observable or estimated using

another valuation technique.

These policies have been consistently

applied to all periods presented, unless

otherwise stated.

Functional and presentation currency.

Items included in the financial statements

of each of the Group’s entities are

measured using the currency of the

primary economic environment in which

the Group operates (“the functional

currency”). The consolidated financial

statements are presented in Ukrainian

hryvnias (“UAH”), which is the Company’s

functional and the Group’s presentation

currency. All amounts presented in

the consolidated financial statements

are presented in UAH, rounded to the

nearest million, if not otherwise stated.

Transactions denominated in currencies

other than the relevant functional

currency are translated into the

functional currency, using the exchange

rate prevailing at the date of the

transaction. Foreign exchange gains and

losses, resulting from settlement of such

transactions and from the translation of

foreign currency denominated monetary

assets and liabilities at year end, are

recognised in the consolidated statement

of profit or loss. Translation at year end

does not apply to non-monetary items

including equity investments.

As at 31 December, the exchange rates

used for translating foreign currency

balances were:

In Ukrainian

hryvnias

2018

2017

USD 1.00

27.69

28.07

EUR 1.00

31.71

33.50

The average exchange rates for the year

ended 31 December were:

In Ukrainian

hryvnias

2018

2017

USD 1.00

27.20

26.60

EUR 1.00

32.14

30.00

During 2018 and 2017 in Ukraine there

were certain restriction in respect of

transactions with foreign currency,

imposed by the National Bank of Ukraine

(Note 2). Foreign currency can be easily

converted at a rate close to the National

Bank of Ukraine rate. At present, UAH is

not freely convertible outside Ukraine.

Basis for consolidation. Subsidiaries are

those companies over which the Group

has control. The Group controls an entity

when the Group has power over the

investee; is exposed to, or has rights to,

variable returns from its involvement

with the investee and has the ability

to use its power to affect its returns.

Subsidiaries are consolidated from the

date on which control is transferred

to the Group (acquisition date) and

are deconsolidated from the date that

control ceases.

Intercompany transactions, balances and

unrealised gains or losses on transactions

between the Group companies are

eliminated. Accounting policies of

subsidiaries have been changed where

necessary to ensure consistency with the

policies adopted by the Group.

The Company reassesses whether or

not it controls an investee if facts and

circumstances indicate that there are

changes to one or more elements of

control listed above.

When the Group has a majority of the

voting rights of an investee, it still considers

whether the voting rights are sufficient

to give it the practical ability to direct

the relevant activities of the investee

unilaterally and, thus, has the power over

the investee.

The Group considers all relevant facts

and circumstances in assessing whether

or not the Group’s voting rights in an

investee are sufficient to give it power,

including:

● the size of the Group’s holding of

voting rights relative to the size and

dispersion of holdings of the other vote

holders;

● potential voting rights held by the

Group, other vote holders or other

parties;

● rights arising from other contractual

arrangements; and

● any additional facts and circumstances

that indicate that the Group has, or

does not have, the current ability to

direct the relevant activities at the

time that decisions need to be made,

including voting patterns at previous

shareholders’ meetings.

Business combinations. Acquisitions of

businesses are accounted for using the

acquisition method. The consideration

transferred in a business combination is

measured at fair value, which is calculated

as the sum of the acquisition-date fair

values of the assets transferred by the

Group, liabilities incurred by the Group

to the former owners of the acquiree and

the equity interests issued by the Group

in exchange for control of the acquiree.

Acquisition-related costs are generally

recognised in profit or loss as incurred.

At the acquisition date, the identifiable

assets acquired and the liabilities

assumed are recognised at their fair

value, except that:

● deferred tax assets or liabilities, and

assets or liabilities related to employee

benefit arrangements are recognised

and measured in accordance with

IAS 12 “Income Taxes” and IAS 19

“Employee Benefits” respectively;

● liabilities or equity instruments related

to share-based payment arrangements

of the acquiree or share-based

payment arrangements of the Group

entered into to replace share-based

payment arrangements of the acquiree

are measured in accordance with

IFRS 2 “Share-based Payments” at the

acquisition date; and

● assets (or disposal groups) that are

classified as held for sale in accordance

with IFRS 5 “Non-current assets Held

for Sale and Discontinued Operations”

are measured in accordance with that

Standard.

