Annual Report and Accounts 2010

Notes to the financial statements

1The Group and a summary of its significant accounting policies and financial risk management

1aGeneral information about the Group

The business of the Group

ARM Holdings plc and its subsidiary companies (ARM or “the Group”) designs microprocessors, physical IP and related technology and software, and sells development tools, to enhance the performance, cost-effectiveness and energy-efficiency of high-volume embedded applications.

The Group licenses and sells its technology and products to leading international electronics companies, which in turn manufacture, market and sell microprocessors, application-specific integrated circuits (ASICs) and application-specific standard processors (ASSPs) based on ARM’s technology to systems companies for incorporation into a wide variety of end products.

By creating a network of Partners, and working with them to best utilise ARM’s technology, the Group is establishing its processor architecture and physical IP for use in many high-volume embedded microprocessor applications, including cellular phones, digital televisions and PC peripherals and for potential use in many growing markets, including smart cards and microcontrollers.

The Group also licenses and sells development tools direct to systems companies and provides support services to its licensees, systems companies and other systems designers.

The Group’s principal geographic markets are Europe, the US and Asia Pacific.

Incorporation and history

ARM is a public limited company incorporated and domiciled under the laws of England and Wales. The registered office of the Company is 110 Fulbourn Road, Cambridge, CB1 9NJ, UK.

The Company was formed on 16 October 1990, as a joint venture between Apple Computer (UK) Limited and Acorn Computers Limited, and operated under the name Advanced RISC Machines Holdings Limited until 10 March 1998, when its name was changed to ARM Holdings plc. Its initial public offering was on 17 April 1998.

Group undertakings include ARM Limited (incorporated in the UK), ARM Inc. (incorporated in the US), ARM KK (incorporated in Japan), ARM Korea Limited (incorporated in South Korea), ARM France SAS (incorporated in France), ARM Germany GmbH (incorporated in Germany), ARM Norway AS (incorporated in Norway), ARM Sweden AB (incorporated in Sweden), ARM Embedded Technologies Pvt. Limited (incorporated in India), ARM Physical IP Asia Pacific Pte. Limited (incorporated in Singapore), ARM Taiwan Limited (incorporated in Taiwan) and ARM Consulting (Shanghai) Co. Limited (incorporated in PR China).

1bSummary of significant accounting policies

The principal accounting policies applied in the presentation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

Basis of preparation

These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), as adopted by the EU, IFRIC interpretations and with those parts of the Companies Act 2006 applicable to companies reporting under IFRS. This is in accordance with the Listing Rules of the Financial Services Authority.

The consolidated financial statements have been prepared under the historical cost convention as modified by the revaluation to fair value of available-for-sale investments; share-based payments; financial assets and liabilities (including derivative instruments) at fair value through the income statement; and embedded derivatives.

Critical accounting estimates and judgements

The preparation of these financial statements requires the directors to make critical accounting estimates and judgements that affect the amounts reported in the financial statements and accompanying notes. These estimates and judgements are summarised in note 1d.

New standards, amendments and interpretations

(a) Standards, amendments and interpretations effective in 2010

IFRS 3 (Revised), “Business combinations” This is equivalent to FAS 141R issued by the FASB in December 2007. The revision to this standard changes accounting for business combinations. While the acquisition method is still applied, there are significant changes to the treatment of contingent payments, transaction costs and the calculation of goodwill. Published by the IASB in January 2008, the standard is applicable to business combinations occurring in accounting periods beginning on or after 1 July 2009 and was endorsed by the EU on 3 June 2009. This could impact the Group’s financial statements in the future if it makes further acquisitions.

Amendment to IAS 39, “Financial Instruments: Recognition and measurement of eligible hedged items” This amendment makes two significant changes. It prohibits designating inflation as a hedgeable component of a fixed rate debt. It also prohibits including time value in the one-sided hedged risk when designating options as hedges. Published by the IASB in July 2008, it is effective for periods beginning on or after 1 July 2009 and must be applied retrospectively. This was endorsed by the EU on 15 September 2009 and has not impacted the Group since it does not currently designate any financial instruments as hedges.

Amendment to IFRS 2, “Share-based payments; group cash-settled transactions” This amendment provides a clear basis to determine the classification of share-based payment awards in both consolidated and separate financial statements. Published by the IASB in 2009, it is effective for periods beginning on or after 1 January 2010 and was endorsed by the EU on 23 March 2010. This has had no material impact on the Group.

Annual improvements 2009 This is a series of amendments to 12 standards as part of the IASB programme on annual improvement. Published by the IASB in April 2009, these are effective for accounting periods beginning on or after 1 January 2010. These were endorsed by the EU on 23 March 2010. These improvements have had no material impact on the results of the Group. Included within these improvements were:

IAS 36 (amendment), “Impairment of assets” This amendment clarifies that the largest cash-generating unit (or group of units) to which goodwill should be allocated for the purposes of impairment testing is an operating segment. This has no impact on the Group since it does not aggregate segments for this purpose.

IAS 1   (amendment), “Presentation of financial statements” The amendment clarifies that the potential settlement of a liability by the issue of equity is not relevant to its classification as current or non-current. By amending the definition of current liability, the  amendment permits a liability to be classified as non-current (provided that the entity has an unconditional right to defer settlement by transfer of cash or other assets for at least 12 months after the accounting period) notwithstanding the fact that the entity could be required by the counterparty to settle in shares at any time. This has no impact on the Group as it does not settle liabilities in this manner.

IAS 38 (amendment), “Intangible assets” The amendment clarifies guidance in measuring the fair value of an intangible asset acquired in a business combination and permits the grouping of intangible assets as a single asset if each asset has similar useful economic lives. This standard could have an impact on the Group in the event that it makes an acquisition and chooses to adopt this policy.

IFRS 5 (amendment) “Non-current assets held for sale and discontinued operations” This amendment clarifies that IFRS5 specifies the disclosures required in respect of non-current assets classified as held for sale or discontinued operations. This could have an impact on the Group if it holds such assets in the future.

(b) Standards, amendments and interpretations effective in 2010 but not relevant to the Group

IFRIC 15, “Agreements for construction of real estate” This clarifies which standard (IAS 18, ‘Revenue’, or IAS 11, ‘Construction contracts’) should be applied to particular transactions and means that IAS 18 is applied to a wider range of transactions. This is not relevant to the Group as it does not have any transactions involving real estate. Published by the IASB in July 2008, it is effective for periods beginning on or after 1 January 2009. This standard was endorsed by the EU on 1 January 2010 for periods beginning on or after 1 December 2010.

