AstraZeneca Annual Report and Form 20-F Information 2008

Critical accounting policies and estimates

Our Financial Statements are prepared in accordance with International Accounting Standards and International Financial Reporting Standards (collectively "IFRSs") as adopted by the European Union ("adopted IFRS") and as issued by the International Accounting Standards Board and the accounting policies employed are set out under the heading Financial Statements - Accounting Policies. In applying these policies, we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. The actual outcome could differ from those estimates. Some of these policies require a high level of judgement, either because the areas are especially subjective or complex. We believe that the most critical accounting policies and significant areas of judgement and estimation are in:

Revenue Recognition

Revenue is recorded at the invoiced amount (excluding inter-company sales and value added taxes) less movements in estimated accruals for product returns and rebates given to managed care and other customers – a particular feature in the US but also occurring in the rest of the world. Cash discounts for prompt payment are also deducted from sales. Revenue is recognised at the point of delivery, which is usually when title passes to the customer either on shipment or on receipt of goods by the customer depending on local trading terms. Income from royalties and from disposals of intellectual property, brands and product lines are included in other operating income.

			2008  $m	2007  $m	2006  $m
Gross sales			20,029	18,456	16,577
Chargebacks			(1,726)	(1,130)	(975)
Regulatory – US government and state programmes			(1,005)	(732)	(532)
Contractual – Managed care and group purchasing organisation rebates			(3,658)	(3,179)	(2,413)
Cash and other discounts			(390)	(356)	(329)
Customer returns			(48)	(18)	(46)
Other			(167)	(145)	(256)
Net sales			13,035	12,896	12,026

Rebates and chargebacks

At the time of invoicing sales in the US, rebates and chargebacks that we expect to pay, in as little time as two weeks or as much as eight months, are estimated. These rebates typically arise from sales contracts with third party managed care organisations, hospitals, long-term care facilities, group purchasing organisations and various federal or state programmes (Medicaid "best price" contracts, supplemental rebates etc) and can be classified as follows:

• Chargebacks, where we enter into arrangements under which certain parties, typically hospitals, the Department of Veterans Affairs and the Department of Defense, are able to buy products from wholesalers at the lower prices we have contracted with them. The chargeback is the difference between the price we invoice to the wholesaler and the contracted price charged by the wholesaler. Chargebacks are paid directly to the wholesalers.
• Regulatory, including Medicaid and other federal and state programmes, where we pay rebates based on the specific terms of agreements in individual states which include product usage and information on best prices and average market prices benchmarks.
• Contractual, under which entities such as third party managed care organisations, long-term care facilities and group purchasing organisations are entitled to rebates depending on specified performance provisions, which vary from contract to contract.

The effects of these deductions on our US pharmaceuticals turnover are set out below.

Accrual assumptions are built up on a product-by-product and customer-by-customer basis taking into account specific contract provisions coupled with expected performance and are then aggregated into a weighted average rebate accrual rate for each of our products. Accrual rates are reviewed and adjusted on a monthly basis. There may be further adjustments when actual rebates are invoiced based on utilisation information submitted to us (in the case of contractual rebates) and claims/invoices are received (in the case of regulatory rebates and chargebacks). We believe that we have been reasonable in our estimates for future rebates using a similar methodology to that of previous years. Inevitably, however, such estimates involve judgements on aggregate future sales levels, segment mix and the respective customer contractual performance.

Cash discounts are offered to customers to encourage prompt payment. Accruals are calculated based on historical experience and are adjusted to reflect actual experience.

Industry practice in the US allows wholesalers and pharmacies to return unused stocks within six months of, and up to 12 months after, shelf-life expiry. At point of sale, we estimate the quantity and value of goods which may ultimately be returned. Our returns accruals are based on actual experience over the preceding 12 months for established products together with market related information such as estimated stock levels at wholesalers and competitor activity. For newly launched products, we use rates based on our experience with similar products or a pre-determined percentage.

For products facing generic competition (such as Ethyol and Toprol-XL in the US) our experience is that we usually lose the ability to estimate the levels of returns from wholesalers with the same degree of precision that we can for products still subject to patent protection. This is because we have limited or no insight into a number of areas – the actual timing of the launch of a generic competitor following regulatory approval of the generic product (for example, a generic manufacturer may or may not have produced adequate prelaunch inventory), the pricing and marketing strategy of the competitor, the take-up of the generic and (in cases where a generic manufacturer has approval to launch just one dose size in a market of several dose sizes) the likely level of switching from one dose to another. Under our accounting policy revenue is only recognised when the amount of the revenue can be measured reliably. Our approach in meeting this condition for products facing generic competition will vary from product to product depending on the specific circumstances.