Goodwill is measured as the excess of the

sum of the consideration transferred, the

amount of any non-controlling interests

in the acquiree, and the fair value of

the acquirer's previously held equity

interest in the acquiree (if any) over the

net of the acquisition-date amounts of

the identifiable assets acquired and the

liabilities assumed. If, after reassessment,

the net of the acquisition-date amounts

of the identifiable assets acquired and

liabilities assumed exceeds the sum

of the consideration transferred, the

amount of any non-controlling interests

in the acquiree and the fair value of the

acquirer's previously held interest in the

acquiree (if any), the excess is recognised

immediately in profit or loss as a bargain

purchase gain.

Non-controlling interests that are

present ownership interests and

entitle their holders to a proportionate

share of the entity's net assets in the

event of liquidation may be initially

measured either at fair value or at the

non-controlling interests' proportionate

share of the recognised amounts of the

acquiree's identifiable net assets. The

choice of measurement basis is made

on a transaction-by-transaction basis.

Other types of non-controlling interests

are measured at fair value or, when

applicable, on the basis specified in

another IFRS.

When the consideration transferred by

the Group in a business combination

includes assets or liabilities resulting

from a contingent consideration

arrangement, the contingent

consideration is measured at its

acquisition-date fair value and

included as part of the consideration

transferred in a business combination.

Changes in the fair value of the

contingent consideration that qualify

as measurement period adjustments

are adjusted retrospectively, with

corresponding adjustments against

goodwill. Measurement period

adjustments are adjustments that

arise from additional information

obtained during the ‘measurement

period’ (which cannot exceed one year

from the acquisition date) about facts

and circumstances that existed at the

acquisition date.

The subsequent accounting for changes

in the fair value of the contingent

consideration that do not qualify as

measurement period adjustments

depends on how the contingent

consideration is classified. Contingent

consideration that is classified as equity

is not remeasured at subsequent

reporting dates and its subsequent

settlement is accounted for within

equity. Contingent consideration that

is classified as an asset or a liability is

remeasured at subsequent reporting

dates in accordance with IFRS 9

“Financial Instruments”, or IAS 37

“Provisions, Contingent Liabilities and

Contingent Assets”, as appropriate, with

the corresponding gain or loss being

recognised in profit or loss.

When a business combination is achieved

in stages, the Group's previously

held equity interest in the acquiree is

remeasured to its acquisition-date fair

value and the resulting gain or loss, if any,

is recognised in profit or loss. Amounts

arising from interests in the acquiree

prior to the acquisition date that have

previously been recognised in other

comprehensive income are reclassified

to profit or loss where such treatment

would be appropriate if that interest

were disposed of.

If the initial accounting for a business

combination is incomplete by the

end of the reporting period in which

the combination occurs, the Group

reports provisional amounts for the

items for which the accounting is

incomplete. Those provisional amounts

are adjusted during the measurement

period (see above), or additional assets

or liabilities are recognised, to reflect

new information obtained about facts

and circumstances that existed at the

acquisition date that, if known, would

have affected the amounts recognised at

that date.

Goodwill. Goodwill arising on an

acquisition of a business is carried at cost

as established at the date of acquisition

of the business less accumulated

impairment losses, if any.

For the purposes of impairment testing,

goodwill is allocated to each of the

Group's cash-generating units (or groups

of cash-generating units) that is expected

to benefit from the synergies of the

combination.

A cash-generating unit to which

goodwill has been allocated is tested for

impairment annually, or more frequently

when there is an indication that the

unit may be impaired. If the recoverable

amount of the cash-generating unit

is less than its carrying amount, the

impairment loss is allocated first to

reduce the carrying amount of any

goodwill allocated to the unit and then

to the other assets of the unit pro rata

based on the carrying amount of each

asset in the unit. Any impairment loss for

goodwill is recognised directly in profit or

loss. An impairment loss recognised for

goodwill is not reversed in subsequent

periods.

On disposal of the relevant cash-

generating unit, the attributable

amount of goodwill is included in the

determination of the profit or loss on

disposal.