IFRIC 16, “Hedges of a net investment in a foreign operation” This clarifies the usage and requirements of IAS 21 with respect to net investment hedging. This is not relevant to the Group as it does not undertake such activities. Published by the IASB in July 2008, it is effective for periods beginning on or after 1 October 2008. This interpretation was endorsed by the EU for periods beginning on or after 1 July 2009.

IFRIC 17, “Distributions of non-cash assets to owners” This clarifies how an entity should measure distributions of assets, other than cash, when it pays dividends to its owners. This is not relevant to the Group as it does not make any distributions of assets to its owners, other than cash. Published by the IASB in November 2008, it is effective for periods beginning on or after 1 July 2009. This interpretation was endorsed by the EU for periods beginning on or after 1 July 2009.

IFRIC 18, “Transfer of assets from customers” This clarifies the accounting for arrangements where an item of property, plant and equipment, which is provided by the customer, is used to provide an ongoing service. This is not relevant to the Group as it does not engage in such activities. Published by the IASB in January 2009, it is effective for transfers of assets from customers received on or after 1 July 2009. This interpretation was endorsed by the EU for periods beginning on or after October 2010.

Amendments to IFRIC 9 and IAS 39, “Embedded derivatives” This amendment allows entities to reclassify particular financial instruments from the fair value through the income statement or available-for-sale categories in specific circumstances. This is not relevant to the Group since it currently does not meet the criteria of the amendment. Published by the IASB in March 2009, it is effective for periods commencing on or after 30 June 2009. It was endorsed by the EU on 30 November 2009.

IAS 27 (Revised), “Consolidated and separate financial statements” This amendment revises the accounting for transactions with non-controlling interests. Published by the IASB in January 2008, this is effective for accounting periods beginning on or after 1 July 2009 and was endorsed by the EU on 3 June 2009. This is not relevant to the Group as it does not have any non-controlling interests.

(c) Standards, amendments and interpretations that are not yet effective and have not been early adopted

Amendment to IAS 24, “Related party disclosures” This removes the requirement for government-related entities to disclose details of all transactions with the government and it clarifies and simplifies the definition of a related party. Published by the IASB in November 2009, this is effective for accounting periods beginning on or after 1 January 2011. This amendment was endorsed by the EU on 19 July 2010.

IFRS 9, “Financial instruments on classification and measurement” This is the first part of a new standard to replace IAS 39. IFRS 9 has two measurement categories: amortised cost and fair value. All equity instruments are measured at fair value. A debt instrument is measured at amortised cost only if the entity is holding it to collect contractual cash flows and the cash flows represent principal and interest. Otherwise it is measured at fair value through the income statement. Published by the IASB in November 2009, this is effective for accounting periods beginning on or after 1 January 2013. This standard is not yet endorsed by the EU.

Amendment to IFRIC 14, “Prepayments of a minimum funding requirement” This relates to companies that are required to make minimum funding contributions to a defined benefit pension plan. The Group does not have any such schemes and therefore it will not be relevant. Published by the IASB in November 2009, it is effective for annual periods beginning on or after 1 January 2011. This interpretation was endorsed by the EU on 19 July 2010.

IFRIC 19, “Extinguishing financial liabilities with equity instruments” This clarifies the accounting when an entity re-negotiates the terms of its debt with the result that the liability is extinguished through the debtor issuing its own equity instruments to the creditor. Published by the IASB in November 2009, this is effective for accounting periods beginning on or after 1 July 2010. This was endorsed by the EU on 23 July 2010.

Annual improvements 2010 This set of amendments includes changes to six standards and one IFRIC. These are minor amendments and are not expected to have a significant impact on the Group. Published by the IASB in May 2010, these are generally applicable for accounting periods beginning after 1 January 2011.

Amendment to IAS 32, “Rights Issues” This addresses the accounting for rights issues which are denominated in a currency other than the functional currency of the issuer. Published by the IASB October 2009, this is effective for accounting periods beginning on or after 1 February 2010. This was endorsed by the EU on 23 December 2009.

Amendment to IAS 12, “Income taxes on deferred tax” This amendment introduces an exception to the existing principle for the measurement of deferred tax assets or liabilities arising on investment property measured at fair value. This is not relevant to the Group as it does not currently own any investment properties. Published by the IASB in December 2010, it is effective for accounting periods on or after 1 January 2012. This is not yet endorsed by the EU.

It is too early to tell whether the adoption of these standards, annual improvements and interpretations will have an impact in future periods on the financial statements when they come into effect for accounting periods after 1 January 2011.

Principles of consolidation The consolidated financial statements incorporate the financial statements of the Company and all its subsidiaries. Intra-group transactions, including sales, profits, receivables and payables, have been eliminated on consolidation. All subsidiaries use uniform accounting policies for like transactions and other events and similar circumstances.

Business combinations The results of subsidiaries acquired in the year are included in the income statement from the date they are acquired. On acquisition, all of the subsidiaries’ assets and liabilities that exist at the date of acquisition are recorded at their fair values reflecting their condition at that date.

Segment reporting

At 31 December 2010, the Group was organised on a world-wide basis into three business segments, namely the Processor Division (PD), the Physical IP Division (PIPD) and the System Design Division (SDD). This is based upon the Group’s internal organisation and management structure and is the primary way in which the Chief Operating Decision Maker (CODM) and the rest of the board are provided with financial information. The directors believe that the CODM is the Chief Executive Officer of the Group.

Segment expenses are expenses that are directly attributable to a segment together with the relevant portion of other expenses that can reasonably be allocated to the segment. Foreign exchange gains or losses, investment income, interest payable and similar charges and tax are not allocated by segment.

Segment assets and liabilities include items that are directly attributable to a segment plus an allocation on a reasonable basis of shared items. Corporate assets and liabilities are not included in business segments and are thus unallocated. At 31 December 2010 and 2009, these comprised cash and cash equivalents, short- and long-term deposits, short-term marketable securities, available-for-sale financial assets, loans and receivables, embedded derivatives, and the fair value of currency exchange contracts. Any current and deferred tax assets and liabilities are also not included in business segments and are thus unallocated.

Foreign currency translation

(a) Functional and presentation currency The functional currency of each Group entity is the currency of the primary economic environment in which each entity operates. The consolidated financial statements are presented in sterling, which is the presentation currency of the Group.

(b) Transactions and balances Transactions denominated in foreign currencies have been translated into the functional currency of each Group entity at actual rates of exchange ruling at the date of transaction. Monetary assets and liabilities denominated in foreign currencies have been translated at rates ruling at the balance sheet date. Exchange differences have been included in general and administrative expenses.

