Bombardier Inc. – Annual report – 31 December 2020
4. USE OF ESTIMATES AND JUDGMENT
The application of the Corporation’s accounting policies requires management to use estimates and judgments that can have a significant effect on the revenues, expenses, comprehensive income, assets and liabilities recognized and disclosures made in the consolidated financial statements. An accounting estimate and judgement is considered critical if:
- the estimate requires us to make assumptions about matters that are highly uncertain at the time the estimate is made; and
- we could have reasonably used different estimates in the current period, or changes in the estimate are reasonably likely to occur from period to period that would have a material impact on our financial condition, our changes in financial condition or our results of operations.
Management’s best estimates regarding the future are based on the facts and circumstances available at the time estimates are made. Management uses historical experience, general economic conditions and trends, as well as assumptions regarding probable future outcomes as the basis for determining estimates. Estimates and their underlying assumptions are reviewed periodically and the effects of any changes are recognized immediately. Actual results will differ from the estimates used, and such differences could be material.
Management’s budget and strategic plan cover a five-year period and are fundamental information used as a basis for many estimates necessary to prepare financial information. Management prepares a budget and a strategic plan covering a five-year period, on an annual basis, using a process whereby a detailed one-year budget and four-year strategic plan are prepared by each reportable segment and then consolidated. Cash flows and profitability included in the budget and strategic plan are based on existing and future contracts and orders, general market conditions, current cost structures, anticipated cost variations and in-force collective agreements. The budget and strategic plan are subject to approval at various levels, including senior management and the Board of Directors. Management uses the budget and strategic plan, as well as additional projections or assumptions, to derive the expected results for periods thereafter. Management then tracks performance as compared to the budget and strategic plan at various levels within the Corporation. Significant variances in actual performance are a key trigger to assess whether certain estimates used in the preparation of financial information must be revised.
The following areas require management’s most critical estimates and judgments, including the impact of the COVID-19 pandemic, if any. The sensitivity analyses below should be used with caution as the changes are hypothetical and the impact of changes in each key assumption may not be linear.
Long-term contracts – Transportation conducts most of its business under long-term manufacturing and service contracts and Aviation has some long-term maintenance service contracts, as well as design and development contracts for third parties. Revenues and margins from long-term contracts relating to the designing, engineering or manufacturing of specially designed products (including rail vehicles, vehicle overhaul and signalling contracts) and service contracts are recognized over time. The long-term nature of these contracts requires estimates of total contract costs and the transaction price. The measure of progress toward complete satisfaction of the performance obligation is generally determined by comparing the actual costs incurred to the total costs anticipated for the entire contract, excluding costs that are not representative of the measure of performance.
The contract transaction price includes adjustments for change orders, claims, performance incentives, price escalation clauses and other contract terms that provide for the adjustment of prices to the extent they represent enforceable rights for the Corporation. Variable consideration such as assumptions for price escalation clauses, performance incentives and claims is only included in the transaction price to the extent it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
Contract costs include material, direct labour, manufacturing overhead and other costs, such as warranty and freight. Estimated contract costs at completion incorporate forecasts for material usage and costs, including escalation clauses, labour hours and costs, foreign exchange rates (including the effect of hedges) and labour productivity. These costs are influenced by the nature and complexity of the work to be performed, as well as the impact of change orders and potential delays in delivery. Cost estimates are based mainly on historical performance trends, economic trends, collective agreements and contracts signed with suppliers. Management applies judgment to determine the probability that the Corporation will incur additional costs from delays or other penalties, and such costs, if probable, are included in estimated costs at completion, unless there is an adjustment to the transaction price in which case it is recorded as a reduction of estimated revenues at completion.
Recognized revenues and margins are subject to revisions as contracts progress towards completion. Management conducts quarterly reviews of estimated costs and revenues to completion on a contract-by-contract basis, including a review of escalation assumptions. In addition, a detailed annual review is performed on a contract-by-contract basis as part of the budget and strategic plan process. The effect of any revision may be significant and is recorded by way of a cumulative catch-up adjustment in the period in which the estimates are revised.
As part of its financial statement close process, Transportation updated its long-term contract accounting for identified changes in estimated contract revenues, contract costs and progress toward completion. During fiscal year 2020, Transportation revised its estimates on a number of projects leading to a charge of $1.1 billion, mainly in Germany, U.K. and Switzerland. Manufacturing overheads during the shut-down as well as incremental costs required as a result of the pandemic were recorded as expenses for the fiscal year 2020.
A 1% increase in the estimated future costs to complete all ongoing long-term contracts would have decreased gross margin from discontinued operations for fiscal year 2020 by approximately $124 million.