Transactions with non-controlling

interests. The Group treats transactions

with non-controlling interests as

transactions with equity owners of

the Group. For purchases from non-

controlling interests, the difference

between any consideration paid and the

relevant share acquired of the carrying

amount of net assets of the subsidiary

is recorded in equity. Gains or losses on

disposals to non-controlling interests are

also recorded in equity.

When the Group ceases to have control

or significant influence, the retained

interest in the entity is remeasured

to its fair value, with the change in

carrying amount recognised in profit

or loss. The fair value is the initial

carrying amount for the purposes of

subsequent accounting for the retained

interest in an associate, joint venture

or financial asset. In addition, any

amounts previously recognised in other

comprehensive income in respect of that

entity are accounted for as if the Group

had directly disposed of the related

assets or liabilities. This may mean that

amounts previously recognised in other

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198

FINANCIAL STATEMENTS

ANNUAL REPORT 2018

2018

comprehensive income are reclassified to

profit or loss.

If the ownership interest in an associate

is reduced but significant influence is

retained, only a proportionate share

of the amounts previously recognised

in other comprehensive income are

reclassified to profit or loss where

appropriate.

Investments in associates. Associates

are entities over which the Group

has significant influence but not

control. Investments in associates are

accounted for using the equity method

of accounting. The Group’s investment

in associate includes goodwill identified

on acquisition, net of any accumulated

impairment loss.

The Group’s share of its associates’ post-

acquisition profits or losses is recognised

in the consolidated statement of profit

or loss, and its share of post-acquisition

movements in other comprehensive

income is recognised in other

comprehensive income. The cumulative

post-acquisition movements are adjusted

against the carrying amount of the

investment. When the Group’s share of

losses in an associate equals or exceeds

its interest in the associate, including

any other unsecured receivables, the

Group does not recognise further losses,

unless it has incurred obligations or made

payments on behalf of the associate.

Unrealised gains on transactions

between the Group and its associates are

eliminated.

Accounting policies of associates have

been changed where necessary to ensure

consistency with the policies adopted by

the Group.

Dilution of gains and losses arising on

investments in associates are recognised

in the consolidated statement of profit

or loss.

Interest in joint ventures. A joint

venture is a joint arrangement whereby

the parties that have joint control of the

arrangement have rights to the net assets

of the joint arrangement. Joint control

is the contractually agreed sharing of

control of an arrangement, which exists

only when decisions about the relevant

activities require unanimous consent of

the parties sharing control.

The Group recognises its interest in the

joint venture using the equity method

applied as described above in the

paragraph Investments in associates.

Interests in joint operations. A joint

operation is a joint arrangement whereby

the parties that have joint control of the

arrangement have rights to the assets,

and obligations for the liabilities, relating

to the arrangement. Joint control is the

contractually agreed sharing of control of

an arrangement, which exists only when

decisions about the relevant activities

require unanimous consent of the parties

sharing control.

When a group entity undertakes its

activities under joint operations, the

Group as a joint operator recognises in

relation to its interest in a joint

operation:

● its assets, including its share of any

assets held jointly;

● its liabilities, including its share of any

liabilities incurred jointly;

● its revenue from the sale of its share

of the output arising from the joint

operation;

● its share of the revenue from the sale

of the output by the joint operation;

and

● its expenses, including its share of any

expenses incurred jointly.

The Group accounts for the assets,

liabilities, revenues and expenses relating

to its interest in a joint operation in

accordance with the IFRSs applicable to

the particular assets, liabilities, revenues

and expenses.

When a group entity transacts with a

joint operation in which a group entity

is a joint operator (such as a sale or

contribution of assets), the Group

is considered to be conducting the

transaction with the other parties to

the joint operation, and gains and losses

resulting from the transactions are

recognised in the Group’s consolidated

financial statements only to the extent

of other parties’ interests in the joint

operation.

When a group entity transacts with a

joint operation in which a group entity

is a joint operator (such as a purchase

of assets), the Group does not recognise

its share of the gains and losses until it

resells those assets to a third

party.