(c) Group companies The results and financial position of all Group entities (none of which has the currency of a hyper-inflationary economy) not based in the UK are translated into sterling as follows:

(i)

Assets and liabilities for each balance sheet presented are translated at the closing rate of exchange at the balance sheet date;

(ii)

Income and expenses for each income statement presented are translated at the exchange rate ruling at the time of each transaction during the period; and

(iii)

All resulting exchange differences are recognised as a separate component of equity, being taken directly to equity via the cumulative translation adjustment.

When a foreign operation is partially disposed of or sold, exchange differences that were recognised in equity are recognised in the income statement as part of the gain or loss on sale.

Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate.

Fair value estimation

The fair value of financial instruments traded in active markets (such as trading and available-for-sale securities) is based on quoted market prices at the balance sheet date. The quoted market price used for financial assets held by the Group is the current bid price.

The fair value of financial instruments that are not traded in an active market (for example, over-the-counter derivatives) is determined using valuation techniques. The Group uses a variety of methods and makes assumptions that are based on market conditions existing at each balance sheet date. The fair value of forward exchange contracts is determined using quoted forward exchange rates at the balance sheet date. The fair value of foreign currency options is based upon valuations performed by an independent bank as well as management’s view of market conditions.

The carrying value less impairment provision of trade receivables and payables are assumed to approximate their fair values as this is the amount which would be receivable/payable if the assets/liabilities had crystallised at the balance sheet date. Any current tax liabilities are not included in this category.

Revenue recognition

The Group follows the principles of IAS 18, “Revenue recognition”, in determining appropriate revenue recognition policies. In principle, therefore, revenue associated with the sale of goods is recognised when all of the following conditions have been satisfied:

the Group has transferred to the buyer the significant risks and rewards of ownership of the goods;

the Group does not retain either continuing managerial involvement to the degree usually associated with ownership or effective control over the goods sold;

the amount of revenue can be measured reliably;

it is probable that the economic benefits associated with the transaction will flow to the Group; and

the costs incurred or to be incurred in respect of the sale can be measured reliably.

Revenue associated with the rendering of services is recognised when all of the following conditions have been satisfied:

the amount of revenue can be measured reliably;

it is probable that the economic benefits associated with the transaction will flow into the Group;

the stage of completion of the transaction at the end of the reporting period can be measured reliably; and

the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

Revenue is shown net of value-added tax, returns, rebates and discounts, and after eliminating sales within the Group.

Revenue comprises the value of sales of licences to ARM technology, royalties arising from the resulting sale of licensees’ ARM technology-based products, revenues from support, maintenance and training, consulting contracts and the sale of development boards and software toolkits.

Revenue from standard licence products which are not modified to meet the specific requirements of each customer is recognised when the all of the conditions relevant to revenue associated with the sale of goods have been satisfied:

The significant risks and rewards of ownership are transferred when a license arrangement has been agreed and the goods have been delivered to the customer;

Continuing managerial involvement and effective control over goods sold is relinquished at the point at which goods are delivered to the customer;

Revenue is recognised to the extent that it is reliably measurable; any consideration due under the licensing arrangement that is not deemed to be reliably measurable is deferred until it can be measured reliably; and

Revenue is recognised to the extent that it is probable that the economic benefits associated with the transaction will flow to the Group; any economic benefits of the transaction that are deemed unlikely to flow to the Group are deferred until it becomes probable that they will flow to the Group.

The majority of the Group’s revenues come from the licensing of intellectual property and there are therefore very few direct costs associated with the sale of goods; where there are direct costs of sale, these are measured with reference to the purchasing agreements in place with the Group’s suppliers.

Many licence agreements are for products which are designed to meet the specific requirements of each customer. Revenue from the sale of such licences is recognised on a percentage-of-completion basis over the period from signing of the licence to customer acceptance. Under the percentage-of-completion method, provisions for estimated losses on uncompleted contracts are recognised in the period in which the likelihood of such losses is determined. The percentage-of-completion is measured by monitoring progress using records of actual time incurred to date in the project compared with the total estimated project requirement, which approximates to the extent of performance.

Where invoicing milestones on licence arrangements are such that the receipts fall due significantly outside the period over which the customisation is expected to be performed or significantly outside its normal payment terms for standard licence arrangements, the Group evaluates whether it is probable that economic benefits associated with these milestones will flow to the Group and therefore whether these receipts should initially be included in the arrangement consideration.

In particular, it considers:

whether there is sufficient certainty that the invoice will be raised in the expected timeframe, particularly where the invoicing milestone is in some way dependent on customer activity;

whether it has sufficient evidence that the customer considers that the Group’s contractual obligations have been, or will be, fulfilled;

whether there is sufficient certainty that only those costs expected to be incurred will indeed be incurred before the customer will accept that a future invoice may be raised; and

the extent to which previous experience with similar product groups and similar customers supports the conclusions reached.

Where the Group considers that there is insufficient evidence that it is probable that the economic benefits associated with such future milestones will flow to the Group, taking into account these criteria, such milestones are excluded from the arrangement consideration until there is sufficient evidence that it is probable that the economic benefits associated with the transaction will flow into the Group. The Group does not discount future invoicing milestones, as the effect of so doing would be immaterial.

Where agreements involve several components, the entire fee from such arrangements is allocated to each of the individual components based on each component’s fair value, where fair value is the price that is regularly charged for an item when sold separately. Where a component in a multiple-component agreement has not previously been sold separately, the assessment of fair value for that component is based on other factors including, but not limited to, the price charged when it was sold alongside other items and the book price of the component relative to the book prices of the other components in the agreement. If fair value of one or more components in a multiple-component agreement is not determinable (where such component is not considered incidental to the overall arrangement), the entire arrangement fee is deferred until such fair value is determinable, or the component has been delivered to the licensee. Where, in substance, two or more elements of a contract are linked and fair values cannot be allocated to the individual components, the revenue recognition criteria are applied to the elements as if they were a single element.

Agreements including rights to unspecified future products (as opposed to unspecified upgrades and enhancements) are accounted for using subscription accounting, with revenue from the arrangement being recognised on a straight-line basis over the term of the arrangement, or an estimate of the economic life of the products offered if no term is specified, beginning with the delivery of the first product.

