Major Transaction - Part 1b

Air China Ld 30 May 2006 Notes to Financial Statements 31 December 2005 1. GROUP REORGANISATION, PRINCIPAL ACTIVITIES AND BASIS OF PRESENTATION OF FINANCIAL STATEMENTS Air China Limited (the 'Company') was incorporated on 30 September 2004 in Beijing, the People's Republic of China (the 'PRC' or 'Mainland China'), as a joint stock limited company as part of the restructuring (the 'Restructuring') of CNAHC, a PRC state-owned enterprise under the supervision of the State Council, in preparation for the listing of the Company's H shares on The Stock Exchange of Hong Kong Limited (the 'Hong Kong Stock Exchange') and the London Stock Exchange as described below. As disclosed in the Company's prospectus dated 3 December 2004, pursuant to the Restructuring, CNAHC and through its wholly-owned subsidiaries, effected the transfer of the following to the Company upon its incorporation: (a) the assets, liabilities and undertakings which principally relate to airline operations (the 'Relevant Businesses'); and (b) the shareholding interests in certain subsidiaries, joint ventures and associates which principally engage in airline operations, the provision of aircraft engineering services, air catering services, airport ground handling services and other airline-related businesses (the 'Relevant Companies'). The principal activities of the Company, its subsidiaries and joint ventures (collectively the 'Group') and associates are airline and airline-related services, including aircraft engineering services, air catering services and airport ground handling services conducted mainly in Mainland China, Hong Kong and Macau. The registered office of the Company is located at 9th Floor, Blue Sky Mansion, 28 Tianzhu Road, Zone A, Tianzhu Airport Industrial Zone, Shunyi District, Beijing 101312, the PRC. In the opinion of the Directors, the Company's parent and ultimate holding company is CNAHC. As CNAHC controlled the Relevant Businesses and the Relevant Companies before the Restructuring and continues to control the Company after the Restructuring, the consolidated financial statements of the Group prior to the incorporation of the Company on 30 September 2004 had been prepared as a reorganisation of companies under common control in a manner similar to a pooling-of-interests. The consolidated results and consolidated cash flows for the year ended 31 December 2004 include the Group's results of operations and cash flows as if the Relevant Businesses and interests in the Relevant Companies had been transferred to the Group at 1 January 2001, which is the earliest date for the preparation of the financial information in relation to the listing of the Company's H shares. The Company's Directors are of the opinion that the consolidated income statement and consolidated cash flow statement prepared on this basis present fairly the consolidated results and consolidated cash flows of the Group as a whole. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of preparation The consolidated financial statements of the Group have been prepared in accordance with International Financial Reporting Standards ('IFRSs') which comprise standards and interpretations approved by the International Accounting Standards Board, and International Accounting Standards ('IAS') and Standing Interpretations Committee interpretations approved by the International Accounting Standards Committee that remain in effect. The consolidated financial statements are presented in Renminbi ('RMB') and all values are rounded to the nearest thousand (RMB'000) except when otherwise indicated. The consolidated financial statements of the Group have been prepared on a historical cost basis, except for the measurement at fair value of financial instruments in accordance with IAS 39 (amended 2004) Financial Instruments: Recognition and Measurement. The principal accounting policies used in the preparation of the consolidated financial statements of the Group are consistent with those used in the annual audited financial statements of the Group for the year ended 31 December 2004, except that the Group has adopted the following new/revised standards mandatory for financial years beginning on or after 1 January 2005. (a) IFRS 2 Share-based Payment requires the Group to recognise share-based payment transactions in its financial statements, including transactions with employees or other parties to be settled in cash, other assets, or equity instruments of the Group. For equity-settled share-based payment transactions, IFRS 2 requires an entity to measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the Group cannot estimate reliably the fair value of the goods or services received, the Group is required to measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted. For cash-settled share-based payment transactions, IFRS 2 requires an entity to measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the Group is required to re-measure the fair value of the liability at each reporting date and at the date of settlement, with any changes in value recognised in the income statement for the period. For share-based payment transactions in which the terms of the arrangement provide either the Group or the supplier of goods or services with a choice of whether the Group settles the transaction in cash or by issuing equity instruments, the Group is required to account for that transaction, or the components of that transaction, as a cash-settled share-based payment transaction if, and to the extent that, the Group has incurred a liability to settle in cash (or other assets), or as an equity settled share-based payment transaction if, and to the extent that, no such liability has been incurred. The provisions of IFRS 2 apply to grants of shares, share options or other equity instruments that were granted after 7 November 2002 and had not yet vested on or after 1 January 2005. The adoption of IFRS 2 did not give rise to any adjustment to the opening balances of retained earnings of the current and prior years or to any change in comparatives. (b) IAS 16 (amended 2004) Property, Plant and Equipment replaces IAS 16 (revised 1998), Property, Plant and Equipment. There are a number of differences between the amended standard and the previous version. Firstly, the amended standard requires an entity to evaluate under the general recognition principle all property, plant and equipment costs at the time they are incurred. Those costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service an item. The previous version of IAS 16 contained specific recognition principles for the accounting of subsequent costs. Secondly, the amended standard requires that the cost of an item of property, plant and equipment includes the costs of its dismantlement, removal or restoration, and the obligation for which an entity incurs as a consequence of installing the item. Its cost also includes the costs of its dismantlement, removal or restoration, and the obligation for which an entity incurs as a consequence of using the item during a particular period for purposes other than to produce inventories during that period. The previous version of the standard included within its scope only the costs incurred as a consequence of installing the item. Thirdly, under the amended standard an entity is required to determine the depreciation charge separately for each significant part of an item of property, plant and equipment, a requirement which was not clearly set out in the previous version. In addition, under the amended standard, an entity is required to measure the residual value of an item of property, plant and equipment as the amount that it estimates it would currently receive for the asset if the asset was already of the age and in the condition expected at the end of its useful life. The previous version of IAS 16 did not specify whether the residual value was to be this amount or the amount, inclusive of the effects of inflation, that an entity expected to receive at the asset's actual retirement date. Furthermore, the amended standard requires major inspection and overhaul costs to be recognised in the carrying amount of an item of property, plant and equipment when such services are performed. The adoption of the revised treatment of IAS 16 (amended 2004) has been accounted for prospectively, which resulted in the following: (i) In prior years, the aircraft were depreciated over their estimated useful lives of 20 years. With effect from 1 January 2005, the estimated useful lives of certain components within the aircraft which are subject to replacement during major overhauls have been reduced to the life of the overhaul cycle. The change in accounting estimate has increased the Group's depreciation charge for the year ended 31 December 2005 by approximately RMB899 million. As a result, the profit after tax of the Group for the year ended 31 December 2005 has decreased by approximately RMB604 million. (ii) Major overhaul costs incurred for the year ended 31 December 2005 of approximately RMB1,639 million have been capitalised and depreciated over the life of the overhaul cycle. Prior to 1 January 2005, such costs have been charged to the income statement on an incurred basis. In this respect, the costs of aircraft maintenance, repair and overhaul of the Group charged to the income statement for the year ended 31 December 2005 decreased by RMB1,639 million. In addition, the Group has derecognised and charged to the income statement for the year ended 31 December 2005 the carrying amount of certain