BAE Systems 143 Annual Report 2017 Preparation continued Judgements made in applying accounting policies In the course of preparing the financial statements, no judgements have been made in the process of applying the Group’s accounting policies, other than those involving estimates, that have had a significant effect on the amounts recognised in the financial statements. Sources of estimation uncertainty The application of the Group’s accounting policies requires the use of estimates. In the event that these estimates prove to be incorrect, there may be an adjustment to the carrying amounts of assets and liabilities within the next financial year. The significant estimates in relation to the Group’s critical accounting policies are set out above. The only significant risk of a material adjustment to the carrying amounts of assets and liabilities during 2018 relates to the determination of the discount rate and inflation assumptions underpinning the valuation of the liabilities of the Group’s defined benefit pension schemes. A description of the discount rate and inflation assumptions, together with sensitivity analysis, is set out in note 21 to the Group accounts. Changes in accounting policies IFRS 9, Financial Instruments IFRS 9 is effective from 1 January 2018. The standard, replacing the requirements of IAS 39, Financial Instruments: Recognition and Measurement, introduces new requirements for recognition, classification and measurement, a new impairment model for financial assets based on expected credit losses, and simplified hedge accounting. Any changes to the classification and measurement of financial instruments are applied retrospectively by adjusting opening retained earnings at 1 January 2018. There is no requirement to restate comparatives for prior periods. The Group has determined that there is no adjustment to retained earnings on transition to IFRS 9. IFRS 15, Revenue from Contracts with Customers IFRS 15 is effective from 1 January 2018. The standard requires the identification of performance obligations in contracts with customers and allocation of the total contractual value to each of the performance obligations identified. Revenue is recognised as each performance obligation is satisfied either at a point in time or over time. The standard will replace IAS 11, Construction Contracts, IAS 18, Revenue, and all other existing revenue accounting requirements within IFRS. The impact of the adoption of IFRS 15 on BAE Systems is set out in note 34. IFRS 16, Leases IFRS 16 is effective from 1 January 2019. The standard, which replaces IAS 17, Leases, was EU endorsed in October 2017. Whilst lessor accounting is similar to IAS 17, lessee accounting is significantly different. Under IFRS 16, the Group will recognise within the balance sheet a right-of-use asset and a lease liability for future lease payments in respect of all leases unless the underlying assets are of low value or the lease term is 12 months or less. Within the income statement, rental expense on the impacted leases will be replaced with depreciation on the right-of-use asset and interest expense on the lease liability. As set out in note 32, BAE Systems has operating lease commitments totalling £1.6bn at 31 December 2017 and, therefore, IFRS 16 will have a material impact on the Group. The implications of the standard are currently under review and the Group has not yet determined which transition option will be applied. As the impact of transition is dependent on the option chosen, the Group is unable to quantify the effect at this time. Consolidation The financial statements of the Group consolidate the results of the Company and its subsidiary entities, and include its share of its joint ventures’ results accounted for under the equity method. A subsidiary is an entity controlled by the Group. The Group controls a subsidiary when it is exposed, or has the rights, to variable returns from its involvement with the subsidiary and has the ability to affect those returns through its power over the subsidiary. The results of subsidiaries are included in the income statement from the date of acquisition. Intra-group balances and transactions, and any unrealised income and expenses arising from intra-group transactions, are eliminated in preparing the consolidated financial statements. Joint ventures are accounted for under the equity method where the Consolidated income statement includes the Group’s share of their profits and losses, and the Consolidated balance sheet includes its share of their net assets within equity accounted investments. The assets and liabilities of overseas subsidiaries and equity accounted investments are translated at the exchange rates ruling at the balance sheet date. The income statements of such entities are translated at average rates of exchange during the year. All resulting exchange differences are recognised directly in a separate component of equity. Translation differences that arose before the transition date to IFRS (1 January 2004) are presented in equity, but not as a separate component. When a foreign operation is sold, the cumulative exchange differences recognised in equity since 1 January 2004 are recognised in the income statement as part of the profit or loss on sale.