Concession agreement (product

sharing agreement). The Company

entered into a concession agreement

for oil exploration and development

(“Concession Agreement”) with the

Arab Republic of Egypt and the Egyptian

General Petroleum Corporation (“EGPC”)

on 13 December 2006.

The Concession Agreement includes the

following conditions:

● Subject to the auditing provisions

under the Concession Agreement, the

Company shall recover on a quarterly

basis all exploration and development

costs to the extent and out of 25%

of all petroleum produced and saved

from all production areas and not

used in petroleum operations (“Cost

Recovery”). Petroleum products

under the Concession Agreement

include crude oil or gas and liquefied

petroleum gas (“LPG”).

● Remaining 75% of the petroleum

produced is shared by the Company

and EGPC depending on the volume

of production and the product type

(crude oil or gas and LPG). The

Company’s share varies from 15% to

19%.

● EGPC shall become the owner of

all the Company’s assets acquired

and owned within the Concession

Agreement, which were charged

to Cost Recovery by the Company

in connection with the operations

carried out by the Company: land shall

become the property of EGPC as soon

as it is purchased; title to fixed and

movable assets shall be transferred

automatically and gradually from the

Company to EGPC as they become

subject to the Cost Recovery..

The development period under the

Concession Agreement is limited to

maximum 25 years from the date of

commercial oil discovery or from the date

of first gas deliveries, started in 2010.

Segment reporting. Operating segments

are reported in a manner consistent

with the internal reporting provided to

the Group’s chief operating decision

maker. Segments whose revenue,

results or assets are ten percent or

more of all the segments are reported

separately. Segments falling below this

threshold can be reported separately at

management decision.

Property, plant and equipment. The

Group uses the revaluation model to

measure property, plant and equipment,

except for construction in progress which

is carried at cost. Fair value was based on

valuations made by external independent

appraisers. The frequence of revaluation

depends on the movements in the fair

values of the assets being revalued.

The last independent valuation of the

fair value of the Group’s property, plant

and equipment was performed as at 31

December 2017. Subsequent additions

to property, plant and equipment

are recorded at cost. Cost includes

expenditure directly attributable to

acquisition of the items. The cost of self-

constructed assets includes the cost of

materials, direct labor and an appropriate

proportion of production overheads.

Сost of acquired and self-constructed

qualifying assets includes borrowing

costs.

Any increase in the carrying amounts

resulting from revaluations are credited

to revaluation reserve in equity

through other comprehensive income.

Decreases that offset previously

recognised increases of the same asset

are charged against revaluation reserve

in equity through other comprehensive

income; all other decreases are

charged to the consolidated statement

of profit or loss. To the extent that an

impairment loss on the same revalued

asset was previously recognised in the

consolidated statement of profit or

loss, a reversal of that impairment loss

is also recognised in the consolidated

statement of profit or loss

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 replaced

component being derecognised.

Subsequent costs are included in the

asset’s carrying amount or recognised

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 cost

of the item can be measured reliably.

All other repairs and maintenance are

charged to the consolidated statement

of profit or loss during the financial

period in which they are incurred.

Property, plant and equipment are

derecognised upon disposal or when no

future economic benefits are expected

to be received from the continued

use of the asset. Gains and losses on

disposal determined by comparing

proceeds with carrying amount

of property, plant and equipment

are recognised in the consolidated

statement of profit or loss. When

revalued assets are sold or disposed,

the amounts included in revaluation

reserve are transferred to retained

earnings.

Property, plant and equipment includes

cushion gas which is required to be held

in the storage facilities for the operating

activities of the Group’s subsidiary in

transportation of gas and gas storage

segments, respectively

Cushion gas is a gas intended for

maintaining pressure in underground

storage facilities of the Group and

protecting them from flooding. Cushion

gas is considered to be fully recoverable

based on an engineering analysis, and

at any time that the storage facility is

closed will be available for sale or other

use. Cushion gas is revalued when there

is an indication that its carrying amount

as of the reporting date is materially

different from its fair value.

Construction in progress includes also

prepayments for property, plant and

equipment.

Exploration expenses. Exploration

expenses comprise the costs associated

with unproved reserves. These include

geological and geophysical costs for the

identification and investigation of areas

with possible oil and gas reserves and

administrative, legal and consulting costs

in connection with exploration. They also

include all impairments on exploration

wells where no proved reserves could be

demonstrated.