components of approximately RMB430 million which have been replaced during the major overhaul. As a result, the profit after tax of the Group for the year ended 31 December 2005 has increased by approximately RMB824 million. (c) IAS 24 (revised 2003) Related Party Disclosures replaces IAS 24 Related Party Disclosures (reformatted in 1994). The main objective of such revision was to provide additional guidance and clarity in the scope of IAS 24 for the definition and the disclosures for related parties. The wording of IAS 24's objective was amended to clarify that the Group's financial statements should contain the disclosures necessary to draw attention to the possibility that the financial position and the income statement may have been affected by the existence of related parties and by transactions and outstanding balances with them. Since IAS 24 is a standard for disclosure requirements only, there is no material effect on the Group's results of operations and financial position upon adoption. IFRSs and International Financial Reporting Interpretation Committee Interpretations ('IFRIC Interpretations') not yet effective The Group has not applied the following new and revised IFRSs and IFRIC interpretations that have been issued but are not yet effective in these financial statements: IAS 1 Amendment Capital Disclosures IAS 19 Amendment Actuarial Gains and Losses, Group Plans and Disclosures IAS 39 Amendment Cash Flow Hedge Accounting of Forecast Intragroup Transactions IAS 39 Amendment The Fair Value Option IAS 39 and IFRS 4 Financial Guarantee Contracts Amendments IFRS 1 and IFRS 6 First-time Adoption of International Amendments Financial Reporting Standards and Exploration for and Evaluation of Mineral Resources IFRS 6 Exploration for and Evaluation of Mineral Resources IFRS 7 Financial Instruments: Disclosures IFRIC - Int 4 Determining whether an Arrangement contains a Lease IFRIC - Int 5 Rights to Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds IFRIC - Int 6 Liabilities arising from Participating in a Specific Market - Waste Electrical and Electronic Equipment The above standards and interpretations are required to be applied for annual periods beginning on or after 1 January 2006. The IAS 1 Amendment shall be applied for annual periods beginning on or after 1 January 2007. The revised standard will affect the disclosures about qualitative information about the Group's objective, policies and procedures for managing capital; quantitative data about what the Company regards as capital and compliance with any capital requirements and the consequences of any non-compliance. IFRS 7 will replace IAS 32 and has modified the disclosure requirements of IAS 32 relating to financial instruments. The IFRS shall be applied for annual periods beginning on or after 1 January 2007. In accordance with the amendments to IAS 39 and IFRS 4 regarding financial guarantee contracts, financial guarantee contracts are initially recognised at fair value and are subsequently measured at the higher of (i) the amount determined in accordance with IAS 37 and (ii) the amount initially recognised less cumulative amortisation, when appropriate, recognised in accordance with IAS 18. The IAS 19 Amendment, IAS 39 Amendments regarding cash flow hedge accounting of forecast intragroup transactions and the fair value option, IFRSs 1 and 6 Amendments, IFRS 6, IFRIC-Int 4, IFRIC-Int 5 and IFRIC-Int 6 do not apply to the activities of the Group. IFRIC-Int 6 shall be applied for annual periods beginning on or after 1 December 2005. Except as stated above, the Group expects that the adoption of the other pronouncements listed above will not have any significant impact on the Group's financial statements in the period of initial application. Basis of consolidation The consolidated financial statements comprise the financial statements of the Company and its subsidiaries. The financial statements of the subsidiaries are prepared for the same reporting year as the parent company, using consistent accounting policies. Adjustments are made to bring into line any dissimilar accounting policies that may exist. Subsidiaries are fully consolidated from the date on which control is transferred to the Group and cease to be consolidated from the date on which control is transferred out of the Group. This control is normally evidenced when the Group owns, either directly or indirectly, more than 50% of the voting rights of a company's share or registered capital, is able to govern the financial and operating policies of an enterprise so as to benefit from its activities. All significant inter-company transactions and balances within the Group are eliminated on consolidation. Minority interests represent the interests of outside shareholders in the results and net assets of the Company's subsidiaries not held by the Group, and are presented in the consolidated balance sheet within equity, separately from the shareholders' equity. Foreign currency translation The consolidated financial statements are presented in RMB, which is the Company's functional and presentation currency. Each entity in the Group determines its own functional currency and items included in the financial statements of each entity are measured using that functional currency. Transactions in foreign currencies are initially recorded in the functional currency rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are retranslated at the functional currency rate of exchange ruling at the balance sheet date. All differences are taken to the income statement. Non-monetary items that are measured in terms of historical cost in a foreign currency are translated using the exchange rates as at the dates of the initial transactions. Non-monetary items measured at fair value in a foreign currency are translated using the exchange rates at the date when the fair value was determined. As at the reporting date, the assets and liabilities of the foreign entities are translated into the presentation currency of the Group which is RMB at the rate of exchange ruling at the balance sheet date and, their income statements are translated at the weighted average exchange rates for the year. The exchange differences arising on the translation are taken directly to a separate component of equity. On the disposal of a foreign entity, the deferred cumulative amount recognised in equity relating to that particular foreign entity is recognised in the income statement. Subsidiaries A subsidiary is a company whose financial and operating policies the Company controls, directly or indirectly, so as to obtain benefits from its activities. A subsidiary is consolidated from the date the Company obtains control until such time as control ceases. The results of subsidiaries are included in the Company's income statement to the extent of dividends received and receivable. In the Company's balance sheet, the Company's interests in subsidiaries are stated at cost less any impairment losses. Interests in joint ventures The Group has interests in certain joint ventures which are jointly-controlled entities. A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control, and a jointly-controlled entity is a joint venture that involves the establishment of a separate entity in which each venturer has an interest. The Group recognises its interests in the joint ventures using proportionate consolidation. The Group combines its share of each of the assets, liabilities, income and expenses of the joint ventures with the similar items, line by line, in its consolidated financial statements. The financial statements of the joint ventures are prepared for the same reporting year as the parent, using consistent accounting policies. Adjustments are made to bring into line any dissimilar accounting policies that may exist. When the Group contributes or sells assets to the joint ventures, any portion of gain or loss from the transaction is recognised based on the substance of the transaction. When the Group purchases assets from the joint ventures, the Group does not recognise its share of the profits of the joint ventures from the transaction until it resells the assets to an independent party. The joint ventures are proportionately consolidated until the date on which the Group ceases to have joint control over the joint ventures. Interests in associates The Group's interests in its associates is accounted for under the equity method of accounting. An associate is an entity in which the Group has significant influence and which is neither a subsidiary nor a joint venture of the Group. Under the equity method, the interests in associates are carried in the consolidated balance sheet at cost plus post-acquisition changes in the Group's share of net assets of the associates. Goodwill relating to the associates is included in the carrying amount of the investment and is not amortised. After application of the equity method, the Group determines whether it is necessary to recognise any additional impairment loss with respect to the Group's net investment in the associates. The consolidated income statement reflects the share of the results of operations of the associates. Where there has been a change recognised directly in the equity of the associates, the Group recognises its share of any changes and disclose this, when applicable, in the consolidated statement of changes in equity. The reporting dates of the associates and the Group are identical and the associates' accounting policies conform to those used by the Group for like transactions and events in similar