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Significant Accounting Principles

3. Significant Accounting Principles

a. Basis of consolidation         
             
(i) Subsidiaries            
             
 Subsidiaries are entities controlled by the Company. Control exists when the Company has the power, directly or indirectly, to govern the financial and operating policies of an entity so as to obtain benefits from its activities. In assessing control, potential voting rights that presently are exercisable or convertible are taken into account. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases.            
             
(ii) Associates            
             
 Associates are those entities in which the Group has significant influence, but not control, over the financial and operating policies.  Associates are accounted for using the equity method.  The consolidated financial statements include the Group's share of the total recognised gains and losses of associates on an equity accounted basis, from the date that significant influence commences until the date that significant influence ceases. When the Group's share of losses exceeds its interest in an associate, the Group's carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of an associate.            
             
(iii) Transactions eliminated on consolidation            
             
 Intra-group balances and any unrealised income and expenses arising from intra-group transactions, are eliminated in preparing the consolidated financial statements. Unrealised gains arising from transactions with associates are eliminated against the investment to the extent of the Group's interest in the entity. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment.            
             
b. Foreign currency            
             
(i) Foreign currency transactions            
             
 Transactions in foreign currencies are translated to the respective functional currency of Group entities at exchange rates ruling at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies at the reporting date are translated to the functional currency at the exchange rate ruling at that date. Foreign currency differences arising on re-translation are recognised in the income statement.           
             
(ii) Foreign operations            
             
 The assets and liabilities of foreign operations including goodwill and fair value adjustments arising on acquisitions are translated to Icelandic kronas at exchange rates at the reporting date. The income and expenses of foreign operations are translated to Icelandic kronas at the average exchange rate for the period.  Foreign currency differences arising on re-translation are recognised directly in a separate component of equity.            
(iii) Hedge of net investment in foreign operations            
             
 Foreign currency differences arising on the retranslation of a financial liability designated as a hedge of a net investment in foreign operation are recognised directly in equity, to the extent that the hedge is effective. To the extent that the hedge is ineffective, such differences are recognised in profit or loss. When the hedged net investment is disposed of, the cumulative amount in equity is transferred to profit or loss as an adjustment to the profit or loss on disposal.            
             
c. Financial instruments            
             
(i) Non-derivative financial instruments            
             
 "Non-derivative financial instruments comprise trade and other receivables, cash and cash equivalents, loans and borrowings, and trade and other payables.

Non-derivative financial instruments are recognised initially at fair value plus, for instruments not at fair value through profit or loss, any directly attributable transaction costs, except as described below. Subsequent to initial recognition non-derivative financial instruments are measured as described below."

            
 A financial instrument is recognised if the Group becomes a party to the contractual provisions of the instrument. Financial assets are derecognised if the Group’s contractual rights to the cash flows from the financial assets expire or if the Group transfers the financial asset to another party without retaining control or substantially all risks and rewards of the asset. Regular way purchases and sales of financial assets are accounted for at trade date, i.e. the date that the Group commits itself to purchase or sell the asset. Financial liabilities are derecognised if the Group’s obligations specified in the contract expire or are discharged or cancelled.            
 Cash and cash equivalents comprise cash balances and call deposits.             
             
 Accounting for finance income and expense is discussed in note 3(m).            
             
 Other non-derivative financial instruments.            
             
 Other non-derivative financial instruments are measured at amortised cost using the effective interest method, less any impairment losses.            
             
(ii) Derivative financial instruments            
             
 "The Group holds derivative financial instruments to hedge its foreign currency, fuel price and interest rate risk exposures.  Derivatives are recognised initially at fair value; attributable transaction costs are recognised in profit or loss when incurred. Subsequent to initial recognition, derivatives are measured at fair value, and changes therein are accounted for as described hereafter.

Cash flow hedges
Changes in the fair value of the derivative hedging instrument designated as a cash flow hedge are recognised directly in equity to the extent that the hedge is effective. To the extent that the hedge is ineffective, changes in fair value are recognised in profit or loss.


           
             
 "If the hedging instrument no longer meets the criteria for hedge accounting, expires or is sold, terminated or exercised, then hedge accounting is discontinued prospectively. The cumulative gain or loss previously recognised in equity remains there until the forecast transaction occurs. When the hedged item is a non-financial asset, the amount recognised in equity is transferred to the carrying amount of the asset when it is recognised. In other cases the amount recognised in equity is transferred to profit or loss in the same period that the hedged item affects profit or loss.