In addition to the licence fees, contracts generally contain an agreement to provide post-delivery service support, in the form of support, maintenance and training which consists of the right to receive services and/or unspecified product upgrades or enhancements that are offered on a when-and-if-available basis. Fees for post-delivery service support are generally specified in the contract. Revenue related to post-delivery service support is recognised based on fair value, which is determined with reference to contractual renewal rates. If no renewal rates are specified, and fair value of the post-delivery support service cannot be determined by other methods, the entire fee under the transaction is amortised and recognised on a straight-line basis over the contractual post-delivery service support period. Where renewal rates are specified, revenue for post-delivery service support is recognised on a straight-line basis over the period for which support and maintenance is contractually agreed by the Group with the licensee.

If the amount of revenue recognised exceeds the amounts invoiced to customers, the excess amount is recorded as amounts recoverable on contracts within accounts receivable. The excess of licence fees and post-delivery service support invoiced over revenue recognised is recorded as deferred revenue.

Revenue recognition continued

Sales of software, including development systems, which are not specifically designed for a given licence (such as off-the-shelf software) are recognised upon delivery, when the significant risks and rewards of ownership have been transferred to the customer. At that time, the Group has no further obligations except that, where necessary, the costs associated with providing post-delivery service support have  been accrued. Services (such as training) that the Group provides which are not essential to the functionality of the IP are separately stated and priced in the contract and, therefore, accounted for separately. Revenue is recognised as services are performed and it is probable that the economic benefits associated with the transaction will flow into the Group.

Royalty revenues are earned on sales by the Group’s customers of products containing ARM technology. Royalty revenues are recognised when it is probable that the economic benefits associated with the transaction will flow to the Group and the amount of revenue can be reliably measured. Revenues are recognised when the Group receives notification from the customer of product sales, or receives payment of any fixed royalties. Notification is typically received in the quarter following shipment of the products by the customer.

Certain products have been co-developed by the Group and a collaborative partner, where both parties had the right to sell licences to the product. In those cases where the Group receives royalty revenues from the sale of these products, the total value of the royalty is recorded as revenue and the amount payable to the collaborative partner is recorded as cost of sales. Where the collaborative partner collects royalties on the sales of these products, the Group records as revenue the commission it is due when informed by the collaborative partner that a sale has been made.

As disclosed above, in accordance with IAS 8, “Accounting policies, changes in accounting estimates and errors”, the Group makes significant estimates in applying its revenue recognition policies. In particular, as discussed in detail above, estimates are made in relation to the use of the percentage-of-completion accounting method, which requires that the extent of progress toward completion of contracts may be anticipated with reasonable certainty. The use of the percentage-of-completion method is itself based on the assumption that, at the outset of licence agreements, there is an insignificant risk that customer acceptance is not obtained. The Group also makes assessments, based on prior experience, of the extent to which future milestone receipts represent a probable future economic benefit to the Group. In addition, when allocating revenue to various components of arrangements involving several components, it is assumed that the fair value of each element is reflected by its price when sold separately. The complexity of the estimation process and issues related to the assumptions, risks and uncertainties inherent with the application of the revenue recognition policies affect the amounts reported in the financial statements. If different assumptions were used, it is possible that different amounts would be reported in the financial statements.

Research and development expenditure

All ongoing research expenditure is expensed in the period in which it is incurred. Where a product is technically feasible, production and sale are intended, a market exists, expenditure can be measured reliably, and sufficient resources are available to complete the project, development costs are capitalised and amortised on a straight-line basis over the estimated useful life of the respective product. The Group believes its current process for developing products is essentially completed concurrently with the establishment of technological feasibility which is evidenced by a working model. Accordingly, development costs incurred after the establishment of technological feasibility have not been significant and, therefore, no costs have been capitalised to date.

Where no internally-generated intangible asset can be recognised, development expenditure is recognised as an expense in the period in which it is incurred. Any collaborative agreement whereby a third party agrees to partially fund the Group’s research and development is recognised over the period of the agreement as a credit within research and development costs.

Retirement benefit costs

The Group contributes to defined contribution plans substantially covering all employees in Europe and the US and to government pension schemes for employees in Japan, South Korea, Taiwan, PR China, Israel and India. The Group contributes to these plans based upon various fixed percentages of employee compensation, and such contributions are expensed as incurred.

Operating leases

Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Costs, net of any lease incentives, in respect of operating leases are charged on a straight-line basis over the lease term even if payments are not made on such a basis.

Investment income, and interest payable and similar charges

Investment income, and interest payable and similar charges relate to interest income and expense, which is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable.

Dividends

Distributions to equity holders are not recognised in the income statement under IFRS, but are disclosed as a component of the movement in shareholders’ equity. A liability is recorded for a dividend when the dividend is approved by the Company’s shareholders. Interim dividends are recognised as a distribution when paid.

Earnings per share

Basic earnings per share is calculated by dividing the earnings attributable to ordinary shareholders by the weighted average number of ordinary shares in issue during the period, excluding treasury, which are treated as cancelled. For diluted earnings per share, the weighted number of ordinary shares in issue is adjusted to assume conversion of all dilutive potential ordinary shares. The diluted share base for the year ended 31 December 2010 excludes incremental shares of approximately 185,000 (2009: 11,986,000) related to employee share options. These shares are excluded due to their anti-dilutive effect as a result of the exercise price of these shares being higher than the market price.

Property, plant and equipment

The cost of property, plant and equipment is their purchase cost, together with any incidental costs of acquisition. External costs and internal costs are capitalised to the extent they enhance the future economic benefit of the asset.

Depreciation is calculated so as to write off the cost of property, plant and equipment, less their estimated residual values, which are adjusted, if appropriate, at each balance sheet date, on a straight-line basis over the expected useful economic lives of the assets concerned. The principal economic lives used for this purpose are:

Freehold buildings

25 years

Leasehold improvements

Five to seven years or term of lease, whichever is shorter

Computer equipment

Three to five years

Fixtures and fittings

Five to ten years

Motor vehicles

Four years

Provision is made against the carrying value of property, plant and equipment where an impairment in value is deemed to have occurred. Asset lives and residual values are reviewed on an annual basis.

Intangible assets

(a) Goodwill Goodwill represents the excess of the fair value of the consideration paid on acquisition of a business over the fair value of the assets, including any intangible assets identified and liabilities acquired. Goodwill is not amortised but is measured at cost less impairment losses. In determining the fair value of consideration, the fair value of equity issued is the market value of equity at the date of completion, the fair value of share options assumed is calculated using the Black-Scholes valuation model, and the fair value of contingent consideration is based upon whether the directors believe any performance conditions will be met and thus whether any further consideration will be payable.