circumstances. Adjustments are made to bring into line any dissimilar accounting policies that may exist. In the Company's balance sheet, the investments in associates are stated at cost less any impairment losses. The results of associates are accounted for by the Company on the basis of dividends received and receivable. Property, plant and equipment Property, plant and equipment, other than construction in progress ('CIP'), are stated at cost, excluding the costs of day-to-day servicing, less accumulated depreciation and accumulated impairment in value. Such costs include the costs of replacing part of such property, plant and equipment when the costs are incurred if the recognition criteria are met. CIP represents office buildings and various infrastructure projects under construction and equipment pending installation in the aircraft and is stated at cost less any impairment losses, and is not depreciated. Costs comprise the direct costs of construction, the cost of equipment as well as finance charges from borrowings used to finance these assets during the construction or installation period. CIP is reclassified to the appropriate categories of property, plant and equipment when completed and ready for use. Depreciation is calculated on a straight-line basis over the useful life of the asset, after taking into account its estimated residual value, as follows: Depreciation life Residual value Aircraft and flight equipment 4 to 20 years Nil-5% Buildings 15 to 35 years 5% Machinery, transportation 4 to 20 years 5% equipment and office equipment An item of property, plant and equipment is derecognised upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the new disposal proceeds and the carrying amount of the asset) is included in the income statement in the year the asset is derecognised. The carrying values of property, plant and equipment are reviewed for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable. The asset's residual value, useful life and methods are reviewed, and adjusted if appropriate, at each year end. When each major inspection is performed, its cost is recognised in the carrying amount of the property, plant and equipment as a replacement if the recognition criteria are satisfied. Lease prepayments Lease prepayments represent acquisition costs of land use rights less accumulated amortisation and impairment losses. Leases The determination of whether an arrangement is, or contains, a lease is based on the substance of the arrangement and requires an assessment of whether the fulfillment of the arrangement is dependent on the use of a specific asset or assets and the arrangement conveys a right to use the asset. Finance leases, which transfer to the Group substantially all the risks and benefits incidental to ownership of the leased item, are capitalised at the inception of the lease at the fair value of the leased asset or, if lower, at the present value of the minimum lease payments. Lease payments are apportioned between the finance charges and reduction of the lease liability so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income. Capitalised leased assets are depreciated over the shorter of the estimated useful life of the asset and the lease term, if there is no reasonable certainty that the Group will obtain ownership by the end of the lease term. Leases where the lessor retains substantially all the risks and benefits of ownership of the asset are classified as operating leases. Where the Group is the lessor, assets leased by the Group under operating leases are included in non-current assets and rentals receivables under the operating leases are credited to the income statement on the straight-line basis over the lease terms. Where the Group is the lessee, rentals payable under the operating leases are charged to the income statement on the straight-line basis over the lease terms. Goodwill Goodwill acquired in a business combination is initially measured at cost being the excess of the cost of the business combination over the Group's interest in the net fair value of the identifiable assets, liabilities and contingent liabilities. Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is reviewed for impairment, annually or more frequently if events or changes in circumstances indicate that the carrying value may be impaired. For the purpose of impairment testing, goodwill acquired in a business combination is, from the acquisition date, allocated to each of the Group's cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the Group are assigned to those units or groups of units. Each unit or group of units to which the goodwill is so allocated: â€¢ represents the lowest level within the Group at which the goodwill is monitored for internal management purposes; and â€¢ is not larger than a segment based on either the Group's primary or the Group's secondary reporting format determined in accordance with IAS 14 Segment Reporting. Impairment is determined by assessing the recoverable amount of the cash-generating unit (group of cash-generating units), to which the goodwill relates. Where the recoverable amount of the cash-generating unit (group of cash-generating units) is less than the carrying amount, an impairment loss is recognised. Where goodwill forms part of a cash-generating unit (group of cash-generating units) and part of the operation within that unit is disposed of, the goodwill associated with the operation disposed of is included in the carrying amount of the operation when determining the gain or loss on disposal of the operation. Goodwill disposed of in this circumstance is measured based on the relative values of the operation disposed of and the portion of the cash-generating unit retained. Advance payments for aircraft and related equipment Advance contract payments to aircraft manufacturers to secure deliveries of aircraft and related equipment in future years, including attributable finance costs, are included in assets. The advances are accounted for as part of the costs of property, plant and equipment upon delivery of the aircraft. Investments and other financial assets Financial assets in the scope of IAS 39 are classified as either financial assets at fair value through profit or loss, loans and receivables, held-to-maturity investments, and available-for-sale financial assets, as appropriate. When financial assets are recognised initially, they are measured at fair value, plus, in the case of investments not at fair value through profit or loss, directly attributable transactions costs. The Group determines the classification of its financial assets after initial recognition and, where allowed and appropriate, re-evaluates this designation at each financial year end. All regular way purchases and sales of financial assets are recognised on the trade date i.e. the date that the Group commits to purchase the asset. Regular way purchases or sales are purchases or sales of financial assets that require delivery of assets within the period generally established by regulation or convention in the marketplace. Financial assets at fair value through profit or loss Financial assets classified as held for trading are included in the category 'financial assets at fair value through profit or loss'. Financial assets are classified as held for trading if they are acquired for the purpose of selling in the near term. Derivatives are also classified as held for trading unless they are designated and effective hedging instruments. Gains or losses on investments held for trading are recognised in income. Held-to-maturity investments Non-derivative financial assets with fixed or determinable payments and fixed maturity are classified as held-to-maturity when the Group has the positive intention and ability to hold to maturity. Investments intended to be held for an undefined period are not included in this classification. Other long-term investments that are intended to be held-to-maturity, such as bonds, are subsequently measured at amortised cost. This cost is computed as the amount initially recognised minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initially recognised amount and the maturity amount. This calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums and discounts. For investments carried at amortised cost, gains and losses are recognised in income when the investments are derecognised or impaired, as well as through the amortisation process. Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are carried at amortised cost using the effective interest method. Gains and losses are recognised in income when the loans and receivables are derecognised or impaired, as well as through the amortisation process. Available-for-sale financial assets Available-for-sale financial assets are those non-derivative financial assets that are designated as available for sale or are not classified as financial assets at fair value through profit or loss, held-to-maturity investments and loans and receivables. After initial recognition, available-for-sale financial assets are measured at fair value with gains or losses being recognised as a separate component of equity until the investment is derecognised or until the investment is determined to be impaired at which time the cumulative gain or loss previously reported in equity is included in the income statement. The fair value of investments that are actively traded in organised financial markets is determined by reference to quoted market bid prices at the close of business on the balance sheet date. For investments where there is no active market, fair value is determined using valuation techniques. Such techniques include using recent arm's length market transactions, reference to the current market value of another instrument, which is substantially the same, discounted cash flow analysis and option pricing models. Inventories Inventories, which consist primarily of expendable spare parts and supplies, are stated at cost less any provision for obsolescence, and are expensed when consumed in operations. Cost is determined on the weighted average basis. Work in progress represents material costs, labour costs and overhead costs capitalised for the provision of aircraft engineering services and is stated at the lower of cost, calculated on a weighted average basis, and net realisable value. Net realisable value is determined on the basis of anticipated sales proceeds less estimated costs to be incurred to completion and disposal. Cash and cash equivalents Cash and cash equivalents in the balance sheets comprise cash at banks and on hand and short-term deposits with an original maturity of three months or less, which are not restricted as to use. For the purpose of the consolidated cash flow statement, cash and cash equivalents consist of cash and cash equivalents as defined above. Manufacturers' credits In connection with the acquisition of certain aircraft and related equipment, the Group receives various credits from the manufacturers. Such credits are deferred until the aircraft and related equipment are delivered, at which time they are applied as a reduction of the cost of acquiring the aircraft and related equipment. Provisions Provisions are recognised when the Group has a present obligation (legal or constructive) as a result of a past event and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. The expense relating to any provision is presented in the income statement. If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage of time is recognised as a borrowing cost. Employee benefits (a) Pension obligations The full-time employees of the Group are covered by various government-sponsored pension plans under which the employees are entitled to a monthly pension based on certain formulae. Certain government agencies are responsible for the pension liability to these retired employees. The Group contributes on a monthly basis to these pension plans. Under these plans, the Group has no legal or constructive obligation for retirement benefits beyond the contributions made. Contributions to these plans are expensed as incurred. (b) Termination and early retirement benefits Termination benefits are payable whenever an employee's employment is voluntary terminated before the normal retirement date or whenever an employee accepts voluntary redundancy in exchange for these benefits. The Group recognises termination benefits when it is demonstrably committed to either terminating the employment of current employees according to a detailed formal plan without possibility of withdrawal or to providing termination benefits as a result of an offer made to encourage voluntary redundancy. (c) Housing benefits In prior years, the Group sold staff quarters to its employees, subject to a number of eligibility requirements, at below market prices. When staff quarters are identified as being subject to sale under these arrangements, the carrying value of the staff quarters is written down to the net recoverable amount. Upon sale, any difference between sales proceeds and the carrying amount of the staff quarters is charged to the income statement. The above staff quarters' allocation scheme was phased out before the incorporation of the Company in accordance with the policies of the PRC government. In 1998, the State Council of the PRC issued a circular, which stipulated that the sale of quarters to employees at preferential prices should be withdrawn. In 2000, the State Council further issued a circular stating that cash subsidies should be made to the employees following the withdrawal of allocation of staff quarters. However, the specific timetable and procedures to implement these policies are to be determined by the individual provincial or municipal government based on the particular situation of the province or municipality. Based on the relevant detailed local government regulations promulgated, certain entities within the Group have adopted cash housing subsidy plans, whereby, for those eligible employees who have not been allocated with any quarters or who have not been allocated with quarters up to the prescribed standards before the staff quarters' allocation scheme was terminated, the Group will pay them one-off cash housing subsidies based on their years of service, position and other criteria. These cash housing subsidies are charged to the income statement in the year in which it was determined that the payment of such subsidies is probable and the amounts can be reasonably estimated. In addition, all full-time employees of the Group are entitled to participate in various government-sponsored housing funds. The Group contributes on a monthly basis to these funds based on certain percentages of the salaries of the employees. The Group's liability in respect of these funds is limited to the contributions payable in each year. Maintenance and overhaul costs In respect of aircraft and engines under operating leases, the Group has the responsibility to fulfil certain return conditions under the relevant operating leases. In order to fulfil these return conditions, major overhauls are required to be conducted on a regular basis. Accordingly, estimated costs of major overhauls for aircraft and engines under operating leases are accrued and charged to the income statement over the estimated period between overhauls using the ratios of actual flying hours/cycles and estimated flying hours/cycles between overhauls. The costs of major overhauls comprise mainly labour and materials. Differences between the estimated costs and the actual costs of overhauls are included in the income statement in the period of overhaul. In respect of aircraft and engines owned by the Group or held under finance leases, costs of major overhauls are recognised in the carrying amount of the property, plant and equipment as a replacement if the recognition criteria are satisfied. All other routine repair and maintenance costs incurred in restoring such property, plant and equipment to their normal working condition are charged to the income statement as and when incurred. Frequent flyer programme For Air China Companion Club member accounts that have sufficient mileage credits to claim the lowest level of free travel, the Group records a liability for the estimated incremental costs associated with providing travel awards that are expected to be redeemed. Incremental costs include the costs of incremental fuel, meals and insurance but do not include any costs for aircraft ownership, maintenance, labour or overhead allocation. The liability is adjusted periodically based on awards earned, awards redeemed, changes in the incremental costs and changes in the Air China Companion Club programme, and is included in the balance sheet as a current liability. Revenue recognition Revenue is recognised to the extent that it is probable that the economic benefits will flow to the Group and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognised: (a) Provision of airline and airline-related services Passenger revenue is recognised either when transportation services are provided or when a ticket expires unused rather than when a ticket is sold. Unused tickets generally expire one year from the date the ticket was sold, or for partially used tickets, the date of first flight. Ticket sales for transportation not yet provided are included in current liabilities as air traffic liabilities. In addition, the Group has code-sharing agreements with other airlines under which a carrier's flights can be marketed under the two-letter airline designator code of another carrier. Revenue earned under these arrangements are allocated between the code share partners based on existing contractual agreements and airline industry standard pro-ratio formulae and are recognised as passenger revenue when the transportation services are provided. Cargo and mail revenue is recognised when transportation services are provided. Revenue from airline-related services is recognised when services are rendered. Revenue is stated net of business tax. (b) Sale of goods Revenue is recognised when the significant risks and rewards of ownership of the goods have been passed to the buyer. (c) Trading of investments Revenue is recognised on a trade date basis. (d) Interest income Revenue is recognised on a time proportion basis taking into account the principal outstanding and the effective rate of interest applicable. (e) Dividends Revenue is recognised when the Group's right to receive payments is established. (f) Rental income and aircraft and related equipment lease income Revenue is recognised on a time proportion basis over the terms of the respective leases. Government grants Government grants are recognised where there is reasonable assurance that the grant will be received and all attaching conditions will be complied with. When the grant relates to an expense item, it is recognised as income over the period necessary to match the grant on a systematic basis to the costs that it is intended to compensate. Where the grant relates to an asset, the fair value is credited to a deferred income account and is released to the income