Research and development expenses.

Research and development (“R&D”)

expenses include all direct and indirect

materials, personnel and external

services costs incurred in connection with

the focused search for new development

techniques and significant improvements

in products, services and processes and

in connection with research activities.

Expenditures related to research

activities is shown as R&D expenses in

the period in which they are incurred.

Development costs are capitalised if the

recognition criteria according to IAS 38

“Intangible Assets” are fulfilled.

Exploration and evaluation assets.

Oil and gas exploration and evaluation

expenditures are accounted for using the

successful efforts method of accounting.

Expenditures at the exploration stage

of hydrocarbon reserves’ exploration

and evaluation, including the economic

and technical feasibility studies for

exploratory field development and

advisory services, are recognised as

expenses of the period when incurred.

Expenses directly related to obtaining

special rights to extraction of mineral

resources reserves are capitalised in cost

of licenses for exploration and recognised

as intangible assets from the date of

special rights. Subsequently, the relevant

assets are accounted for using the

requirements of IAS 38 “Intangible Assets”.

Expenses arising at the stage of field

development, including costs of drilling

and trenching, leases and depreciation

of property, plant, and equipment, are

capitalised in construction in progress

as exploration and evaluation assets.

The assets created are reviewed for

impairment on an annual basis. In case

the exploratory drilling does not give a

result or it is probable that the expenses

incurred will not generate revenue,

the asset is partially or fully written off

against expenses of the period.

In the event a decision is taken on further

development of the field and from the

date of putting into operation of the first

producing well, the Group classifies the

capitalised exploration and evaluation

costs related to this well as oil and gas

extraction assets within property, plant,

and equipment in the statement of

financial position.

Depreciation and depletion.

Depreciation is charged to the

consolidated statement of profit or loss

on a straight-line basis to allocate costs

of individual assets except their residual

value over their estimated useful lives.

Depreciation commences on the date

of acquisition or, in respect of self-

constructed assets, from the time an

asset is completed and ready for use.

Hydrocarbon extraction wells are

depleted using a unit-of-production

method over the life of proved and

probable hydrocarbons reserves.

Specialised drilling tools and other fixed

assets used to perform any work on

the well are depleted using a unit-of-

production method based on relevant

output standard established by the

Group.

Other property, plant and equipment are

depreciated on a straight line basis over

its expected useful life. The useful lives

of the Group’s other property, plant and

equipment are as follows:

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201

200

FINANCIAL STATEMENTS

ANNUAL REPORT 2018

2018

Useful lives in years

Exploration, evaluation and drilling assets

2-60

Gas and oil upstream

2-60

Gas transmission system

2-60

Underground gas storages

2-60

Cushion gas

2-60

Oil transmission system

2-60

Gas and oil refinery

2-60

Filling stations

2-60

Gas distribution assets

2-60

LNG transportation

2-60

Other fixed assets

3-30

Construction in progress and cushion gas

are not depreciated.

Intangible assets. Intangible assets

have definite useful lives and primarily

include licenses for exploration and

extraction and capitalised computer

software. Acquired computer software

is capitalised on the basis of the costs

incurred to acquire and bring it to use.

Intangible assets are carried at cost

less accumulated amortisation and

impairment losses, if any. If impaired,

the carrying amount of intangible assets

is written down to the higher of value in

use and fair value less costs to sell.

Leases. Leases in which a significant

portion of the risks and rewards of

ownership are retained by the lessor are

classified as operating leases. Payments

made under operating leases (net of any

incentives received from the lessor) are

charged to the consolidated statement

of profit or loss on a straight-line basis

over the period of the lease. Finance

leases are capitalised at the lease

commencement at the lower of the fair

value of the leased property and the

present value of the minimum lease

payments.

Decommissioning liabilities.

