ArcelorMittal South Africa 2007 Annual Report Page 98 Notes to the group and company annual financial statements continued for the year ended 31 December 2007 4. CRITICAL JUDGEMENTS In the process of applying the group’s and company’s accounting policies, management has made the following judgements that have the most significant effect on the amounts recognised in the financial statements (apart from those involving estimation, which are dealt with in note 5). 4.1 Derivative and embedded derivative instruments The group and company follow the guidance of IAS 39, Financial Instruments: Recognition and Measurement, in identifying derivative contracts and contracts containing embedded derivatives. Other than for over-the-counter stand-alone derivative contracts, most of the group’s and company’s contracts encompass non-financial items. Consequently, the identification process requires significant judgement. In assessing if an embedded derivative requires separate identification and measurement from the host contract, management assesses the available facts with regards to the impact the embedded derivative instrument has on the underlying value of the host contract. Judgement was applied as to whether the correlation between the host contract and derivative instrument could be regarded as closely related. Where the correlation relationship was judged to be weak, the embedded derivative instrument is separately identified (i.e. bifurcated). In synthesising the value of a bifurcated embedded derivative, judgement is applied as to how best to model the derivative, for example, as a forward, an option etc. 4.2 Asset retirement and environmental remediation obligations Upon decommissioning of a facility or business operation, the group and company have a legal obligation with regards to the retirement of the facility and the related environmental remediation. The plant removal and housekeeping costs that are not of a legal nature, are not provided for, unless a definitive constructive obligation exists that can be subject to objective measurement and recognition criteria. Management applied its judgement and the advice received from its external environmental experts in recognising such obligations as liabilities in terms of IAS 37, Provisions, Contingent Liabilities and Contingent Assets. 4.3 Contingent liabilities and uncertain tax positions Management applied its judgement to the facts and advice it receives from its attorneys, advocates and other advisers in assessing if a loss outcome is probable, reasonably possible, or remote. Such judgements are used to determine if the obligation is recognised as a liability or disclosed as a contingent liability in terms of IAS 37, Provisions, Contingent Liabilities and Contingent Assets and IAS 12, Income Taxes. 4.4 Consolidation of subsidiaries and special purpose entities In assessing all its major procurement, sales and investment relationships, management has applied its judgement in the assessment of whether the commercial and economic relationship is tantamount to de facto control. Based on the facts and management’s judgement, if such control exists, the relationship of control is recognised in terms of IAS 27, Consolidated and Separate Financial Statements, and SIC-12, Consolidation – Special Purpose Entities. 4.5 Equity-settled compensation benefits Share-based payment transactions in which an entity receives services as consideration for its own equity instruments should be accounted for as equity-settled. This applies regardless of whether the entity chooses or is required to buy those equity instruments from another party to satisfy its obligations to its employees under the share-based payment arrangement. Management has classified its share option plan as equity-settled based on its assessment of its role, that of the Management Share Trust, employees and the brokerage firm in the transactions. In applying its judgement, management consulted with external expert advisers in the share-based payment advisory industry. 4.6 Determination of the functional currencies of foreign operations IAS 21, The Effects of Changes in Foreign Exchange Rates, requires the functional currency of each individual foreign operation of the group to be the currency used in the primary economic environment in which a foreign operation operates, which it uses to primarily generate and expend cash. To aid the decision, the standard details primary, secondary and other indicators to be considered.