statement over the expected useful life of the relevant asset by equal annual instalments. Related parties Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Related parties may be individuals or corporate entities. Taxes Current tax Current tax assets and liabilities for the current and prior periods are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted by the balance sheet date. Deferred tax Deferred income tax is provided, using the liability method on temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred income tax liabilities are recognised for all taxable temporary differences, except: â€¢ where the deferred income tax liability arises from the initial recognition of goodwill or an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit or loss; and â€¢ in respect of taxable temporary differences associated with investments in subsidiaries, associates and interests in joint ventures, where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. Deferred income tax assets are recognised for all deductible temporary differences, carry-forward of unused tax assets and unused tax losses, to the extent that it is probable that taxable profit will be available against which the deductible temporary differences, and the carry-forward of unused tax credits and unused tax losses can be utilised, except: â€¢ where the deferred income tax asset relating to the deductible temporary difference arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit or loss; and â€¢ in respect of deductible temporary differences associated with investments in subsidiaries, associates and interests in joint ventures, deferred income tax assets are recognised only to the extent that it is probable that the temporary differences will reverse in the foreseeable future and taxable profit will be available against which the temporary differences can be utilised. The carrying amount of deferred income tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred income tax asset to be utilised. Unrecognised deferred income tax assets are reassessed at each balance sheet date and are recognised to the extent that it has become probable that future taxable profit will allow the deferred income tax asset to be recovered. Deferred income tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the balance sheet date. Income tax relating to items recognised directly in equity is recognised in equity and not in the income statement. Deferred income tax assets and deferred income tax liabilities are offset, if a legally enforceable right exists to set off current tax assets against current tax liabilities and the deferred taxes relate to the same taxable entity and the same taxation authority. Trade and other receivables Trade receivables, which generally have terms of 30 to 90 days, are recognised and carried at original invoice amount less an allowance for any uncollectible amounts. Provision is made when there is objective evidence that the Group will not be able to collect the debts. Bad debts are written off when identified. Other receivables are recognised and carried at cost less allowances for any uncollectible amounts. Derivative financial instruments and hedging The Group uses derivative financial instruments to hedge its exposure to jet fuel prices. Such derivative financial instruments are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently re-measured at fair value. Derivatives are carried as assets when the fair value is positive and as liabilities when the fair value is negative. Any gains or losses arising from changes in fair value on derivatives that do not qualify for hedge accounting are taken directly to the income statement for the year. For the purposes of hedge accounting, hedges are classified as follows: â€¢ fair value hedges, when hedging the exposure to changes in the fair value of a recognised asset or liability; â€¢ cash flow hedges, when hedging exposure to variability in cash flows that is either attributable to a particular risk associated with a recognised asset or liability or a forecast transaction; or â€¢ hedges of a net investment in a foreign operation. Hedges which meet the strict criteria for hedge accounting are accounted for as follows: Fair value hedges Fair value hedges are hedges of the Group's exposure to changes in the fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss. For fair value hedges, the carrying amount of the hedged item is adjusted for gains and losses attributable to the risk being hedged, the derivative is re-measured at fair value and gains and losses from both are taken to profit or loss. For fair value hedges relating to items carried at amortised cost, the adjustment to carrying value is amortised through profit or loss over the remaining term to maturity. Any adjustment to the carrying amount of a hedged financial instrument for which the effective interest method is used is amortised to profit or loss. Amortisation may begin as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged. When an unrecognised firm commitment is designated as a hedged item, the subsequent cumulative change in the fair value of the firm commitment attributable to the hedged risk is recognised as an asset or liability with the corresponding gain or loss recognised in profit or loss. The changes in the fair value of the hedging instrument are also recognised in profit or loss. The Group discontinues fair value hedge accounting if the hedging instrument expires or is sold, terminated or exercised; the hedge no longer meets the criteria for hedge accounting; or the Group revokes the designation. Any adjustment to the carrying amount of a hedged financial instrument for which the effective interest method is used is amortised to profit or loss. Amortisation may begin as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged. Cash flow hedges Cash flow hedges are a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction and could affect profit or loss. The effective portion of the gain or loss on the hedging instrument is recognised directly in equity, while the ineffective portion is recognised in profit or loss. Amounts taken to equity are transferred to the income statement when the hedged transaction affects profit or loss, such as when hedged financial income or financial expense is recognised or when a forecast sale or purchase occurs. Where the hedged item is the cost of a non-financial asset or liability, the amounts taken to equity are transferred to the initial carrying amount of the non-financial asset or liability. If the forecast transaction is no longer expected to occur, amounts previously recognised in equity are transferred to the profit or loss. If the hedging instrument expires or is sold, terminated or exercised without replacement or rollover, or if its designation as a hedge is revoked, amounts previously recognised in equity will remain in equity until the forecast transaction occurs. If the related transaction is not expected to occur, the amount is taken to profit or loss. Hedges of a net investment Hedges of a net investment in a foreign operation, including a hedge of a monetary item that is accounted for as part of the net investment, are accounted for in a way similar to cash flow hedges. Gains or losses on the hedging instrument relating to the effective portion of the hedge are recognised directly in equity while any gains or losses relating to the ineffective portion are recognised in profit or loss. On disposal of the foreign operation, the cumulative value of any such gains or losses recognised directly in equity is transferred to profit or loss. Borrowing costs Borrowing costs directly attributable to the acquisition of aircraft, construction or production of qualifying assets, i.e. assets that necessarily take a substantial period of time to get ready for their intended use, are capitalised as part of the costs of those assets. The capitalisation of aircraft borrowing costs ceases when the aircraft is placed into revenue earning services and the capitalisation of other assets' borrowing costs ceases when the assets are substantially ready for their intended use or sale. Where funds have been borrowed generally, and used for the purpose of obtaining qualifying assets, a capitalisation rate of 4.5% (2004: ranging between 5.6% and 5.8%) has been applied to the expenditure on the individual asset. All other borrowing costs are recognised as an expense when incurred. Interest-bearing loans and borrowings All loans and borrowings are initially recognised at the fair value of the consideration received less directly attributable transaction costs. After initial recognition, interest-bearing loans and borrowings are subsequently measured at amortised cost using the effective interest rate method. Gains and losses are recognised in the income statement when the liabilities are derecognised as well as through the amortisation process. Impairment of assets The Group assesses at each reporting date whether there is an indication that an asset may be impaired. If any such indication exists, or when annual impairment testing for an asset is required, the Group makes an estimate of the asset's recoverable amount. An asset's recoverable amount is the higher of an asset's or cash-generating unit's fair value less costs to sell and its value in use, and is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. Where the carrying amount of an asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Impairment losses of continuing operations are recognised in the income statement in those expense categories