(b) Other intangible assets Computer software, purchased patents and licences to use technology are capitalised at cost and amortised on a straight-line basis over a prudent estimate of the time that the Group is expected to benefit from them, which is typically three to ten years. Costs that are directly attributable to the development of new business application software and which are incurred during the period prior to the date that the software is placed into operational use, are capitalised. External costs and internal costs are capitalised to the extent they enhance the future economic benefit of the asset.

Although an independent valuation is made of any intangible assets purchased as part of a business combination, the directors are primarily responsible for determining the fair value of intangible assets. Developed technology, existing agreements and customer relationships, core technology, trademarks and tradenames, and order backlog are capitalised and amortised over a period of one to ten years, being a best estimate of the time that the Group is expected to benefit from them.

In-process research and development projects purchased as part of a business combination may meet the criteria set out in IFRS 3, “Business combinations”, for recognition as intangible assets other than goodwill. The directors track the status of in-process research and development intangible assets such that their amortisation commences when the assets are brought into use. This typically means a write off period of one to five years.

Amortisation is calculated so as to write off the cost of intangible assets, less their estimated residual values, which are adjusted, if appropriate, at each balance sheet date, on a straight-line basis over the expected useful economic lives of the assets concerned. The principal economic lives used for this purpose are:

Computer software

Three to five years

Patents and licences

Three to ten years

In-process research and development

One to five years

Developed technology

One to five years

Existing agreements and customer relationships

Two to ten years

Core technology

Five years

Trademarks and tradenames

Four to five years

Order backlog

One year

Impairment of non-financial assets

Assets that have an indefinite useful life, for example goodwill, are not subject to amortisation but are tested annually for impairment.

Assets that are subject to amortisation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

An impairment loss is recognised for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value in use. For purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash generating units). Non-financial assets other than goodwill that suffered an impairment are reviewed for possible reversal of the impairment at each reporting date.

The annual impairment tests in 2010 and 2009 showed there was no impairment with respect to goodwill. Furthermore, no trigger events have been identified that would suggest the impairment of any of the Group’s other intangible assets.

Financial assets

The Group classifies its financial assets in the following categories: at fair value through the income statement, loans and receivables, and available-for-sale. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition.

(a) Financial assets at fair value through the income statement Financial assets at fair value through the income statement are financial assets held for trading – that is, assets that have been acquired principally for the purpose of selling in the short-term. Assets in this category are classified as current assets. They are initially recognised at fair value with transaction costs being expensed in the income statement. Specifically, the Group’s currency exchange contracts and embedded derivatives fall within this category. Gains or losses arising from changes in the fair value of “financial assets at fair value through the income statement” are presented in the income statement within general and administrative expenses in the period in which they arise.

(b) Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They are included in current assets, except for maturities greater than 12 months after the balance sheet date. These are classified as non-current assets. “Accounts receivable” and “cash and cash equivalents” are classified as “Loans and receivables” in the balance sheet.

Loan and receivables are measured initially at fair value and then annually are measured at amortised cost.

(c) Available-for-sale financial assets Available-for-sale financial assets are non-derivatives that are either designated in this category or not classified in any of the other categories. They are included in non-current assets unless management intends to dispose of the investment within 12 months of the balance sheet date.

Publicly-traded investments are classified as available-for-sale. Initially recognised at fair value plus transaction costs on the trade date, they are revalued at market value at each period end. Unrealised holding gains or losses on such securities are included, net of related taxes, directly in equity via a revaluation reserve except where there is evidence of permanent impairment (see below).

Equity securities that are not publicly traded are also classified as available-for-sale and are recorded at fair value plus transaction costs at the trade date. Given that the markets for these assets are not active, the Group establishes fair value by using valuation techniques. At  31 December 2010 and 2009, the estimated fair value of these investments approximated to cost less any permanent diminution in value, based on estimates determined by the directors.

Impairment of financial assets The Group considers at each reporting date whether there is any indication that any financial asset is impaired. If there is such an indication, the Group carries out an impairment test by measuring the assets’ recoverable amount, which is the higher of the assets’ fair value less costs to sell and their value in use. If the recoverable amount is less than the carrying amount an impairment loss is recognised, and the assets are written down to their recoverable amount.

In the case of equity securities classified as available-for-sale, a significant or prolonged decline in the fair value of the security below its cost is considered as an indicator that the securities are permanently impaired. If any such evidence exists for available-for-sale financial assets, the cumulative loss – measured as the difference between the acquisition cost and the current fair value, less any permanent impairment loss on that financial asset previously recognised in the income statement – is removed from equity and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement.

When securities classified as available-for-sale are sold or permanently impaired, the accumulated fair value adjustments recognised in equity are recycled through the income statement.

Impairment testing of trade receivables is described under “Accounts receivable” below.

Derivative financial instruments

The Group utilises currency exchange contracts to manage the exchange risk on actual transactions related to accounts receivable, denominated in a currency other than the functional currency of the business. The Group’s currency exchange contracts do not subject the Group to risk from exchange rate movements because the gains and losses on such contracts offset losses and gains, respectively, on the transactions being hedged. The currency exchange contracts and related accounts receivable are recorded at fair value at each period end. Fair value is estimated using the settlement rates prevailing at the period end. All recognised gains and losses resulting from the settlement of the contracts are recorded within general and administrative expenses in the income statement. The Group does not enter into currency exchange contracts for the purpose of hedging anticipated transactions.

Cash and cash equivalents

Cash and cash equivalents includes cash in hand, deposits held with banks and other short-term highly liquid investments with original maturities of three months or less.

Short- and long-term deposits and short-term marketable securities

The Group considers all highly-liquid investments with original maturity dates of greater than three months but less than one year to be either short-term deposits or short-term marketable securities. Deposits with a maturity date of greater than one year from the balance sheet date are classified as long-term.

Accounts receivable

Accounts receivable are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method, less provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables.

Accounts receivable are first assessed individually for impairment. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial reorganisation, and default or delinquency in payments (more than 90 days overdue) are considered indicators that the trade receivable may be impaired. The amount of the provision is the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the original effective interest rate.

Where there is no objective evidence of impairment for an individual receivable, it is included in a group of receivables with similar credit risk characteristics and these are collectively assessed for impairment.

In the case of impairment, the carrying amount of the asset(s) is reduced through the use of an allowance account, and the amount of the loss is recognised in the income statement within general and administrative costs. When a trade receivable is uncollectible, it is written off against the allowance account for trade receivables. Subsequent recoveries of amounts previously written off are credited against general and administrative costs in the income statement.

Inventories

Inventories are stated at the lower of cost and net realisable value. In general, cost is determined on a first-in, first-out basis and includes transport and handling costs. Where necessary, provision is made for obsolete, slow-moving and defective inventory.