The Group’s assessment of the

decommissioning liabilities is based on

the estimated future costs expected

to be incurred in respect of the

decommissioning and site restoration,

adjusted for the effect of the projected

inflation for the upcoming periods and

discounted using interest rates applicable

to the provision. Estimated costs of

dismantling and removing an item of

property, plant and equipment are

added to the cost of an item of property,

plant and equipment when the item is

acquired, and corresponding obligation is

recognised. Changes in the measurement

of an existing decommissioning liability,

that result from changes in the estimated

timing or amount of the outflows, or

from changes in the discount rate used

for measurement, are recognised in

the consolidated statement of profit or

loss or, to the extent of any revaluation

balance existence in respect of the

related asset, in other comprehensive

income or loss. Provisions in respect

of decommissioning activities are

evaluated and re-estimated annually,

and are included in the consolidated

financial statements at each reporting

date at their expected present value,

using discount rates which reflect the

economic environment in which the

Group operates.

Interest expense related to the provision

is included in finance costs in profit or

loss..

Impairment of non-financial assets.

Assets are reviewed for impairment when

events and changes in circumstances

indicate that the carrying amount may

not be recoverable. An impairment loss

is recognised for the amount by which

the assets carrying amount exceeds its

recoverable amount. The recoverable

amount is the higher of fair value less

cost to sell and value in use. For purposes

of assessing impairment, assets are

grouped to the lowest levels for which

there are separately identifiable cash

flows (cash generating unit). Non-

financial assets that have incurred

impairment are reviewed for possible

reversal of the impairment at each

reporting date

An impairment loss is recognised

immediately in profit or loss, unless the

relevant asset is carried at a revalued

amount, in which case the impairment

loss is treated as a revaluation decrease.

When an impairment loss subsequently

reverses, the carrying amount of the

asset (or a cash-generating unit) is

increased to the revised estimate of

its recoverable amount, but so that

the increased carrying amount does

not exceed the carrying amount that

would have been determined had no

impairment loss been recognised for the

asset (or cash-generating unit) in prior

years. A reversal of an impairment loss

is recognised immediately in profit or

loss, unless the relevant asset is carried

at a revalued amount, in which case the

reversal of the impairment loss is treated

as a revaluation increase.

Financial instruments. The Group has

adopted IFRS 9 from 1 January 2018.

In accordance with the transitional

provisions of IFRS 9, comparative figures

were not restated.

Initial recognition of financial

instruments. Financial assets and

financial liabilities are initially measured

at fair value.

The Group’s principal financial instruments

comprise borrowings, cash and bank

balances, trade accounts receivables and

trade accounts payables.

All purchases and sales of financial

instruments that require delivery within

the time frame established by regulation

or market convention (“regular way”

purchases and sales) are recorded at

trade date basis, which is the date that

the Group commits to deliver a financial

instrument. All other purchases and sales

are recognised on the settlement date.

Classification and subsequent

measurement of financial assets. Ф

Financial assets are subsequently

measured at amortised cost or fair value.

Specifically, debt investments that are

held within a business model whose

objective is to collect the contractual

cash flows, and that have contractual

cash flows that are solely payments of

principal and interest on the principal

outstanding are generally measured at

amortised cost at the end of subsequent

accounting periods. Debt instruments

that are held within a business model

whose objective is achieved both by

collecting contractual cash flows and

selling financial assets, and that have

contractual terms that give rise on

specified dates to cash flows that are

solely payments of principal and interest

on the principal amount outstanding, are

generally measured at fair value through

other comprehensive income. All other

debt investments and equity investments

are measured at their fair value at the

end of subsequent accounting periods.

Amortised cost is calculated using

the effective interest method and, for

financial assets, it is determined net of

any impairment losses. 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.

The Group uses practical expedient

according to which the amortised cost

of financial assets with a maturity of less

than one year, less any estimated credit

losses, are assumed to be their face

values.

Equity instruments. An equity

instrument is any contract that evidences

a residual interest in the assets of an

entity after deducting all of its liabilities.

Dividends on equity instruments are

recognised in the consolidated statement

of profit or loss when the Group’s right to

receive payment is established and the

inflow of economic benefits is probable.

Impairment losses are recognised in

the consolidated statement of profit or

loss when incurred as a result of one

or more events that occurred after the

initial recognition of equity investments.