consistent with the function of the impaired asset. An assessment is made at each reporting date as to whether there is any indication that previously recognised impairment losses may no longer exist or may have decreased. If such indication exists, the recoverable amount is estimated. A previously recognised impairment loss is reversed only if there has been a change in the estimates used to determine the asset's recoverable amount since the last impairment loss was recognised. If that is the case the carrying amount of the asset is increased to its recoverable amount. That increased amount cannot exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognised for the asset in prior years. Such reversal is recognised in profit or loss. After such a reversal the depreciation charge is adjusted in future periods to allocate the asset's revised carrying amount, less any residual value, on a systematic basis over its remaining useful life. Derecognition of financial assets and liabilities Financial assets A financial asset (or, where applicable a part of a financial asset or part of a group of similar financial assets) is derecognised where: â€¢ the rights to receive cash flows from the asset have expired; â€¢ the Group retains the right to receive cash flows from the asset, but has assumed an obligation to pay them in full without material delay to a third party under a 'pass-through' arrangement; or â€¢ the Group has transferred its rights to receive cash flows from the asset and either (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Where the Group has transferred its rights to receive cash flows from an asset and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognised to the extent of the Group's continuing involvement in the asset. Continuing involvement that takes the form of a guarantee over the transferred asset is measured at the lower of the original carrying amount of the asset and the maximum amount of consideration that the Group could be required to repay. Where continuing involvement takes the form of a written and/or purchased option (including a cash-settled option or similar provision) on the transferred asset, the extent of the Group's continuing involvement is the amount of the transferred asset that the Group may repurchase, except that in the case of a written put option (including a cash-settled option or similar provision) on an asset measured at fair value, the extent of the Group's continuing involvement is limited to the lower of the fair value of the transferred asset and the option exercise price. Financial liabilities A financial liability is derecognised when the obligation under the liability is discharged or cancelled or expires. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the respective carrying amounts is recognised in profit or loss. Impairment of financial assets The Group assesses at each balance sheet date whether a financial asset or group of financial assets is impaired. Available-for-sale financial assets If an available-for-sale asset is impaired, an amount comprising the difference between its cost (net of any principal payment and amortisation) and its current fair value, less any impairment loss previously recognised in profit or loss, is transferred from equity to the income statement. Reversals of impairment loss in respect of equity instruments classified as available-for-sale are not recognised in profit or loss. Reversals of impairment losses on debt instruments are reversed through profit or loss, if the increase in fair value of the instruments can be objectively related to an event occurring after the impairment loss was recognised in profit or loss. Significant accounting estimates Estimation uncertainty The key assumptions concerning the future and other key sources of estimation uncertainty at the balance sheet date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next year are discussed below. (a) Impairment of goodwill The Group determines whether goodwill is impaired at least on an annual basis. This requires an estimation of the value in use of the cash-generating units to which the goodwill is allocated. Estimating the value in use requires the Group to make an estimate of the expected future cash flows from the cash-generating unit and also to choose a suitable discount rate in order to calculate the present value of those cash flows. The carrying amount of goodwill at 31 December 2005 was RMB1,444 million (2004: RMB1,405 million). More details are given in note 19 to these financial statements. 3. SEGMENT INFORMATION Segment information of the Group is presented by way of two segment formats: (i) on a primary segment reporting basis, by business segment; and (ii) on a secondary segment reporting basis, by geographical segment. The Group's operating businesses are structured and managed separately, according to the nature of their operations and the services they provide. Each of the Group's business segments represents a strategic business unit that offers services which are subject to risks and returns that are different from those of the other business segments. Currently, the Group's business segment information is divided into the following four business segments: (a) the airline operations segment comprises the provision of air passenger and air cargo services; (b) the engineering services segment comprises the provision of aircraft engineering services which include aircraft maintenance, repair and overhaul services; (c) the airport terminal services segment comprises the provision of ground services which include check-in service, boarding service, premium class lounge service, ramp service, luggage handling service, loading and unloading services, cabin cleaning and transit services; and (d) the 'others' segment comprises the provision of air catering services and other airline-related services. The profit before tax of a segment represents revenue less expenses directly attributable to a segment and the relevant portion of enterprise revenue less expenses that can be allocated on a reasonable basis to a segment, whether from external transactions or from transactions with other segments of the Group. Segment assets and liabilities mainly comprise operating assets and liabilities that are directly attributable to the segment or can be allocated to the segment on a reasonable basis. In determining the Group's geographical segments, revenue is attributed to the segments based on the origin and destination of each flight segment. Assets, which consist principally of aircraft and ground equipment, supporting the entire worldwide transportation system, are mainly located in Mainland China. An analysis of assets and capital expenditure of the Group by geographical distribution has therefore not been included. Intersegment sales and transfers are transacted with reference to the selling prices used for sales made to third parties at the then prevailing market prices. Business segments The following tables present revenue, profit and certain asset, liability and expenditure information for the Group's business segments for the years ended 31 December 2005 and 2004: For the year ended 31 December 2005 Airport Airline Engineering terminal operations services services Others Eliminations Total RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 REVENUE Sales to external customers 37,380,669 376,437 320,477 213,383 - 38,290,966 Intersegment sales - 619,098 - 108,873 (727,971) - Total revenue 37,380,669 995,535 320,477 322,256 (727,971) 38,290,966 PROFIT FROM OPERATIONS Segment results 3,367,949 772,877 123,679 137,282 (727,971) 3,673,816 Finance revenue 1,231,986 8,512 37 8,072 - 1,248,607 Finance costs (1,762,481) (7,504) (2,320) (794) - (1,773,099) Share of profits less losses from associates 81,645 (8,628) 148,096 3,817 - 224,930 Profit before tax 2,919,099 765,257 269,492 148,377 (727,971) 3,374,254 Tax (903,874) Minority interests (64,124) Net profit attributable to equity holders of the parent 2,406,256 ASSETS Segment assets 63,703,084 1,046,799 122,474 668,200 (1,630,942) 63,909,615 Interests in associates 3,312,608 18,700 192,084 270,565 - 3,793,957 Unallocated assets 498,371 Total assets 68,201,943 LIABILITIES Segment liabilities (46,191,851) (489,320) (404,229) (775,802) 1,630,942 (46,230,260) Unallocated liabilities (421,077) Total liabilities (46,651,337) OTHER INFORMATION Capital expenditures - property, plant and equipment 13,222,058 37,219 855 30,836 - 13,290,968 Depreciation of property, plant and equipment 4,409,021 38,381 61,303 3,975 - 4,512,680 Amortisation of lease prepayments 19,555 - - - - 19,555 Increase in fair value of financial assets, net (125,868) - - - - (125,868) Provision/(write-back of provision) for doubtful debts, net 14,836 118 - (231) - 14,723 For the year ended 31 December 2004 Airport Airline Engineering terminal operations services services Others Eliminations Total RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 REVENUE Sales to external customers 32,766,164 296,775 287,905 169,913 - 33,520,757 Intersegment sales - 731,589 - 131,299 (862,888) - Total revenue 32,766,164 1,028,364 287,905 301,212 (862,888) 33,520,757 PROFIT FROM OPERATIONS Segment results 4,146,402 824,858 203,133 173,746 (862,888) 4,485,251 Finance revenue 73,943 278 - 5,140 - 79,361 Finance costs (1,859,139) (14,819) (1,978) (3,298) - (1,879,234) Dilution gains on investments 330,222 - - 79,915 - 410,137 Share of profits less losses from associates 331,530 (5,083) 130,661 6,936 - 464,044 Profit before tax 3,022,958 805,234 331,816 262,439 (862,888) 