Economic hedges
Hedge accounting is not applied to derivative instruments that economically hedge monetary assets and liabilities denominated in foreign currencies. Changes in the fair value of such derivatives are recognised in profit or loss as foreign currency gains and losses."            
             
(iii) Compound financial instruments            
             
 "Compound financial instruments issued by the Group comprise convertible notes that can be converted to share capital at the option of the holder, and the number of shares to be issued does not vary with changes in their fair value.

The liability component of a compound financial instrument is recognised initially at the fair value of a similar liability that does not have an equity conversion option. The equity component is recognised initially at the difference between the fair value of the compound financial instrument as a whole and the fair value of the liability component. Any directly attributable transaction costs are allocated to the liability and equity components in proportion to their initial carrying amounts.

Subsequent to initial recognition, the liability component of a compound financial instruments is measured at amortised cost using the effective interest method. The equity component of a compound financial instruments is not remeasured subsequent to initial recognition."            
             
(iv) Share capital            
             
 "Incremental costs directly attributable to issue of shares are recognised as a deduction from equity.

Repurchase of share capital
When share capital recognised as equity is repurchased, the amount of the consideration paid, including directly attributable costs, is recognised as a deduction from equity. Repurchased shares are classified as treasury shares and are presented as a deduction from total equity."

            
 Dividends               
 Dividends are recognised as a decrease in equity in the period in which they are declared.            
             
d. Operating assets            
             
(i) Aircrafts and flight equipment            
             
 Aircrafts and flight equipment, e.g. aircraft engines and aircraft spare parts, are measured at cost less accumulated depreciation and impairment losses. When aircrafts are acquired the purchase price is divided between the aircraft itself and engines.  Aircrafts are depreciated over the estimated useful life of the relevant aircraft until a residual value is met.  Engines are depreciated according to flown hours. When an engine is overhauled the cost of the overhaul is capitalised and the remainder of the cost of the previous overhaul that has not already been depreciated, if there is any, is expensed in full.          
             
(ii) Buildings and other operating assets            
             
 Buildings and other operating assets are stated at cost less accumulated depreciation and impairment losses.            
             
(iii) Subsequent costs            
             
 The cost of replacing part of an item of operating asset is recognised in the carrying amount of the item if it is probable that the future economic benefits embodied with the item will flow to the Group and the cost of the item can be measured reliably. All other costs are recognised in the income statement as an expense as incurred.             
             
(iv) Depreciation            
             
 Depreciation is recognised in the income statement on a straight-line basis over the estimated useful lives of each item of operating assets. The estimated useful lives are as follows:            

Aircrafts and flight equipment

        

  Useful life 
 Aircrafts and flight equipment  10-25 years
 Engines  Flying hrs.
 Buildings  15-50 years
Other property and equipment 3-8 years


                                    
 The depreciation method, useful lives and residual values are reassesed at each reporting date.            
             
e. Intangible assets            
             
(i) Goodwill and other intangible assets with indefinite useful lives             
             
 "All business combinations are accounted for by applying the purchase method. Goodwill represents amounts arising on acquisition of subsidiaries. In respect of business acquisitions goodwill represents the difference between the cost of the acquisition and the fair value of the net identifiable assets acquired.

Goodwill is stated at cost less any accumulated impairment losses. Goodwill is allocated to cash-generating units and is tested annually for impairment.

Negative goodwill arising on an acquisition is recognised directly in profit or loss."            
             
 Goodwill, trademarks and slots with indefinite useful lives are stated at cost less accumulated impairment losses.             
             
(ii) Other intangible assets            
             
 Other intangible assets are measured at cost less accumulated amortisation and impairment losses.  Amortisation is recognised in the income statement on a straight-line basis over the estimated useful lives as follows:            
  

  Useful life     
 Software  3 years    
 Customer relations  7-10 years    
 Favourable aircraft lease contracts  2-3 years    
Other intangible assets 6-10 years

            
             
(iii) Subsequent expenditure            
             
 Subsequent expenditure is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed as incurred.             
             
f. Prepaid aircraft acquisitions            
             
 Prepaid aircraft acquisitions consist of pre-payments on Boeing aircrafts that are still to be delivered.   Borrowing cost related to these pre-payments is capitalised based on the interest rate on the directly related financing.             
             
g. Inventories            
             
 "Goods for resale and supplies are measured at the lower of cost and net realisable value.  The cost of inventories is based on first-in first-out principle and includes expenditure incurred in acquiring the inventories and bringing them to their existing location and condition.  Net realisable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and selling expenses. Aircraft equipment is capitalised at the foreign exchange rate ruling at the date of acquisition. "            
             
h. Impairment            
             
(i) Financial assets            
             
 "A financial asset is considered to be impaired if objective evidence indicates that one or more events have had a negative effect on the estimated future cash flows of that asset.

