Notes to the Financial Statements

1. GENERAL

Severočeské doly a.s. (“Severočeské doly” or “the Company”) is a Czech Republic joint-stock company, which was established on January 1, 1994 and its registered seat is in Chomutov, Czech Republic. Prior to January 1, 1994, the Company was a state owned enterprise operating in the Czech Republic as Severočeské hnědouhelné doly, s.p. As of December 31, 2001 the state represented by National Property Fund held 55.38% of its shares.

Severočeské doly is a mining company which has approximately 44. 38% market share in the Czech Republic. The Company has an agreement with ČEZ, a.s. , the dominant electricity producer in the Czech Republic and a holder of 37.21% of the Company’s outstanding shares, to supply lignite to ČEZ’s five fossil power plants in the North Bohemia region and certain large fossil power plants elsewhere in the Czech Republic. As a result, approximately 80% of the lignite production was supplied to ČEZ, a.s., which represented 61% of ČEZ’s coal consumption. The Company operates two separate mines;the Nástup Tušimice (“DNT”) mine and the Bílina (“DB”) mine. The geological reserves of the mines amount to 1,090 million tons of lignite from which 592 million tons still can be mined. Annual production of the mines is about 23 million tons of lignite, with an overburden roof close to 98 million cubic meters of earth.

The Company also operates railway lignite product transportation.

The financial statements were authorised for issue by Erich Grünbaum, Chief Financial Officer of Severočeské doly a.s., on February 22, 2002.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies adopted in preparing the financial statements of Severočeské doly are as follows:

Basis of Preparation

The accompanying financial statements are prepared in accordance with International Financial Reporting Standards (“IFRS”), as published by the International Accounting Standards Board, effective as of December 31, 2001.
The financial statements are prepared under the historical cost convention, except that investments held for trading and available-for-sale investments are stated at their fair value (see Note 5).
The Company did not prepare consolidated financial statements, because the impact of consolidation on the financial statements would not be significant. The investments in subsidiaries and associates are included in financial investments and are stated at cost net of provision for diminution in value (see Note 5).

Basis of Accounting

The Company maintains its books and records in accordance with accounting principles and practices mandated by the Czech Law on Accounting. Czech Accounting Standards and IFRS differ in certain respects. The accompanying financial statements reflect certain adjustments and reclassifications not recorded in the accounting records of the Company in order to conform the Czech statutory balances to financial statements prepared in accordance with IFRS issued by the International Accounting Standards Committee. The adjustments are summarized in Note 19.

Change in Accounting Principle

Following the implementation of IAS 39, Financial Instruments: Recognition and Measurement, available-for-sale investments are carried at fair value. The opening balance of equity (retained earnings) as of January 1, 2001 has been adjusted. Prior year comparative figures have not been restated. Changes in fair values in 2001 resulted in a net gain of CZK 31 million.

Measurement currency

Based on the economic substance of the underlying events and circumstances relevant to the Company, the measurement currency of the Company has been determined to be CZK.

Estimates

The preparation of financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the year. Actual results could differ from those estimates.

Revenue Recognition

Revenue is recognised when it is probable that the economic benefits associated with the transaction will flow to the enterprise and the amount of the revenue can be measured reliably. Sales are recognised net of sales taxes and discounts.
Revenue from sales of goods are recognised when delivery has taken place and transfer of risks and rewards has been completed.
Revenues from sales of services are recognized on providing services to third parties.
Interest is recognised on a time proportion basis that reflects the effective yield on the asset.
Dividends are recognised when the shareholder's right to receive payment is established.

Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment loss. When assets are sold or retired, their cost and accumulated depreciation are eliminated from the accounts and any gain or loss resulting from their disposal is included in the income statement.
The initial cost of property, plant and equipment comprises its purchase price, including import duties and non-refundable purchase taxes and any directly attributable costs of bringing the asset to its working condition and location for its intended use. The original cost also includes the estimated cost of dismantling and removing the asset and restoring the site to the extent that it is recognised as a provision under IAS 37, Provisions, Contingent Liabilities and Contingent Assets.
Expenditures incurred after the fixed assets have been put into operation, such as repairs and maintenance and overhaul costs, are normally charged to income in the period in the costs are incurred. In situations where it can be clearly demonstrated that the expenditures have resulted in an increase in the future economic benefits expected to be obtained from the use of an item of property, plant and equipment beyond its originally assessed standard of performance, the expenditures are capitalised as an additional cost of property, plant and equipment.

Depreciation is computed on a straight-line basis over the following estimated useful lives:

Financial Investments

The company adopted IAS 39, Financial Instruments: Recognition and Measurement as of January 1, 2001. As a result, financial investments are classified into the following categories: held-to-maturity, trading and available-for-sale. Investments with fixed or determinable payments and fixed maturity that the Company has the positive intent and ability to hold to maturity other than loans and receivables originated by the Company are classified as held-to-maturity investments. Investments acquired principally for the purpose of generating a profit from short-term fluctuations in price are classified as trading. All other investments, other than loans and receivables originated by the Company, are classified as available-for-sale.
Held-to-maturity investments are included in non-current assets unless they mature within 12 months of the balance sheet date. Investments held for trading are included in current assets. Available-for-sale investments are classified as current assets if management intends to realise them within 12 months of the balance sheet date. All purchases and sales of investments are recognised on the settlement date.
Investments are initially measured at cost, which is the fair value of the consideration given for them, including transaction costs.
Available-for-sale and trading investments are subsequently carried at fair value, without any deduction for transaction costs, by reference to their quoted market price at the balance sheet date.
Changes in the fair values of available-for-sale and trading investments are included in investment income, net.
Held-to-maturity investments are carried at amortised cost using the effective interest rate method.
Investments in subsidiaries and associates are recorded at acquisition cost, or the underlying book value of the holdings if lower, and the difference is considered a temporary decline in value and adjusted through an allowance account.