Aerospace program tooling – Aerospace program tooling amortization and the calculation of recoverable amounts used in impairment testing require estimates of the expected number of aircraft to be delivered over the life of each program. The expected number of aircraft is based on management’s aircraft market forecasts and the Corporation’s expected share of each market. Such estimates are reviewed in detail as part of the budget and strategic plan process. For purposes of impairment testing, management exercises judgment to identify independent cash inflows to identify CGUs by family of aircraft. Other key estimates used to determine the recoverable amount include the applicable discount rate, the expected future cash flows over the remaining life of each program, which include costs to complete the development activities, if any, as well as potential upgrades, and derivatives expected over the life of the program. The estimated cost of potential upgrades and derivatives is based on past experience with previous programs. The expected future cash flows also include cash flows from aftermarket activities. The inputs used in the discounted cash flow model are Level 3 inputs (inputs that are not based on observable market data).
The recoverable amounts of aerospace assets or CGUs are based on fair value less costs of disposal. The recoverable amounts were established during the fourth quarter of 2020. The fair value measurements are categorized within Level 3 of the fair value hierarchy. The estimate of the fair value less costs of disposal was determined using forecast future cash flows. The estimated future cash flows for the first five years are based on the budget and strategic plan. After the initial five years, long-range forecasts prepared by management are used. Forecast future cash flows are based on management’s best estimate of future sales under existing firm orders, expected future orders, timing of payments based on expected delivery schedules, revenues from related services, procurement costs based on existing contracts with suppliers, future labour costs, general market conditions, foreign exchange rates and applicable long-range forecast income tax rates and a post-tax discount rate of 9% based on a weighted average cost of capital calculated using market-based inputs, available directly from financial markets or based on a benchmark sampling of representative publicly-traded companies in the aerospace sector.
An impairment test was performed for the Global 7500 in the fourth quarter of 2020, and following this assessment the Corporation concluded there was no impairment.
The following analyses are presented in isolation from one another, i.e. all other estimates left unchanged:
A 10% decrease, evenly distributed over future periods, in the expected future net cash inflows for the Global 7500 aircraft program would not have resulted in an impairment charge in fiscal year 2020.
An increase of 100-basis points in the discount rate used to perform the impairment tests would not have resulted in an impairment charge in fiscal year 2020 for the Global 7500 aircraft program.
Goodwill – The recoverable amount of the Transportation operating segment, the group of CGUs at which level goodwill is monitored by management, is based on fair value less costs of disposal using the transaction price. During the fourth quarter of 2020, the Corporation performed an impairment test. Following this assessment the Corporation concluded there was no impairment.
Valuation of deferred income tax assets – To determine the extent to which deferred income tax assets can be recognized, management estimates the amount of probable future taxable profits that will be available against which deductible temporary differences and unused tax losses can be utilized. Such estimates are made as part of the budget and strategic plan by tax jurisdiction on an undiscounted basis and are reviewed on a quarterly basis. Management exercises judgment to determine the extent to which realization of future taxable benefits is probable, considering factors such as the number of years to include in the forecast period, forecasted taxable gain on closing of transactions, the history of taxable profits and availability of prudent tax planning strategies. See Note 11 – Income taxes for more details.
Tax contingencies – Uncertainties exist with respect to the interpretation of complex tax regulations, changes in tax laws, and the amount and timing of future taxable income. Given the wide range of international business relationships and the long-term nature and complexity of existing contractual agreements, differences arising between the actual results and the assumptions made, or future changes to such assumptions, could necessitate future adjustments to tax expense or recovery already recorded. The Corporation establishes tax provisions for possible consequences of audits by the tax authorities of each country in which it operates. The amount of such provisions is based on various factors, such as experience from previous tax audits and differing interpretations of tax regulations by the taxable entity and the relevant tax authority. Such differences in interpretation may arise for a wide variety of issues depending on the conditions prevailing in the domicile of each legal entity.
Retirement and other long-term employee benefits – The actuarial valuation process used to measure pension and other post-employment benefit costs, assets and obligations is dependent on assumptions regarding discount rates, compensation and pre-retirement benefit increases, inflation rates, health-care cost trends, as well as demographic factors such as employee turnover, retirement and mortality rates. The impacts from changes in discount rates and, when significant, from key events and other circumstances, are recorded quarterly. Discount rates are used to determine the present value of the expected future benefit payments and represent the market rates for high-quality corporate fixed-income investments consistent with the currency and the estimated term of the retirement benefit liabilities. As the Canadian high-quality corporate bond market, as defined under IFRS, includes relatively few medium- and long-term maturity bonds, the discount rate for the Corporation’s Canadian pension and other post-employment plans is established by constructing a yield curve using three maturity ranges. The first maturity range of the curve is based on observed market rates for AA-rated corporate bonds with maturities of less than five years. In the longer maturity ranges, due to the smaller number of high-quality bonds available, the curve is derived using market observations and extrapolated data. The extrapolated data points were created by adding a term-based yield spread over long-term provincial bond yields. This term-based spread is extrapolated between a base spread and a long spread. The base spread is based on the observed spreads between AA-rated corporate bonds and AA-rated provincial bonds for the 4 to 10 years to maturity range. The long spread is determined as the spread required at the point of average maturity of AA-rated provincial bonds in the 11 to 30 years to maturity range such that the average AA-rated corporate bond spread above AA-rated provincial bonds is equal to the extrapolated spread derived by applying the ratio of the observed spreads between A-rated corporate bonds and AA-rated provincial bonds for the 11 to 30 years to maturity range over the 4 to 10 years to maturity range, to the base spread. For maturities longer than the average maturity of AA-rated provincial bonds in the 11 to 30 years to maturity range, the spread is assumed to remain constant at the level of the long spread.