An impairment loss in respect of a financial asset measured at amortised cost is calculated as the difference between its carrying amount, and the present value of the estimated future cash flows discounted at the original effective interest rate.

Individually significant financial assets are tested for impairment on a individual basis. The remaining financial assets are assessed collectively in groups that share similar credit risk characteristics.

All impairment losses are recognised in profit or loss. Any cumulative loss in respect of an available-for-sale financial asset recognised previously in equity is transferred to profit or loss."            
             
 "An impairment loss is reversed if the reversal can be related objectively to an event occurring after the impairment loss was recognised. For financial assets measured at amortised cost, the reversal is recognised in profit or loss."            
             
(ii) Non-financial assets            
             
 "The carrying amounts of the Group’s non-financial assets, other than inventories and deferred tax assets, are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists then the asset’s recoverable amount is estimated. For goodwill and intangible assets that have indefinite lives or that are not yet available for use, recoverable amount is estimated at each reporting date.

An impairment loss is recognised if the carrying amount of an asset or its cash-generating unit exceeds its recoverable amount. A cash-generating unit is the smallest identifiable asset group that generates cash flows that largely are independent from other assets and groups. Impairment losses are recognised in profit or loss. Impairment losses recognised in respect of cash-generating units are allocated first to reduce the carrying amount of any goodwill allocated to the units and then to reduce the carrying amount of the other assets in the unit (group of units) on a pro rata basis."           
             
 "The recoverable amount of an asset or cash-generating unit is the greater of its value in use and its fair value less costs to sell. 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.

An impairment loss in respect of goodwill is not reversed. In respect of other assets, impairment losses recognised in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised."            
             
i. Provisions            
             
 A provision is recognised in the balance sheet when the Group has a present legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability.    

        
(i) Frequent flyer program            
 The deferred income method is used when accounting for frequent flyer programs.  This means that revenue from sold points is recognised immediately and passenger revenue for flights on which passengers earn points is recognised in accordance with the airline´s revenue recognition policy.  A provision is then made based on total points unearned and the average price of point based on points needed to buy tickets with the airline.  The provision is extinguished when the passenger utilizes the points or when the points expire.            

(ii) Overhaul commitments relating to aircrafts under operating lease            
 With respect to the Group´s operating lease agreements, where the group has a commitment to maintain the aircraft, provision is made during the lease term for the obligation based on estimated future cost of major airframe and certain engine maintenance checks by making appropriate charges to the income statement calculated by reference to the number of hours or cycles operated during the year.              
             
j. Deferred income            
             
 Sold unused tickets and other prepayments are presented as deferred income in the balance sheet.            
             
k. Operating income            
             
(i) Transport revenue            
             
 Passenger ticket sales are not recognised as revenue until transportation has been provided. Sold documents not used within nine months from the month of sale are recognised as revenue. Revenue from mail and cargo transportation is recognised in the income statement after transportation has been provided.            
             
(ii) Aircraft and aircrew lease            
             
 Revenue from aircraft and aircrew lease is recognised in the income statement when the service has been provided at the end of each charter flight.           
             
(iii) Other operating revenue            
             
 Revenue from other services rendered is recognised in the income statement when the service has been provided.             
             
 Gain on sale of operating assets is recognised in the income statement after the risks and rewards of ownership have been transferred to the buyer.            
             
l. Expenses            
             
(i) Operating lease payments            
             
 Payments made under operating leases are recognised in the income statement on a straight-line basis over the term of the lease.              
             
m. Finance income and expenses            
             
 "Finance income comprises interest income on funds invested, dividend income, foreign currency gains, and gains on hedging instruments that are recognised in profit or loss.  Interest income is recognised as it accrues, using the effective interest method.  Dividend income is recognised on the date that the Group´s right to receive payment is established.

