Concepts, Rules, and Examples | WILEY IAS 2003: Interpretation and Application of International Accounting Standards

Accounting Policies

IAS 1, which applies to financial statements of all commercial, industrial, and business enterprises in general (which includes banks and similar financial institutions as well), requires that disclosure be made of all significant accounting policies that were adopted in the preparation and presentation of an entity's financial statements. To comply with the standard above and also since different banks use diverse methods for recognition and measurement of items on their financial statements, disclosure of accounting policies relating to certain important items has been prescribed by IAS 30. This will enable users of the bank's financial statements to better understand the basis of preparation of those financial statements. Specifically, disclosure of the following accounting policies is prescribed by the standard:

The accounting policy setting forth the recognition of the principal types of income. An example of this disclosure follows:

"Interest income and loan commitment fees are recognized on a time proportion basis^[1] taking into account the principal outstanding and the rate applicable. Other fee income is recognized when due."

"Accrual of interest ceases on loans placed in the nonaccrual status if in the opinion of the management the loans are unlikely to be repaid as per the terms of agreement or when the principal or interest is past due ninety days or more."^[2]

Accounting policies relating to the valuation of investments and dealing securities. An illustration follows:

Extract from "Summary of Significant Accounting Policies"

Trading investments. Trading investments are carried at fair values with any gain or loss arising from changes in fair values being taken to the Income Statement.

Note

Before amendment (consequential to the enactment of IAS 39), paragraphs 24 and 25 of IAS 30 mandated that banks disclose market values of dealing securities and marketable investment securities if these values were different from their carrying amounts in the financial statements. In order not to be inconsistent with the requirements of IAS 39 (and to conform to the current thinking on fair value accounting), the amended paragraphs 24 and 25 of IAS 30 now require disclosure of fair values of each class of its financial assets and liabilities.

Accounting policy explaining the distinction between transactions and events that result in the recognition of assets and liabilities on the balance sheet versus those that give rise to contingencies and commitments, including off-balance-sheet items. An example follows:

Extract from "Summary of Significant Accounting Policies"

Commitments. Undrawn lending facilities, such as lines of credit extended to customers, that are irrevocable according to agreements with customers (and cannot be withdrawn at the discretion of the bank), are disclosed as commitments rather than as loans and advances to customers. If, and to the extent, the facilities are utilized by customers before year-end, these will be reported as actual loans and advances.
Accounting policy that outlines the basis for the determination of
1. The provision for possible losses on loans and advances
2. Write-off of uncollectable loans and advances
- Note 1: Provision for Loan Losses. Provision is made for possible losses in relation to loans and advances to customers that have been individually reviewed and specifically identified as doubtful and is referred to as specific provision. A general provision based on experience is also made based on the risks that are likely to be present in any portfolio of bank advances that have not yet been identified specifically. Loans and advances on which all legal and other possible courses of action for recovery have been exhausted are written off as bad debts.
Accounting policy explaining the basis for determining and setting aside amounts toward general banking risks and the accounting treatment accorded to this reserve.

Regulatory bodies, such as the central bank of the country in which the bank is incorporated, or local legislation may require or allow a bank to set aside amounts for general banking risks, including future losses or other unforeseeable risks or even reserves for contingencies over and above accruals required by IAS 37. It would not be proper to allow banks to charge these additional reserves to the income statement, as this would distort the true financial position of the bank. Thus, IAS 30 requires that the above mentioned reserves be appropriated out of the retained earnings and be separately disclosed as such. An example is
- Note 1: Statutory Reserves. As required by the Companies Commercial Code of Nation XYZ, and in accordance with the bank's articles of association, 10% of the net income for the year is set aside as a statutory reserve annually. Such appropriations of net income are to continue until the balance in the statutory reserve equals 50% of the bank's paid-up capital.