The movements on US pharmaceuticals revenue accruals, are set out below.

The adjustments in respect of prior years benefited reported US pharmaceuticals turnover by 0.4% in 2006, and decreased turnover by 0.4% in 2007 and 0.2% in 2008.

Chargebacks increased by $173 million compared to 2007 due primarily to increased sales activities with US Government Agencies for Nexium and Crestor. Regulatory rebates increased by $92 million in 2008 largely as a result of increased US State supplemental rebates for our key brands. In 2008 contractual rebates increased by $184 million compared to 2007, mainly as a result of AstraZeneca’s response to increased generic and competitor pricing pressures particularly in the PPI and statin markets.

The increase in contractual rebates in 2007 was driven by the introduction into the US market of generic omeprazole, with resultant price impacts on Nexium.

We have Distribution Service Agreements with major wholesaler buyers, which serve to reduce the speculative purchasing behaviour of the wholesalers and reduce short-term fluctuations in the level of inventory they hold. As a result, we believe inventory movements have been neutral across the year. We track wholesaler stock levels by product, using our own, third party and wholesaler data and, where we believe such distortions occur, we disclose in the Annual Report for each product and in aggregate where shipments may be out of line with underlying prescription trends. We do not offer any incentives to encourage wholesaler speculative buying and attempt, where possible, to restrict shipments to underlying demand when such speculation occurs.

	Brought  forward  1 January  2006  $m	Provision for  current year  $m	Adjustment  in respect  of prior years  $m	Returns  and payments  $m	Carried forward at 31 December 2006 $m
Chargebacks	185	1,001	(26)	(1,068)	92
Regulatory – US government and state programmes	601	597	(65)	(819)	314
Contractual – Managed care and group purchasing organisation rebates	420	2,367	46	(2,198)	635
Cash and other discounts	27	329	–	(327)	29
Customer returns	167	46	–	(53)	160
Other	54	256	–	(263)	47
	1,454	4,596	(45)	(4,728)	1,277

	Brought  forward  1 January  2007  $m	Additions in  respect of  MedImmune  $m	Provision for  current year  $m	Adjustment  in respect  of prior  years  $m	Returns  and  payments  $m	Carried forward at 31 December 2007 $m
Chargebacks	92	2	1,115	15	(1,038)	186
Regulatory – US government and state programmes	314	69	769	(37)	(687)	428
Contractual – Managed care and group purchasing organisation rebates	635	5	3,100	79	(2,919)	900
Cash and other discounts	29	1	356	–	(348)	38
Customer returns	160	1	19	(1)	(94)	85
Other	47	–	153	–	(147)	53
	1,277	78	5,512	56	(5,233)	1,690

	Brought  forward  1 January  2008  $m	Provision for  current year  $m	Adjustment  in respect  of prior years  $m	Returns  and payments  $m	Carried  forward  at 31  December  2008  $m
Chargebacks	186	1,745	(19)	(1,553)	359
Regulatory – US government and state programmes	428	997	8	(913)	520
Contractual – Managed care and group purchasing organisation rebates	900	3,622	36	(3,474)	1,084
Cash and other discounts	38	390	–	(389)	39
Customer returns	85	48	–	(56)	77
Other	53	167	–	(163)	57
	1,690	6,969	25	(6,548)	2,136

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Royalty income

Royalty income is recorded under other operating income in the Financial Statements. Royalties tend to be linked to levels of sales or production by a third party. At the time of preparing the Financial Statements, we may have to estimate the third party’s sales or production when arriving at the royalty income to be included. These estimates, which may differ from actual sales or production, do not result in a material impact on reported other operating income.

Sales of intangible assets

A consequence of charging all internal R&D expenditure to the income statement in the year that it is incurred (which is normal practice in the pharmaceutical industry) is that we own valuable intangible assets which are not recorded on the balance sheet. We also own acquired intangible assets which are included on the balance sheet. As a consequence of regular reviews of product strategy, from time to time we sell such assets and generate income. Sales of product lines are often accompanied by an agreement on our part to continue manufacturing the relevant product for a reasonable period (often about two years) whilst the purchaser constructs its own manufacturing facilities. The contracts typically involve the receipt of an upfront payment, which the contract attributes to the sale of the intangible assets, and ongoing receipts, which the contract attributes to the sale of the product we manufacture. In cases where the transaction has two or more components, we account for the delivered item (for example, the transfer of title to the intangible asset) as a separate unit of accounting and record revenue on delivery of that component provided that we can make a reasonable estimate of the fair value of the undelivered component. Where the fair market value of the undelivered component (for example a manufacturing agreement) exceeds the contracted price for that component we defer an appropriate element of the upfront consideration and amortise this over the performance period. However, where the fair market value of the undelivered component is equal to or lower than the contracted price for that component we treat the whole of the upfront amount as being attributable to the delivered intangible assets and recognise that part of the revenue upon delivery. No element of the contracted revenue related to the undelivered component is allocated to the sale of the intangible asset. This is because the contracted revenue relating to the undelivered component is contingent on future events (such as sales) and so cannot be anticipated.