Accounts payable

Accounts payable are recognised initially at fair value and subsequently measured at amortised cost using the effective interest method.

Income taxes

The current income tax charge is calculated on the basis of tax laws enacted or substantively enacted at the balance sheet date in the countries where the Group’s subsidiaries operate and generate taxable income. Management periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation and establishes provisions where appropriate on the basis of amounts expected to be paid to the tax authorities.

Deferred income taxes are computed using the liability method. Under this method, deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using enacted rates and laws that will be in effect when the differences are expected to reverse. The deferred tax is not accounted for if it arises from initial recognition of an asset or liability in a transaction, other than a business combination, that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax assets are recognised to the extent that it is probable that future taxable profits will arise against which the temporary differences will be utilised.

Deferred tax is provided on temporary differences arising on investments in subsidiaries except where the timing of the reversal of the temporary difference is controlled by the Group and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax assets and liabilities arising in the same tax jurisdiction are offset.

In the UK and the US, the Group is entitled to a tax deduction for amounts treated as compensation on exercise of certain employee share options under each jurisdiction’s tax rules. As explained under “Share-based payments” below, a compensation expense is recorded in the Group’s income statement over the period from the grant date to the vesting date of the relevant options and awards. As there is a temporary difference between the accounting and tax bases, a deferred tax asset is recorded. The deferred tax asset arising is calculated by comparing the estimated amount of tax deduction to be obtained in the future (based on the Company’s share price at the balance sheet date) with the cumulative amount of the compensation expense recorded in the income statement. If the amount of estimated future tax  deduction exceeds the cumulative amount of the compensation expense at the statutory rate, the excess is recorded directly in equity, against retained earnings.

As explained under “Share-based payments” below, no compensation charge is recorded in respect of options granted before 7 November 2002 or in respect of those options which have been exercised or have lapsed before 1 January 2005. Nevertheless, tax deductions have arisen and will continue to arise on these options. The tax effects arising in relation to these options are recorded directly in equity, against retained earnings.

Provisions

Provisions for restructuring costs and legal claims are recognised when: the Group has a present legal or constructive obligation as a result of past events; it is more likely than not that an outflow of resources will be required to settle the obligation; and the amount of the outflow can be reliably estimated.

Embedded derivatives

In accordance with IAS 39, “Financial instruments: recognition and measurement”, the Group has reviewed all its contracts for embedded derivatives that are required to be separately accounted for if they do not meet certain requirements set out in the standard. From time to time, the Group may enter into contracts denominated in a currency (typically US dollars) that is neither the functional currency of the Group entity nor the functional currency of the customer or the collaborative partner. Where there are uninvoiced amounts on such contracts, the Group carries such derivatives at fair value. The resulting gain or loss is recognised in the income statement under general and administrative expenses, as shown below:

 

2010
£000

2009
£000

Loss in income statement

(177)

(9,818)

Share-based payments

The Group issues equity-settled share-based payments to certain employees. In accordance with IFRS 2, “Share-based payments”, equity-settled share-based payments are measured at fair value at the date of grant. Fair value is measured by use of the Black-Scholes pricing model. The fair value determined at the grant date of the equity-settled share-based payments is expensed on a straight-line basis over the vesting period, based on the Group’s estimate of the number of shares that will eventually vest.

The Group operates Save As You Earn (SAYE) schemes in the UK and an Employee Share Purchase Plan (ESPP) in the US. Options under the SAYE schemes are granted at a 20% discount to market price of the underlying shares on the date of announcement of the scheme and at a 15% discount to the lower of the market prices at the beginning and end of the scheme for the ESPP. The UK SAYE schemes are approved by the UK tax authorities, which stipulates that the saving period must be at least 36 months. The Group has recognised a compensation charge in respect of the SAYE plans and US ESPPs. The charges for these are calculated as detailed above.

The Group also has a Long Term Incentive Plan (LTIP) on which it is also required to recognise a compensation charge under IFRS 2, calculated as detailed above.

The share-based payments charge is allocated to cost of sales, research and development expenses, sales and marketing expenses and general and administrative expenses on the basis of headcount.

Employer’s taxes on share options

Employer’s National Insurance in the UK and equivalent taxes in other jurisdictions are payable on the exercise of certain share options and vesting of share awards. In accordance with IFRS 2, this is treated as a cash-settled transaction. A provision is made, calculated using the intrinsic value of the relevant options and awards at the balance sheet date, pro-rated over the vesting period of the options.

Treasury shares

Where the Company purchases its own equity share capital (treasury shares), the consideration paid, including any directly attributable incremental costs is deducted from equity attributable to the Company’s equity holders until the shares are cancelled or reissued. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to equity holders of the Company.

Equity instruments

Equity instruments issued by the Company are recorded at the proceeds received, net of direct issue costs.

1cFinancial risk management

The Group operates in the intensely competitive semiconductor industry which has been characterised by price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened foreign and domestic competition. Significant technological changes in the industry could affect operating results.

The Group’s operations expose it to a variety of financial risks that include currency risk, interest rate risk, securities price risk, credit risk and liquidity risk.

Given the size of the Group, the directors have not delegated the responsibility for monitoring financial risk management to a sub-committee of the board. The policies set by the board of directors are implemented by the Group’s finance department. The Group has a treasury policy that sets out specific guidelines to manage currency risk, interest rate risk, credit risk and liquidity risk and also sets out circumstances where it would be appropriate to use financial instruments to manage these.

Currency risk

The Group’s earnings and liquidity are affected by fluctuations in foreign currency exchange rates, principally in respect of the US dollar, reflecting the fact that most of its revenues and cash receipts are denominated in US dollars, while a significant proportion of its costs are settled in sterling. The Group seeks to use currency exchange contracts and currency options to manage the US dollar/sterling risk as appropriate, by monitoring the timing and value of anticipated US dollar receipts (which tend to arise from low-volume, high-value licence deals and royalty receipts) in comparison with its requirement to settle certain expenses in US dollars. The Group reviews the resulting exposure on a regular basis and hedges this exposure using currency exchange contracts and currency options for the sale of US dollars as appropriate. Such contracts are entered into with the objective of matching their maturity with projected US dollar cash receipts.

The Group is also exposed to currency risk in respect of the foreign currency denominated assets and liabilities of its overseas subsidiaries. At present, the Group does not mitigate this risk, for example by using foreign currency intra-group loans, as it currently has no requirement for external borrowings.