Preparation and Presentation of Banks' Financial Statements

The following ground rules have been established by IAS 30 for the preparation and presentation of the financial statements of banks:

The income statement of a bank should be presented in a manner that groups income and expenses by nature and discloses the amounts of the principal types of income and expenses. This principle has been further elucidated by the standard as follows:

Disclosures in the income statement or in the footnotes should include, but are not limited to, the following items:
1. Interest and similar income
2. Interest expense and similar charges
3. Dividend income
4. Fee and commission income
5. Fee and commission expense
6. Gains less losses arising from dealing securities
7. Gains less losses arising from investment securities
8. Gains less losses arising from dealing in foreign currencies
9. Other operating income
10. Losses on loans and advances
11. General and administrative expenses
12. Other operating expenses
These disclosures, to be incorporated into the bank's income statement, are of course in addition to disclosure requirements of other international accounting standards.
Separate disclosure of the principal types of income and expenses as above is essential in order that users of the bank's financial statements can assess the performance of the bank.
To enhance financial statement transparency, IAS 30 prohibits the offsetting of income and expense items, except those relating to hedges and to assets or liabilities wherein the legal right of setoff exists and the offsetting represents the expectation as to the realization or settlement of the asset or liability. In case income and expense items were allowed to be offset, it would prevent users from assessing the return on particular classes of assets; this, in a way, would restrict users of financial statements in their assessment of the performance of the bank.
The following income statement items are, however, allowed to be presented on a net basis:
1. Gains or losses from dealings in foreign currencies
2. Gains or losses from disposals of investment securities
3. Gains or losses from disposals and changes in the carrying amount of dealing securities

Example of bank financial reporting

ABC Banking Corporation Statement of Income For the Years Ended December 31, 2003 and 2002
	2003	2002
Operating income
Interest income	$400,000	$380,000
Interest expense	(205,000)	(200,000)
Net interest income	195,000	180,000
Net income from trading securities	2,000	2,000
Net gain from dealings in foreign currencies	14,000	10,000
Net gain from disposal of available-for-sale investments	20,000	13,000
Fees and commission	50,000	40,000
Other operating income	$ 8,000	$ 8,000
	$289,000	$253,000
Operating expenses
Provision for losses on loans and advances	70,000	50,000
Provision for impairment of investments	1,000	1,000
	$ 71,000	$ 51,000
Profit from operations	$218,000	$202,000
Other income	9,000	8,000
	$227,000	$210,000
General and administration expenses	$ 80,000	$ 75.000
Depreciation on property and equipment	11,000	10,000
Provision for taxation	6,000	6,000
Net income for the year	$130,000	$119,000

The balance sheet of a bank should group assets and liabilities by nature and list them in the order of their respective liquidity. This is explained further by the standard as follows:

Disclosure of the grouping of assets and liabilities by their nature and listing them by their respective liquidity is illustrated by the standard. These are to be made either on the face of the balance sheet or in the footnotes. The following disclosures are prescribed with a provision that disclosures should include but are not limited to:

*Assets*	*Liabilities*
Cash and balances with the central bank Treasury bills and other bills eligible for rediscounting with the central bank Government and other securities held for dealing purposes Placements with, and loans and advances to, other banks Other money market placements Loans and advances to customers Investment securities	Deposits from other banks Other money market deposits Amounts owed to other depositors Certificates of deposits Promissory notes and other liabilities evidenced by paper Other borrowed funds

Assets

Liabilities

Cash and balances with the central bank

Treasury bills and other bills eligible for rediscounting with the central bank

Government and other securities held for dealing purposes

Placements with, and loans and advances to, other banks

Other money market placements

Loans and advances to customers

Investment securities

Deposits from other banks

Other money market deposits

Amounts owed to other depositors

Certificates of deposits

Promissory notes and other liabilities evidenced by paper

Other borrowed funds

These disclosures, to be incorporated into the bank's income statement, are of course in addition to disclosure requirements of other international accounting standards.