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RESEARCH AND DEVELOPMENT

Our business is underpinned by our marketed products and development portfolio. The R&D expenditure on internal activities to generate these products is generally charged to the income statement in the year that it is incurred. Purchases of intellectual property and product rights to supplement our R&D portfolio are capitalised as intangible assets. Such intangible assets are amortised from the launch of the underlying products and are tested for impairment both before and after launch. This policy is in line with practice adopted by major pharmaceutical companies.

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GOODWILL AND INTANGIBLE ASSETS

We have significant investments in goodwill and intangible assets as a result of acquisitions of businesses and purchases of such assets as product development and marketing rights.

For the purpose of impairment testing of goodwill, the Group is regarded as a single cash-generating unit.

The recoverable amount is based on value in use using discounted risk-adjusted projections of the Group’s pre-tax cash flows over ten years, a period reflecting the average patent-protected lives of our current products. The projections include assumptions about product launches, competition from rival products and pricing policy as well as the possibility of generics entering the market. In setting these assumptions we consider our past experience, external sources of information (including information on expected increases and ageing of the populations in our Established Markets and the expanding patient population in newer markets), our knowledge of competitor activity and our assessment of future changes in the pharmaceutical industry. The 10 year period is covered by internal budgets and forecasts. Given that internal budgets and forecasts are prepared for all projections, no general growth rates are used to extrapolate internal budgets and forecasts for the purposes of determining value in use.

In arriving at value in use, we disaggregate our projected pre-tax cash flows into groups reflecting similar risks and tax effects. For each group of cash flows we use an appropriate discount rate reflecting those risks and tax effects. In arriving at the appropriate discount rate for each group of cash flows, we adjust AstraZeneca’s post-tax weighted average cost of capital (7.6% for 2008) to reflect the impact of risks and tax effects. The weighted average pre-tax discount rate we used was approximately 11%.

As a cross check, we compare our market capitalisation to the book value of our net assets and this indicates significant surplus at 31 December 2008.

No goodwill impairment was identified.

The Group has also performed sensitivity analysis calculations on the projections used and discount rate applied. The Directors have concluded that, given the significant headroom that exists, and the results of the sensitivity analysis performed, there is no significant risk that reasonable changes in key assumptions would cause the carrying value of goodwill to exceed its value in use.

Impairment reviews have been carried out on all intangibles that are in development (and not being amortised), all major intangibles acquired during the year, all intangibles that have had indications of impairment during the year and all intangibles recognised on the acquisition of MedImmune. Sales forecasts and specific allocated costs (which have both been subject to appropriate Senior Management sign off) are discounted using AstraZeneca’s post-tax weighted average cost of capital.

The majority of our investments in intangible assets and goodwill arose from the restructuring of the Astra-Merck joint venture in 1998, the acquisition of MedImmune in 2007 and the payment to partially retire Merck’s interests in our products in the US in 2008, and we are satisfied that the carrying values are fully justified by estimated future cash flows.

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LITIGATION

In the normal course of business, potential liabilities may arise from product-specific and general legal proceedings, from guarantees or from environmental liabilities connected with our current or former sites. Where we believe that potential liabilities have a less than 50% probability of crystallising or are very difficult to quantify reliably, we treat them as contingent liabilities.

These are not provided for but are disclosed in the Notes to the Financial Statements. Further details of these contingent liabilities are set out in Note 25. Where it is considered more likely than not that an actual liability may crystallise, and this can be measured reliably, a provision is made. Although there can be no assurance regarding the outcome of legal proceedings, we do not currently expect them to have a materially adverse effect on our results in any particular period. We also have significant commitments that are not currently recognised in the balance sheet arising from our relationship with Merck. These are described more fully in Note 25 to the Financial Statements.

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POST-RETIREMENT BENEFITS

We offer post-retirement benefit plans which cover many of our employees around the world. In keeping with local terms and conditions, most of these plans are ‘defined contribution’ in nature where the resulting income statement charge is fixed at a set level or is a set percentage of employees’ pay. However, several plans, mainly in the UK (which has by far the largest single scheme), the US and Sweden, are defined benefit plans where benefits are based on employees’ length of service and final salary (typically averaged over one, three or five years). The UK and US defined benefit schemes were closed to new entrants in 2000. All new employees in these countries are offered defined contribution schemes.