3,559,559 Tax (1,010,864) Minority interests (162,731) Net profit attributable to equity holders of the parent 2,385,964 ASSETS Segment assets 62,308,593 1,077,748 160,087 379,390 (2,014,154) 61,911,664 Interests in associates 3,589,574 25,539 186,056 200,352 - 4,001,521 Unallocated assets 776,084 Total assets 66,689,269 LIABILITIES Segment liabilities (48,845,870) (652,749) (312,765) (677,442) 2,014,154 (48,474,672) Unallocated liabilities (186,055) Total liabilities (48,660,727) OTHER INFORMATION Capital expenditures - property, plant and equipment 6,046,355 32,697 25,912 33,641 - 6,138,605 Depreciation of property, plant and equipment 3,395,049 35,797 19,247 13,159 - 3,463,252 Amortisation of lease prepayments 4,884 - - - - 4,884 Decrease in fair value of financial assets, net 28,000 - - - - 28,000 Provision/(write-back of provision) for doubtful debts, net (4,483) 2,642 - 853 - (988) Provision/(write-back of provision) against inventories, net 12,492 (24,000) - - - (11,508) Geographical segments The following tables present consolidated revenue by geographical segments for the years ended 31 December 2005 and 2004: For the year ended 31 December 2005 Asia North Japan/ Pacific, Domestic HK/Macau Europe America Korea others Total RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 REVENUE Sales to external customers and total 20,490,055 2,269,256 5,081,774 2,964,247 4,250,255 3,235,379 38,290,966 revenue For the year ended 31 December 2004 Asia North Japan/ Pacific, Domestic HK/Macau Europe America Korea others Total RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 REVENUE Sales to external customers and total 18,482,949 1,744,590 4,232,489 2,477,214 3,846,973 2,736,542 33,520,757 revenue 4. AIR TRAFFIC REVENUE Air traffic revenue comprises revenue operations business and is stated net of business tax. from the airline An analysis of air traffic revenue is as follows: Group 2005 2004 RMB'000 RMB'000 Passenger 31,584,426 27,665,018 Cargo and mail 3,716,400 3,169,804 35,300,826 30,834,822 Pursuant to various PRC business tax rules and regulations, the Group is required to pay business tax to the local tax bureaus at the following rates: Type of revenue Applicable business tax rate Air traffic revenue 3% of air traffic revenue (all inbound international and Hong Kong and Macau regional flights are exempted from business tax) Other operating revenue 3% to 5% of other operating revenue (note 5) PRC business tax incurred for the years ended 31 December 2005 and 2004, netted against air traffic revenue, amounted to approximately RMB846 million and RMB711 million, respectively. 5. OTHER OPERATING REVENUE Group 2005 2004 RMB'000 RMB'000 Bellyhold income from a joint venture (note 46) 1,496,302 1,384,457 Aircraft engineering income 376,437 296,775 Ground services income 320,477 287,905 General aviation income 155,521 159,990 Air catering income 109,591 118,140 Government grants: (i) Recognition of deferred income (note 36) 76,943 70,593 (ii) Fixed cash subsidy - 37,500 (iii) Others 41,250 44,853 Service charges on return of unused flight 97,951 63,821 tickets Cargo handling service income 67,822 49,850 Sale of materials 11,899 33,008 Import and export service income 12,311 29,767 Training service income 19,029 23,761 Aircraft and related equipment lease income 7,072 11,516 Gain on disposal of property, plant and 74,474 - equipment, net Others 123,061 73,999 2,990,140 2,685,935 6. PROFIT FROM OPERATIONS The Group's profit from operations is arrived at after charging/(crediting): Group 2005 2004 RMB'000 RMB'000 Repair and maintenance costs 2,078,382 3,608,348 Depreciation (note 15) 4,512,680 3,463,252 Amortisation of lease prepayments (note 16) 19,555 4,884 Employee compensation costs (note 7) 3,406,825 2,921,322 Minimum lease payments under operating leases: Aircraft and engines 1,530,754 1,071,256 Land and buildings 211,177 187,471 (Gain)/loss on disposal of property, plant and (74,474) 33,872 equipment, net Loss on derecognition of property, plant and equipment (note 2 (b) (ii)) 430,010 - Auditors' remuneration 11,029 7,206 Provision/(write-back of provision) for doubtful 14,723 (988) debts, net Write-back of provision against inventories, net - (11,508) 7. EMPLOYEE COMPENSATION COSTS Group 2005 2004 RMB'000 RMB'000 Employee compensation costs (including Directors', supervisors' and management's emoluments): Wages, salaries and social security costs 3,200,391 2,732,927 Retirement benefit costs (note 11) 206,434 188,395 3,406,825 2,921,322 8. FINANCE REVENUE AND FINANCE COSTS Finance revenue Group 2005 2004 RMB'000 RMB'000 Exchange gains, net 918,297 - Interest income 108,481 33,703 Gains on fuel derivatives, net 221,661 41,036 Dividend income from available-for-sale 168 4,622 investments 1,248,607 79,361 Finance costs Group 2005 2004 RMB'000 RMB'000 Interest expense 1,792,408 1,827,002 Less: Interest capitalised (19,309) (2,610) 1,773,099 1,824,392 Exchange losses, net - 54,842 1,773,099 1,879,234 The interest capitalisation rate represents the cost of capital from raising the related borrowings and is approximately 4.5% (2004: ranging from 5.6% to 5.8%) per annum. 9. DILUTION GAINS ON INVESTMENTS Group 2005 2004 RMB'000 RMB'000 Dilution gain on investment in Air Cargo - 330,222 Business (note 9(a)) Dilution gains on investments in BACL and - 79,915 SWACL (note 9(b)) - 410,137 Notes: (a) Pursuant to the Restructuring, the air cargo business and relevant air cargo assets and liabilities (the 'Air Cargo Business') were operated and owned solely by the Group as if it had been directly held by the Group prior to 1 January 2004 in accordance with the basis of presentation as set out in note 1 to these financial statements. In 2004, the entire Air Cargo Business was transferred to Air China Cargo Co., Ltd. ('Air China Cargo'), a 51% owned joint venture of the Company, in the form of the Company's capital contribution and advance to Air China Cargo. Subsequent to the transfer of Air Cargo Business to Air China Cargo, the Group's effective interest in the Air Cargo Business was diluted from 100% to 51% and, accordingly, a gain on dilution of the investment in Air Cargo Business of approximately RMB330 million arose. (b) In accordance with the basis of presentation as set out in note 1 to these financial statements, a 60% shareholding interest in Beijing Air Catering Co., Ltd. ('BACL') and a 75% shareholding interest in Southwest Air Catering Company Limited ('SWACL') were deemed to be held by the Group prior to being transferred during 2004. During 2004, the Group transferred its entire 60% shareholding interest in BACL and a 60% shareholding interest in SWACL to Fly Top Limited, a wholly-owned subsidiary of China National Aviation Company Limited ('CNAC'), a subsidiary of the Company, for considerations of RMB294 million and RMB67 million, respectively. In addition to the above, the Group transferred its remaining 15% shareholding interest in SWACL to Hongkong Southwest Air Catering Limited ('HKSACL'), the minority shareholder of SWACL, for a consideration of approximately RMB17 million. Subsequent to the completion of the above transactions, the Group's effective shareholding interests in BACL and SWACL were diluted from 60% and 75%, respectively, to 41% and accordingly gains on dilution of investments in BACL and SWACL in aggregate of approximately RMB80 million arose. 10. DIRECTORS', SUPERVISORS' AND SENIOR MANAGEMENT'S EMOLUMENTS Directors' and supervisors' remuneration for the year disclosed pursuant to the Rules Governing the Listing of Securities on the Hong Kong Stock Exchange and Section 161 of the Hong Kong Companies Ordinance, is as follows: Group 2005 2004 RMB'000 RMB'000 Fees 150 29 Basic salaries, housing other allowances and benefits in 4,443 4,279 benefits, kind Discretionary bonuses 787 636 Retirement benefits 69 43 5,449 4,987 Basic salaries, housing benefits, other allowances and benefits Discretionary Retirement Total Fees in kind bonuses benefits emoluments RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Year ended 31 December 2005 Directors Mr. Li Jiaxiang - - - - - Mr. Kong Dong - 2,132 - - 2,132 Mr. Wang Shixiang - - - - - Mr. Yao Weiting - - - - - Mr. Ma Xulun - 124 245 16 385 Mr. Cai Jianjiang - 124 232 16 372 Mr. Fan Cheng - 113 153 16 282 Dr. Hu Hung Lick, Henry 50 63 - - 113 Mr. Wu Zhipan 50 - - - 50 Mr. Zhang Ke 50 - - - 50 Mr. David Turnbill - - - - - 150 2,556 630 48 3,384 Supervisors Mr. Zhang Xianlin - 1,770 - - 1,770 Mr. Liao Wei - - - - - Ms. Zhang Huilan - - - - - Mr. Liu Feng - 93 132 16 241 Mr. Liu Guoqing - 24 25 5 54 - 1,887 157 21 2,065 150 4,443 787 69 5,449 Basic salaries, housing benefits, other allowances and benefits Discretionary Retirement Total Fees in kind bonuses benefits emoluments RMB'000 RMB'000 RMB'000 RMB'000 RMB'000 Year ended 31 December 2004 Directors Mr. Li Jiaxiang - - - - - Mr. Kong Dong - 2,172 - - 2,172 Mr. Wang Shixiang - - - - - Mr. Yao Weiting - - - - - Mr. Ma Xulun - 103 259 14 376 Mr. Cai Jianjiang - 101 240 14 355 Mr. Fan Cheng - 16 45 1 62 Dr. Hu Hung Lick, Henry 4 - - - 4 Mr. Wu Zhipan 13 - - - 13 Mr. Zhang Ke 12 - - - 12 29 2,392 544 29 2,994 Supervisors Mr. Zhang Xianlin - 1,804 - - 1,804 Mr. Liao Wei - - - - - Ms. Zhang Huilan - - - - - Mr. Liu Feng - 83 92 14 189 - 1,887 92 14 1,993 29 4,279 636 43 4,987 Fees of approximately RMB150,000 (2004: RMB29,000) are wholly payable to the independent non-executive Directors. Except for other emoluments of RMB63,000 paid to Dr. Hu Hung Lick, Henry, there were no other emoluments payable to other independent non-executive Directors during the year (2004: Nil). An analysis of the five individuals whose remuneration were the highest in the Group is as follows: Group 2005 2004 Number of Number of individuals individuals Director 1 1 Supervisor 1 1 Employees 3 3 The emoluments paid to the three non-director, non-supervisor and highest paid individuals are as follows: Group 2005 2004 RMB'000 RMB'000 Basic salaries, housing benefits, other allowances 4,729 5,360 and benefits in kind Discretionary bonuses - - Retirement benefits 216 164 4,945 5,524 The remuneration of these three highest paid individuals for the bands: year fell within the following Group 2005 2004 Number of Number of individuals individuals HK$1,000,001 to HK$1,500,000 (equivalent to RMB1,051,701 to RMB1,575,550) 2 1 HK$1,500,001 to HK$2,000,000 (equivalent to RMB1,575,551 to RMB2,103,400) 1 2 3 3 There was no arrangement under which a Director or a supervisor or any of the five highest paid individuals waived or agreed to waive any remuneration during the year (2004: Nil). There was no emolument paid by the Group to any of the Directors or supervisors or any of the five highest paid individuals as an inducement to join or upon joining the Group or as compensation for loss of office during the year (2004: Nil). 