Interest income is recognised in the income statement as it accrues, using the effective interest method. Dividend income is recognised in the income statement on the date the entity’s right to receive payments is established. "            
             
 Finance expenses comprise interest expense on borrowings, unwinding of the discount on provisions, foreign currency losses, impairment losses recognised on financial assets, and losses on hedging instruments that are recognised in profit or loss.              

n. Income tax expense            
             
 "Income tax on the profit or loss for the year comprises only deferred tax.

Current tax is expected tax payable on the taxable income for the period, using tax rates enacted or substantially enacted at the reporting date, and any adjustment to tax payable in respect of previous years."            
             
 Deferred tax is provided using the balance sheet  method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The following temporary differences are not provided for: goodwill not deductible for tax purposes, the initial recognition of assets or liabilities that affect neither accounting nor taxable profit, and differences relating to investments in subsidiaries to the extent that they will probably not reverse in the foreseeable future. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted at the reporting date.            
             
o. Earnings per share            
             
 The Group presents basic and diluted earnings per share (EPS) data for its ordinary shares. Basic EPS is calculated by dividing the profit attributable to ordinary shareholders of the Company by the weighted average number of ordinary shares outstanding during the year.  Diluted EPS is determined by adjusting the profit or loss attributable to ordinary shareholders and the weighted average number of ordinary shares outstanding for the effects of all dilutive potential ordinary shares.             
             
p. Segment reporting            
             
 A segment is a distinguishable component of the Group that is engaged in providing products or services (business segments) and which is subject to risks and rewards that are different from those of other segments.  The Group´s primary format for segment reporting is based on business segments. The major revenue-earning asset of the Group is the aircraft fleet, the majority of which are registered in Iceland. Since the Group's aircraft fleet is employed flexibly across its route network, there is no suitable basis of allocating such assets and related liabilities to geographical segments.            
             
q. New standards and interpretaions not yet adopted            
             
 "A number of new standards, amendments to standards and interpretations are not yet effective for the year ended 31 December 2006, and have not been applied in preparing these consolidated financial statements:

IFRS 7 Financial Instruments: Disclosures and the Amendment to IAS 1 Presentation of Financial Statements: Capital Disclosures require extensive disclosures about the significance of financial instruments for an entity’s financial position and performance, and qualitative and quantitative disclosures on the nature and extent of risks. IFRS 7 and amended IAS 1, which become mandatory for the Group’s 2007 financial statements, will require extensive additional disclosures with respect to Group’s financial instruments and share capital.

IFRS 8 Operating Segments sets out requirements for disclosure of information about an entity’s operating segments and also about the entity’s products and services, the geographical areas in which it operates, and its major customers.  If adopted by the EU, IFRS 8, which becomes mandatory for the Group's 2009 financial statements, is not expected to have any impact on the consolidated financial statements."

            
 IFRIC 7 Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies addresses the application of IAS 29 when an economy first becomes hyperinflationary and in particular the accounting for deferred tax. IFRIC 7, which becomes mandatory for the Group’s 2007 financial statements, is not expected to have any impact on the consolidated financial statements.            
             
 "IFRIC 8 Scope of IFRS 2 Share-based Payment addresses the accounting for share-based payment transactions in which some or all of goods or services received cannot be specifically identified. IFRIC 8 will become mandatory for the Group’s 2007 financial statements, with retrospective application required. The Group has not yet determined the potential effect of the interpretation.

IFRIC 9 Reassessment of Embedded Derivatives requires that a reassessment of whether embedded derivative should be separated from the underlying host contract should be made only when there are changes to the contract. IFRIC 9, which becomes mandatory for the Group’s 2007 financial statements, is not expected to have any impact on the consolidated financial statements.

IFRIC 10 Interim Financial Reporting and Impairment prohibits the reversal of an impairment loss recognised in a previous interim period in respect of goodwill, an investment in an equity instrument or a financial asset carried at cost. IFRIC 10 will become mandatory for the Group’s 2007 financial statements. "            
             
 IFRIC 11 IFRS 2 Group and Treasury Share Transactions deals with how certain types of agreements on securities related payments shall be recognized in the financial statements of a company and its subsidiaries. If adopted by the EU, IFRIC 11 applies for accounting periods starting as of March 1, 2007.            
             
 IFRIC 12 Service Concession Arrangements.  If adopted by the EU, IFRIC 12 will become mandatory for the Group's 2007 financial statements.  IFRIC 12 is not expected to have any impact on the consolidated financial statements of the Group.            



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