In applying IAS 19 ‘Employee Benefits’, we recognise all actuarial gains and losses immediately through reserves. This methodology results in a less volatile income statement charge than under the alternative approach of recognising actuarial gains and losses over time. Investment decisions in respect of defined benefit schemes are based on underlying actuarial and economic circumstances with the intention of ensuring that the schemes have sufficient assets to meet liabilities as they fall due, rather than meeting accounting requirements. The trustees follow a strategy of awarding mandates to specialist, active investment managers which results in a broad diversification of investment styles and asset classes. The investment approach is intended to produce less volatility in the plan asset returns.

In assessing the discount rate applied to the obligations, we have used rates on AA corporate bonds with durations corresponding to the maturities of those obligations.

In all cases, the pension costs recorded in the Financial Statements are assessed in accordance with the advice of independent qualified actuaries but require the exercise of significant judgement in relation to assumptions for future salary and pension increases, long-term price inflation and investment returns.

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TAXATION

Accruals for tax contingencies require management to make judgements and estimates in relation to tax audit issues and exposures. Amounts accrued are based on management’s interpretation of country-specific tax law and the likelihood of settlement. Tax benefits are not recognised unless the tax positions are probable of being sustained. Once considered to be probable, management reviews each material tax benefit to assess whether a provision should be taken against full recognition of the benefit on the basis of potential settlement through negotiation and/or litigation. All such provisions are included in creditors due within one year. Any recorded exposure to interest on tax liabilities is provided for in the tax charge.

AstraZeneca faces a number of transfer pricing audits in jurisdictions around the world and, in some cases, is in dispute with the tax authorities. These disputes usually result in taxable profits being increased in one territory and correspondingly decreased in another. Our balance sheet positions for these matters reflect appropriate corresponding relief in the territories affected. The total net accrual included in the Financial Statements to cover the worldwide exposure to transfer pricing audits is $1,628 million, an increase of $306 million due to a number of new audits, revisions of estimates relating to existing audits, offset by a number of negotiated settlements and exchange rate effects.

Included in the total net accrual are amounts in respect of the following transfer pricing arrangements:

• AstraZeneca and Her Majesty’s Revenue & Customs (HMRC) have made a joint referral to the UK Court in respect of transfer pricing between our UK and one of our overseas operations for the years 1996 to date as there continues to be a material difference between the Group’s and HMRC’s positions. An additional referral in respect of controlled foreign company aspects of the same case was made during 2008. Absent a negotiated settlement, litigation is set to commence in 2010.
• AstraZeneca has applied for two advance pricing agreements (APAs) in relation to intra-group transactions between the UK and the US and the UK and Japan. Both APAs are being progressed through competent authority proceedings under the relevant double tax treaties.

Management continues to believe that AstraZeneca’s positions on all its transfer pricing audits and disputes are robust and that AstraZeneca is adequately provided.

For transfer pricing audits where AstraZeneca and the tax authorities are in dispute, AstraZeneca estimates the potential for reasonably possible additional losses above and beyond the amount provided to be up to $400 million; however, management believes that it is unlikely that these additional losses will arise. Of the remaining tax exposures, AstraZeneca does not expect material additional losses. It is not possible to estimate the timing of tax cash flows in relation to each outcome, however, it is anticipated that a number of significant disputes may be resolved over the next one to two years. Included in the provision is an amount of interest of $365 million.

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Payments due by period

	Less than 1 year $m	1-3 years $m	3-5 years $m	Over 5 years $m	Total $m
Bank loans and other borrowings	1,616	2,800	2,665	12,478	19,559
Operating leases	101	131	81	145	458
Contracted capital expenditure	332	–	–	–	332
Total	2,049	2,931	2,746	12,623	20,349

SHARE-BASED COMPENSATION

Through the Remuneration Committee we offer share and share option plans to certain employees as part of their compensation and benefits packages, designed to improve alignment of the interests of employees with shareholders. Costs of the plans are determined using valuation models such as Black-Scholes or a modified version of the binomial model. Valuation models require judgements to be made on inputs to the model. Further details of these are given in Note 24 to the Financial Statements.

OFF-BALANCE SHEET TRANSACTIONS AND COMMITMENTS

We have no off-balance sheet arrangements and our derivative activities are non-speculative. The table above sets out our minimum contractual obligations at the year end.

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