Receivables, Payables and Accruals

Receivables are stated at the fair value of the consideration given and are carried at amortised cost, after provision for impairment. At December 31, 2001 and 2000 the provision for impairment of receivables amounted to CZK 158 and 170 million, respectively.
Payables are recorded at invoiced values and accruals are reported at expected settlement values.

Cash and Cash Equivalents

Cash includes cash on hand and cash with banks. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash with original maturities of three months or less and that are subject to an insignificant risk of change in value.

Materials and Supplies

Materials and supplies are principally composed of plant maintenance materials and spare parts. Cost is determined at the lower of cost. These materials are recorded in inventory when purchased and then expensed or capitalized to plant, as appropriate, when used. The Company records a provision for obsolete inventory as such items are identified. An accumulated provision for obsolete stocks of CZK 63 and 64 million was created agaianst inventory as of December 31, 2001 and 2000, respectively.

Intangible Assets

Intangible assets consist mainly of software and are valued at their acquisition cost and related expenses. Intangible assets are amortised on a straight-line basis over the best estimate of their useful lives. The amortisation period and the amortisation method are reviewed annually at each financial year-end.

Stripping Costs

Stripping costs are charged to income over the period of 15 years commencing 1991.

Income Taxes

The provision for corporate tax is calculated in accordance with Czech tax regulations and is based on the income or loss reported under Czech accounting regulations, adjusted for appropriate permanent and temporary differences from Czech taxable income. In the Czech Republic, income taxes are calculated on an individual company basis as the tax laws do not permit consolidated tax returns. Current income taxes are provided at a rate of 31% for the years ended December 31, 2001 and 2000 after adjustments for certain items which are not deductible for taxation purposes.
Certain items of income and expense are recognized in different periods for tax and financial accounting purposes. Deferred income taxes are provided on temporary differences between financial statement and taxable income at the subsequent years tax rate using the liability method. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Income tax rates are published the year preceding their effectiveness and for 2002 the rate will be 31% (see Note 12).
Deferred tax assets and liabilities are recognized regardless of when the timing difference is likely to reverse. Deferred tax assets and liabilities are not discounted. Deferred tax assets are recognized when it is probable that sufficient taxable profits will be available against which the deferred tax assets can be utilized. A deferred tax liability is recognized for all taxable temporary differences, unless the deferred tax liability arises from goodwill for which amortization is not deductible for tax purposes.
Current tax and deferred tax are charged or credited directly to equity if the tax relates to items that are credited or charged, in the same or a different period, directly to equity.

Foreign Currency Transactions

Asset acquisitions or production costs which were denominated in foreign currencies were translated to Czech crowns at the exchange rates prevailing at the date of each acquisition or at the date on which the related items were included in assets.
Foreign currency on hand, bank accounts, receivables and payables denominated in foreign currencies are translated to Czech crowns at the exchange rates existing at the transaction date and are adjusted at year-end to the exchange rates at that date as published by the Czech National Bank.
Exchange rate differences arising on settlement of transactions or on reporting foreign currency transactions at rates different from those at which they were originally recorded are included in the Statement of Income as they occur.

Provision for Decommissioning, Reclamation and Mining Damages

A provision is recognised when, and only when, the Company has a present obligation (legal or constructive) as a result of a past event and it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. Provisions are reviewed at each balance sheet date and adjusted to reflect the current best estimate.
The Company has recognized provisions for its obligations to decommission and reclaim its mines at the end of their operating lives. The provisions recognized represent the best estimate of the expenditures required to settle the present obligation at the current balance sheet date. Such cost estimates, expressed at current price levels, are discounted using a long-term real rate of interest of 2.5% per annum to take into account the timing of payments. The initial discounted cost amounts are capitalized as part of property, plant and equipment and are depreciated over the lives of the mines. Each year, the provisions are increased to reflect the accretion of discount and to accrue an estimate for the effects of inflation, with the charges being recognized as a component of interest expense. The estimate for the effect of inflation is approximately 3.5%, which is based on the current risk free rate of interest of approximately 6% and the 2.5% real rate of interest.
The decommissioning and reclamation process is expected to continue for approximately a fifteen-year period subsequent to the end of operation of the mines, which is currently estimated in 2035. While the Company has made its best estimate in establishing its provisions, because of potential changes in technology as well as safety and environmental requirements, plus the actual time scale to complete decommissioning and reclamation activities, the ultimate provision requirements could either increase or decrease significantly from the Company’s current estimates.

Segments

The Company has identified only one distinguishable business segment engaged in mining and selling lignite. None of the waste disposal, transportation and blasting business segments are considered as a reportable segment as their respective segment revenues, results and total assets are immaterial compared to those of the mining segment.

Contingencies

Contingent assets and liabilities are not recognised in the financial statements. Contingent liabilities are disclosed unless the possibility of an outflow of economic resources is remote. Contingent assets are disclosed when an inflow of economic benefits is probable.

Subsequent Events

Post-year-end events that provide additional information about the company’s position at the balance sheet date (adjusting events), are reflected in the financial statements. Post-year-end events that are not adjusting events are disclosed in the notes when material.