At 31 December 2010, the Group had outstanding currency exchange contracts to sell $65 million (2009: $45 million) for sterling. In addition, the Group utilises option instruments which have various provisions that, depending on the spot rate at maturity, give either the Group or the counterparty the option to exercise. At 31 December 2010, the Group had outstanding currency options under which the Group may, under certain circumstances, be required to sell up to $208 million (2009: $106 million) for sterling. A common scenario with options of this type is that the spot price at expiry is such that neither the Group nor the counterparty chooses to exercise the option. The Group had $153 million (2009: $87 million) of accounts receivable denominated in US dollars at that date, and US dollar cash, cash equivalents, short-term deposits and marketable securities balances of $16 million (2009: $26 million). Thus the Group’s currency exchange contracts and currency options at the year-end potentially exceeded its US dollar current assets. This is because the Group has taken longer term positions through its currency exchange contracts given the predictable nature of the Group’s cash flows.

The Group has elected not to apply hedge accounting, and all movements in the fair value of derivative foreign exchange instruments are recorded in the income statement, offsetting the foreign exchange movements on the accounts receivable, cash, cash equivalents, short-term deposits and short-term marketable securities balances being hedged.

In addition, certain customers remit royalties and licence fees in other currencies, primarily the euro. The Group is also required to settle certain expenses in euros, primarily in its French and German subsidiaries, and as the net amounts involved are not considered significant, the Group does not take out euro currency exchange contracts.

As at 31 December 2010, if sterling had strengthened by 10% against foreign currencies with all other variables held constant, post-tax profit for the year would have been £4.9 million lower (2009: £2.7 million), mainly as a result of the mix of financial instruments at respective year-ends.

Interest rate risk

At 31 December 2010, the Group had £305.1 million (2009: £148.8 million) of interest-bearing assets. At 31 December 2010, 89% (2009: 75%) of interest-bearing assets (comprising cash and cash equivalents, short- and long-term deposits and marketable securities, loans and receivables and the Group’s convertible loan notes) are at fixed rates and are therefore exposed to fair value interest rate risk. Floating rate cash earns interest based on relevant national LIBID or base rate equivalents and is therefore exposed to cash flow interest rate risk. The proportion of funds held in fixed rather than floating rate deposits is determined in accordance with the policy outlined under “Liquidity risk” below. Other financial assets, such as available-for-sale investments, are not directly exposed to interest rate risk.

Had interest rates been 1% lower throughout the year, interest receivable would have reduced by approximately £1.9 million (2009: £0.9 million) and profit after tax by £1.4 million (2009: £0.6 million).

The Group had no borrowings during 2010 or 2009.

The Group had no derivative financial instruments to manage interest rate fluctuations in place at the year-end since it has no loan financing, and as such no hedge accounting is applied. The Group’s cash flow is carefully monitored on a daily basis. Excess cash, considering expected future cash flows, is placed on either short-term or long-term deposits to maximise the interest income thereon. Daily surpluses are swept into higher-interest earning accounts overnight.

Securities price risk

The Group is exposed to equity securities price risk on available-for-sale investments. As there can be no guarantee that there will be a future market for securities (which are generally unlisted at the time of investment) or that the value of such investments will rise, the directors evaluate each investment opportunity on its merits before committing ARM’s funds. The board of directors reviews holdings in such companies on a regular basis to determine whether continued investment is in the best interests of the Group. Funds for such ventures are limited in order that the financial effect of any potential decline of the value of investments will not be substantial in the context of the Group’s financial results.

(i) Listed investments At 31 December 2010 and 2009, the Group had no listed investments.

(ii) Unlisted investments The Group had unlisted investments (including convertible loan notes) with a carrying value as at 31 December 2010 of £20.3 million (2009: £9.4 million). A permanent 10% fall in the underlying value of these companies as at 31 December 2010 would therefore have reduced the Group’s post-tax profit by £1.5 million (2009: £0.7 million) and resulted in a £nil (2009: £nil) reduction in other components of equity.

Credit risk

Credit risk is managed on a Group basis. Credit risk arises from cash and cash equivalents, derivative financial instruments and deposits with banks and financial institutions, as well as credit exposures to customers, including outstanding receivables and committed transactions.

As at 31 December 2010 and 2009, the Group has no significant concentrations of credit risk. The amount of exposure to any individual counterparty is subject to a limit, which is reassessed periodically by the board of directors.

Financial instrument counterparties are subject to pre-approval by the board of directors and such approval is limited to financial institutions with at least an AA rating, or (in the case of UK building societies) had over £1 billion in assets, except in certain jurisdictions where the cash holding concerned is immaterial. At 31 December 2010 and 2009, the majority of the Group’s cash, cash equivalents, short- and long-term deposits and marketable securities were deposited with major clearing banks and building societies in the UK and US in the form of money market deposits and corporate bonds for varying periods up to two years.

Over 95% of the Group’s cash and cash equivalents, short- and long-term deposits and marketable securities were held with global financial institutions with at least an AA rating, or (in the case of UK building societies) had over £1 billion in assets, as at 31 December 2010 and 2009.

The Group has implemented policies that require appropriate credit checks on potential customers before sales commence. The Group generally does not require collateral on accounts receivable, as many of its customers are large, well-established companies. The Group has not experienced any significant losses related to individual customers or groups of customers in any particular industry or geographic area.

The Group markets and sells to a relatively small number of customers with individually large value transactions. At 31 December 2010, three (2009: one) customers each accounted for over 10% of accounts receivable. Monies from two of these customers have been received in full since the year-end. The remaining customer (for which outstanding balances are not yet due) is one of the many large, established semiconductor companies that accounted in total for over 90% of the year-end accounts receivable balance, where the risk of default on monies owed is deemed negligible. The Group performs credit checks on all customers (other than those paying in advance) in order to assess their creditworthiness and ability to pay its invoices as they become due. As such, the balance of accounts receivable not owed by  the large semiconductor companies is still deemed by management to be of low risk of default due to the nature of the checks performed on them, and accordingly a relatively small allowance against these receivables is in place to cover this low risk of default.

No credit limits were exceeded during the reporting period and management does not expect any significant losses from non-performance by these counterparties.

Liquidity risk

The Group’s policy is to maintain balances of cash, cash equivalents, short- and long-term deposits and marketable securities, such that highly liquid resources exceed the Group’s projected cash outflows at all times. Surplus funds are placed on fixed- or floating-rate deposits depending on the prevailing economic climate at the time (with reference to forward interest rates) and also on the required maturity of the deposit (as driven by the expected timing of the Group’s cash receipts and payments over the short- to medium-term).

Management monitors rolling forecasts of the Group’s liquidity reserve on the basis of expected cash flow. This is carried out at both a local and a Group level, with the local subsidiaries being funded by the Group as required.