As the U.K. high-quality corporate bond market, as defined under IFRS, includes relatively few long-term maturity bonds, the discount rate for the Corporation’s U.K. pension and other post-employment plans is established by constructing a yield curve. The yield curve is developed from corporate bond yield information for corporate bonds rated AA or equivalent quality and excluding bonds which have a “corporate” BCLASS assignment but which have actual or implied government backing. Target yields are developed from bonds across a range of maturity points, and a curve is fitted to those targets. Spot rates (zero coupon bond yields) are developed from the yield curve and used to discount benefit payment amounts associated with each future year. Since corporate bonds are generally not available for very long maturities, an assumption is made that spot rates remain level beyond the term of the longest data target point. The term of the longest data target point as at December 31, 2020 was 32 years.
Expected rates of compensation increases are determined considering the current salary structure, as well as historical and anticipated wage increases, in the context of current economic conditions. For some Canadian pension plans, the merit and promotion component of the compensation increases was refined by using an age scale following experience studies performed in 2020.
See Note 23 – Retirement benefits for further details regarding assumptions used and sensitivity analysis to changes in critical actuarial assumptions.
Onerous contract provision – An onerous contract provision is recorded if it is more likely than not that the unavoidable costs of meeting the obligations under a firm contract exceed the economic benefits expected to be received under it. In most cases the economic benefits expected to be received under the contract consist of contract revenue. The calculation of the unavoidable costs requires estimates of expected future costs, including anticipated future cost reductions related to performance improvements and transformation initiatives, anticipated cost overruns, expected costs associated with late delivery penalties and technological problems, as well as allocations of costs that relate directly to the contract. The measurement of the provision is impacted by anticipated delivery schedules since for new aircraft programs early production units require higher cost than units produced later in the process, and for long-term train manufacturing contracts delays result in penalties.
A 1% increase in the expected costs over the life of the contract would have decreased EBIT from discontinued operations for fiscal year 2020 by approximately $57 million.
CDPQ investments equity and derivative liability components – The convertible shares issued to the CDPQ contain no obligation for the Corporation to deliver cash or other financial assets to the CDPQ. Judgment was used to conclude that the CDPQ’s convertible share investment in BT Holdco is considered a compound instrument comprised of an equity component, representing the discretionary dividends and liquidation preference, and a liability component that reflects a derivative to settle the instrument by delivering a variable number of common shares of BT Holdco, as opposed to the entire instrument being characterized as a liability. The Corporation presents convertible shares in its equity (NCI) and derivative component as a liability held for sale.
The fair value of the convertible shares at issuance was assigned to its respective equity and derivative liability components so that no gain or loss arose from recognizing each component separately, the fair value of the derivative liability being established first and the residual amount allocated to the equity component. The liability component is remeasured quarterly. The Corporation uses an internal valuation model to estimate the fair value of the conversion option embedded in the BT Holdco convertible shares. The fair value of the embedded conversion option is based on discounted value of the difference between the CDPQ’s share of proceeds from the sale of Transportation to Alstom, and the carrying value of CDPQ’s non-controlling interest in Transportation.
Consolidation – From time to time, the Corporation participates in structured entities where voting rights are not the dominant factor in determining control. In these situations, management may use a variety of complex estimation processes involving both qualitative and quantitative factors to determine whether the Corporation is exposed to, or has rights to, significant variable returns. The quantitative analyses involve estimating the future cash flows and performance of the investee and analyzing the variability in those cash flows. The qualitative analyses involve consideration of factors such as the purpose and design of the investee and whether the Corporation is acting as an agent or principal. There is a significant amount of judgment exercised in evaluating the results of these analyses as well as in determining if the Corporation has power to affect the investee’s returns, including an assessment of the impact of potential voting rights, contractual agreements and de facto control.
Also, the Corporation uses judgment to determine whether rights held by NCI, such as the CDPQ’s rights in respect of Transportation, are protective in nature as opposed to substantive. The Corporation reassesses the initial determination of control if facts or circumstances indicate that there may be changes to one or more elements of control.