11. RETIREMENT BENEFITS All of the Group's full-time employees in Mainland China are covered by a government-regulated defined contribution retirement scheme, and are entitled to an annual pension determined by their basic salaries upon their retirement. The PRC government is responsible for the pension liabilities to these retired employees. The Group is required to make annual contributions to the government-regulated defined contribution retirement scheme at rates ranging from 15% to 20% of the employees' basic salaries during the year and has no further obligation for post-retirement benefits in respect of the above. This defined contribution plan continues to be available to the Group's employees after the Restructuring. The related pension costs are expensed as incurred. Prior to the Restructuring, the Group also paid certain supplementary pension benefits (the 'Supplementary Pension Benefits') to its employees who retired before the incorporation of the Company. Pursuant to the Restructuring, CNAHC has agreed to assume past payments and future liabilities in respect of the Supplementary Pension Benefits for those employees who retired before the incorporation of the Company for nil consideration. The pension payments relating to the Supplementary Pension Benefits borne by CNAHC was approximately RMB39 million for the year ended 31 December 2004 (note 46 (d)). These pension payments were relating to the period from 1 January 2004 to the date immediately before the incorporation of the Company. The Group's employees who retire after the incorporation of the Company are not entitled to the Supplementary Pension Benefits. CNAHC has agreed to indemnify the Group against losses from any claims for the Supplementary Pension Benefits. Besides, the Group also implemented an early retirement plan for certain employees in addition to the benefits under the government-regulated defined contribution retirement scheme described above. The benefits of the early retirement plan are calculated based on factors including the remaining number of years of services from the date of early retirement to the normal retirement date and the salary amount on the date of early retirement of the employees. The costs of early retirement benefits were recognised in the period when employees opted for early retirement. Where the effect of discounting is material, the amount recognised for early retirement benefits is the present value at the balance sheet date of the future cash flows expected to be required to settle the obligation. The increase in the discounted present value amount arising from the passage of time is included in finance costs in the income statement. The expenses attributed to the PRC government-regulated defined contribution retirement scheme and the early retirement benefits are as follows: Group 2005 2004 RMB'000 RMB'000 Contributions to PRC government-regulated defined contribution retirement scheme 202,535 179,740 Early retirement benefits 3,899 8,655 Total (note 7) 206,434 188,395 Forfeited contributions totalling RMB1,633,000 (2004: RMB1,579,000) was utilised during the year. At 31 December 2005, the Group had no forfeited contributions available to reduce its contributions to the pension scheme in future years (2004: Nil). 12. TAX According to the PRC Enterprise Income Tax Law, the Company, its subsidiaries, joint ventures and associates established in the PRC are subject to enterprise income tax at rates ranging from 15% to 33% (2004: 15% to 33%) on their taxable income. Hong Kong profits tax has been provided at the rate of 17.5% (2004: 17.5%) on the estimated assessable profits arising in Hong Kong during the year. The Group is subject to income tax on an entity basis on profits arising in or derived from the jurisdictions in which members of the Group are domiciled and operate. In accordance with an approval document issued by the relevant tax authorities, the filing of tax returns of the Relevant Businesses and all wholly-owned PRC-established subsidiaries of the Company prior to its incorporation on 30 September 2004 was handled by CNAHC on a consolidated group basis. The share of the income tax liability of the Relevant Businesses and all wholly-owned PRC-established subsidiaries of the Company prior to its incorporation was calculated at the applicable tax rates on their profits determined in accordance with PRC accounting principles and after the relevant adjustments made under the prevailing PRC Enterprise Income Tax Law as applicable to domestic enterprises. Such tax was payable to CNAHC which in turn would settle the tax liability with the relevant tax bureau. Similarly, the net profit attributable to CNAHC for the period from 1 January 2004 to 30 September 2004 (the date of incorporation of the Company) referred to in note 13(b) to these financial statements was calculated after deducting the amount of income tax payable to CNAHC, which in turn would settle any tax liability on profits arising during that period with the relevant tax bureau. Following the incorporation of the Company, the Company will settle its tax liability by itself with the respective tax bureau. In accordance with the PRC Enterprise Income Tax Law and an approval document issued by the relevant tax bureau on 28 November 2005 (the 'Approval Document'), Air China Cargo was approved to be subject to a enterprise income tax rate of 24% on its taxable income as reported in its statutory financial statements for the year ended 31 December 2005 and was fully exempted from corporate income tax for the year ended 31 December 2005 and followed by a 3-year 50% reduction in corporate income tax in the period between 1 January 2006 and 31 December 2008. In addition, pursuant to the Approval Document, Air China Cargo has been granted a 4-year local income tax exemption in the period between 1 January 2005 and 31 December 2008 and followed by a 5-year 50% reduction in local income tax in the period between 1 January 2009 and 31 December 2013. The determination of current and deferred income tax was based on enacted tax rates. Major components of income tax charge are as follows: Group 2005 2004 RMB'000 RMB'000 Current income tax Current income tax charge - Mainland China 614,313 398,944 - Hong Kong 11,848 4,096 Deferred income tax Relating to origination and reversal of temporary differences (note 22) 277,713 607,824 Income tax charge for the year 903,874 1,010,864 Share of tax attributable to associates amounting to RMB33,640,000 (2004: RMB96,974,000) is included in the 'Share of profit less losses from associates' on the face of the consolidated income statement. A reconciliation of income tax expense applicable to profit before income tax at the statutory income tax rates in Mainland China to income tax expense at the Group's effective income tax rate, and a reconciliation of the applicable rate (i.e., the statutory tax rate) to the effective tax rate, are as follows: Group 2005 2004 RMB'000 % RMB'000 % Profit before income tax 3,374,254 3,559,559 At statutory income tax rate of 1,113,504 33.0 1,174,654 33.0 33% Profits and losses attributable (74,227) (2.2) (153,135) (4.3) to associates Lower income tax rates of other (15,024) (0.5) (20,455) (0.6) territories Tax exemption (49,558) (1.4) - - Income not subject to tax (115,131) (3.4) (211,035) (5.9) Expenses not deductible for tax 26,941 0.8 220,835 6.2 purposes Tax losses not recognised 12,537 0.4 - - Effect on opening deferred income tax assets due to decrease in other territories' income tax rates 4,832 0.1 - - Tax charge at Group's effective income tax rate 903,874 26.8 1,010,864 28.4 At 31 December 2005, there was no significant unrecognised deferred tax liability (2004: Nil) for taxes that would be payable on the unremitted earnings of certain of the Group's subsidiaries and joint ventures as the Directors of the Company do not have intention to remit any significant amount of earnings to the Company in the foreseeable future. There are no income tax consequences attaching to the payment of dividends by the Company to its shareholders. This information is provided by RNS The company news service from the London Stock Exchange

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Air China Ltd. (AIRC)

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