The table below analyses the Group’s financial liabilities, which will be settled on a net basis, into relevant maturity groupings based on the remaining period from the balance sheet to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows. Balances due within 12 months equal their carrying balances as the impact of discounting is not significant.

Less than
six months
£000

Between
six months
and one year
£000

At 31 December 2010:

 

 

Accounts payable

4,305

Accrued and other liabilities

41,789

At 31 December 2009:

Accounts payable

2,280

Accrued and other liabilities

29,577

The table on the next page analyses the Group’s derivative financial instruments which will be settled on a gross basis into relevant maturity groupings based on the remaining period at the balance sheet to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows. Balances due within 12 months equal their carrying balances as the impact of discounting is not significant.

Less than
three months
000s

Over three
months but
less than
six months
000s

Between
six months
and one year
000s

Forward foreign exchange contracts – held-for-trading at 31 December 2010

 

 

 

Outflow

$65,000

Inflow

£41,230

Foreign exchange options – held-for-trading at 31 December 2010

 

 

 

Outflow (maximum)

$60,000

$63,000

$85,500

Inflow (maximum)

£40,238

£42,034

£56,155

Forward foreign exchange contracts – held-for-trading at 31 December 2009

Outflow

$42,000

$3,000

Inflow

£25,911

£1,892

Foreign exchange options – held-for-trading at 31 December 2009

Outflow (maximum)

$36,000

$32,500

$37,500

Inflow (maximum)

£23,463

£21,014

£24,599

Capital risk management

The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. The capital structure of the Group consists of cash, cash equivalents, short- and long-term deposits and marketable securities and capital and reserves attributable to equity holders of the Company, as disclosed in note 19 and the consolidated statement of changes in shareholders’ equity.

In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares, sell assets to raise cash or take on debt.

Since 2004, the Group’s strategy has been to increase its balance sheet efficiency by reducing its cash balance via returning cash to shareholders through a progressive dividend policy and a share buyback programme. Whilst the Group intends to further increase balance sheet efficiency over time, since 2008, recognising the uncertain macroeconomic environment, the net cash balance was increased from £51.3 million at the start of 2008 to £78.8 million at 31 December 2008, £141.8 million at 31 December 2009 and to £291.8 million at 31 December 2010. In the year, the interim dividend was increased by 20% reflecting the board’s long-term confidence in the business. No share buybacks were made in the year, though the programme remains in place and will be used as and when the board believe it is appropriate to do so. The capital structure is continually monitored by the Group.

Fair value of currency exchange contracts

The fair value of currency exchange contracts is estimated using the settlement rates. The estimation of the fair value of the liability in respect of currency exchange contracts is £201,000 at 31 December 2010 (2009: asset of £457,000). The resulting gains and losses on the movement of the fair value of currency exchange contracts is recognised in the income statement under general and administrative expenses, as shown below:

 

2010
£000

2009
£000

(Loss)/gain in income statement

(658)

18,914

Valuation hierarchy

The table below shows the financial instruments carried at fair value by valuation method:

2010

Level 1*

£000

Level 2*

£000

Level 3*

£000

Total
£000

Assets

Fair value through the income statement:

 

 

 

 

Embedded derivatives

2,303

2,303

 

2,303

2,303

Available-for-sale:

 

 

 

 

Other long-term investments

20,329

20,329

 

20,329

20,329

Total assets

2,303

20,329

22,632

*Level 1 valued using unadjusted quoted prices in active markets for identical instruments. Level 2 valued using techniques based significantly on    observable market data. Level 3 valued using information other than observable market data.

As at 31 December 2010 there was a liability for currency exchange contracts of £201,000 (2009: £nil), which is considered to be a level 2 valuation.

2009

Level 1*

£000

Level 2*

£000

Level 3*

£000

Total
£000

Assets

Fair value through the income statement:

Embedded derivatives

2,480

2,480

Currency exchange contracts

457

457

 

2,937

2,937

Available-for-sale:

Short-term marketable securities

1,795

1,795

Other long-term investments

9,432

9,432

 

1,795

9,432

11,227

Total assets

1,795

2,937

9,432

14,164

Level 3 financial assets

 

Other
long-term
investments
£000

Balance, at 1 January 2010

9,432

Additions

 

11,019

Disposals

 

(122)

Balance, at 31 December 2010

20,329

 

 

Other
long-term
investments
£000

Balance, at 1 January 2009

1,167

Additions

9,116

Disposals

(439)

Impairments

(412)

Balance, at 31 December 2009

9,432

1d Critical accounting estimates and judgements

The preparation of financial statements in accordance with generally accepted accounting principles requires the directors to make critical accounting estimates and judgements that affect the amounts reported in the financial statements and accompanying notes. These estimates and judgements are continually evaluated and are based on historical experiences and other factors, including expectations of future events that are believed to be reasonable under the circumstances. The resulting accounting estimates will, by definition, seldom equal the related actual results. The estimates and assumptions that have significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below.

Impairment of goodwill

The Group tests goodwill for impairment at least annually. This requires an estimation of the value in use of the cash-generating units (CGUs) to which goodwill is allocated. As discussed in detail in note 15, estimating the value in use requires the Group to make an estimate of the expected future cash flows from the CGUs and also to choose a suitable discount rate in order to calculate the present values of those cash flows. The Group uses a pre-tax discount rate of approximately 11% (2009: 12%).

Revenue recognition

Revenue from the sale of licence agreements which are designed to meet the specific requirements of each customer is recognised on a percentage-of-completion method basis. Use of this method requires the directors to estimate the total project resource requirement and also any losses on uncompleted contracts.

Provisions for income taxes

The Group is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the world-wide provision for income taxes. There are many transactions and calculations for which the ultimate tax determination is uncertain during the ordinary course of business. The Group recognises liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income tax and deferred tax provisions in the period in which such determination is made.

Provision for impairment of trade receivables

The Group assesses trade receivables for impairment which requires the directors to estimate the likelihood of payment forfeiture by customers.

Legal settlements and other contingencies

Determining the amount to be accrued for legal settlement requires the directors to estimate the committed future legal and settlement fees the Group is expecting to incur. Where suits are filed against the Group for infringement of patents, the directors assess the extent of any potential infringement based on legal advice and written opinions received from external counsel and then estimate the level of accrual required.

Contingent consideration for an acquisition is recognised as part of the purchase consideration if the contingent conditions are expected to be satisfied. This requires the directors to estimate the acquiree’s future financial performance, typically more than one year post-acquisition.