A significant or prolonged decline in the

fair value of such instrument below its

cost is an indicator that it is impaired. The

cumulative impairment loss measured as

the difference between the acquisition

cost and the current fair value, less any

impairment loss on that asset previously

recognised in the consolidated statement

of profit or loss, is removed from equity

and recognised in the consolidated

statement of profit or loss.

Impairment losses on equity instruments

are not reversed through the

consolidated statement of profit or loss.

Impairment of financial assets. The

Group applies the simplified approach to

recognise lifetime expected credit losses

for its financial assets, as permitted by

IFRS 9. The Group accounts for expected

credit losses and changes in those

expected credit losses at each reporting

date to reflect changes in credit risk since

initial recognition.

The expected credit losses are estimated

using a migration matrix by reference

to past default experience of the debtor

and an analysis of the debtor’s current

position. In order to use this method, the

Group's counterparties were grouped

with uniform credit risk levels, for which

expected credit losses were calculated

by the Group. The Group recognises

100% provision for impairment on trade

accounts receivable overdue for more than

365 days, for counterparty receivables

that entered bankruptcy, liquidation or

financial reorganisation, and counterparty

receivables that are located on temporarily

occupied territories of Ukraine. According

to historical experience, the probability of

returning such receivables is extremely low.

The carrying amount of the asset is

reduced through the provision, and the

amount of respective loss is recognised

in the consolidated statement of profit or

loss. When receivables are uncollectible,

they are written off against the provision

account for receivables. Subsequent

recovery of amounts previously written

off are credited to the consolidated

statement of profit or loss.

Classification and subsequent

measurement of financial liabilities.

Financial liabilities are subsequently

measured at amortised cost or fair value

through profit or loss (“FVTPL”).

Financial liabilities that are not (i)

contingent consideration of an acquirer

in a business combination, (ii) held for

trading, or (iii) designated as at FVTPL,

are measured subsequently at amortised

cost using the effective interest method.

The effective interest rate is the rate that

exactly discounts estimated future cash

payments (including all fees and points

paid or received, transaction costs and

other premiums or discounts) through

the expected life of the financial liability,

or (where appropriate) a shorter period,

to the amortised cost of a financial

liability.

Derecognition of financial instruments.

The Group derecognises financial assets

when (i) the assets are redeemed or the

rights to cash flows from the assets have

otherwise expired or (ii) the Group has

transferred substantially all the risks and

rewards of ownership of the assets or

(iii) the Group has neither transferred

nor retained substantially all risks and

rewards of ownership but has not

retained control. Control is retained if the

counterparty does not have the practical

ability to sell the asset in its entirety to

an unrelated third party without needing

to impose additional restrictions on the

sale. The Group derecognises financial

liabilities when, and only when, the

Group’s obligations are discharged,

cancelled or they expire. The difference

between the carrying amount of the

financial liability derecognised and

the consideration paid and payable is

recognised in profit or loss.

Income taxes. Income taxes have been

provided for in the consolidated financial

statements in accordance with Ukrainian

legislation enacted or substantively

enacted by the end of reporting date.

The income tax charge comprises current

tax and deferred tax and is recognised in

the consolidated statement of profit or

loss unless it relates to transactions that

are recognised, in the same or a different

period, in other comprehensive income

or directly in equity.

Current tax is the amount expected to be

paid to or recovered from the taxation

authorities in respect of taxable profits or

losses for the current and prior periods.

Taxes other than on income are recorded

within operating expenses.

Deferred income tax is provided using

the balance sheet liability method for tax

losses carried forwards and temporary

differences arising between the tax

bases of assets and liabilities and their

carrying amounts for financial reporting

purposes. In accordance with the

initial recognition exemption, deferred

taxes are not recorded for temporary

differences on initial recognition of

an asset or a liability in a transaction

other than a business combination if

the transaction, when initially recorded,

affects neither accounting nor taxable

profit. Deferred tax liabilities are not

recorded for temporary differences

on initial recognition of goodwill and

subsequently for goodwill which is not

deductible for tax purposes. Deferred

tax balances are measured at tax rates

enacted or substantively enacted at the

reporting date which are expected to

apply to the period when the temporary

differences will reverse or the tax losses

carried forwards will be utilised. Deferred

tax assets and liabilities are netted only

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