Grouping the assets and liabilities by nature does not pose a problem and, in fact, is probably the most logical way of combining financial statement items for presentation on the bank's balance sheet. For instance, deposits with other banks and loans/advances to other banks are combined and presented as a separate line item on the asset side of a bank's balance sheet and referred to as placements with other banks. These items would, however, be presented differently on financial statements of other commercial enterprises since deposits with banks in those instances would be combined with other cash and bank balances, and loans to banks would probably be classified as investments. On the other hand, balances with other banks are not combined with balances with other parts of the money market, even though by nature they are placements with other financial institutions, since this gives a better understanding of the bank's relations with and dependency on other banks versus other constituents of the money market.
Listing of assets by liquidity could be considered synonymous with listing of liabilities by maturity, since maturity is a measure of liquidity in case of liabilities. For instance, certificates of deposits are liabilities of banks and have contractual maturities of perhaps, one month, three months, six months, and one year. Similarly, there are other bank liabilities, such as promissory notes, that may not be due, perhaps, for another three years from the balance sheet date. Thus, a relative maturity analysis would suggest that the certificates of deposit be listed on the bank's balance sheet before or above the promissory notes since they would mature earlier. Similarly, assets of a bank could be analyzed based on their relative liquidity, and those assets that are more liquid than others (i.e., will convert into cash faster than others) should be listed on the balance sheet above the others. Thus, cash balances and balances with the central bank are usually listed above other assets on the balance sheets of all banks, being relatively more liquid than other assets.
Offsetting of assets against liabilities, or vice versa, is generally not allowed unless a legal right of setoff exists and the offsetting represents the expectation as to the realization or settlement of the asset or liability. This is true even in the case of other enterprises; IAS 1, which applies to all enterprises reporting in accordance with IAS, including banks, contains similar provisions.
The recently superseded IAS 25 provided that enterprises not normally distinguishing between current and long-term investments in their balance sheets were nevertheless to make such a distinction for measurement purposes. Under IAS 39, the current versus long-term distinction is no longer important, but it will instead be necessary to assign all such investments to the trading, available-for-sale, or held-to-maturity portfolios. IAS 30 stipulates that banks must disclose the market value of investments in securities if different from the carrying values in the financial statements. Since both trading and available-for-sale securities are carried in the balance sheet at fair value, this added disclosure requirement now only impacts held to maturity securities, which are maintained at amortized cost.

Example

ABC Banking Corporation Balance Sheet As at December 31, 2003 and 2002
	2003	2002
*Assets*
Cash and balances with central bank	$ 480,000	$ 370,000
Placements with other banks	3,685,000	2,990,000
Portfolio held for trading	8,286,000	6,786,000
Nontrading investments	364,000	26,000
Loans and advances, net	40,000	28,000
Investment property	358,000	283,000
Property and equipment, net	90,000	89,000
Other assets	55,000	44,000
Total assets	$13,358,000	$10,616,000
*Liabilities and Shareholders' Equity*
Liabilities:
Due to banks	$ 2,187,000	$ 998,000
Customer deposits	8,040,000	6,536,000
Long-term loan from government	1,300,000	1,380,000
Other liabilities	108,000	96,000
Total liabilities	$11,635,000	$ 8,930,000
Shareholders' Equity:
Share capital	$ 1,250,000	$ 1,250,000
Statutory reserve	73,000	60,000
Contingency reserve	29,000	12,000
General reserve	325,000	325,000
Retained earnings	46,000	39,000
Total shareholders' equity	$ 1,723,000	$ 1,686,000
Total liabilities and shareholders' equity	$13,358,000	$10,616,000
Commitments and contingent liabilities	$ 15,300,000	$12,100,000

Cash Flow Statement for Banks and Other Financial Institutions

Cash flow statements are an integral part of financial statements. Every enterprise is required to present a cash flow statement in accordance with the provisions of IAS 7.

Although the general requirements of IAS 7 are common to all enterprises, the standard does contain special provisions that are applicable only to financial institutions. These specific provisions deal with reporting of certain cash flows on a "net basis." The following cash flows are to be reported on a net basis:

Cash receipts and payments on behalf of customers when the cash flows reflect the activities of the customer rather than those of the enterprise; the standard refers to "the accepting and repayment of demand deposits of a bank"
Cash receipts and payments for the acceptance and repayment of deposits with a fixed maturity date
The placement of deposits with and withdrawal of deposits from other financial institutions
Cash advances and loans made to customers and the repayment of those advances and loans

The appendix to IAS 7 (see the discussion below) illustrates the application of the standard to financial institutions preparing cash flow statements under the direct method (for a more detailed discussion of cash flow statements, see Chapter 4).

Example of cash flow statement for banks

Neighborhood Bank Consolidated Statement of Cash Flows For the Year Ended December 31, 2003
Cash flows from operating activities:
Interest and commission receipts	$28,447
Interest payments	(23,463)
Recoveries on loans previously written off	237
Cash payments to employees and suppliers	(997)
Operating profit before changes in operating assets	4,224
(Increase) decrease in operating assets:
Placements with other banks	(650)
Deposits with Central bank for regulatory purposes	234
Funds advanced to customers	(288)
Net increase in credit card receivables	(360)
Interest receivable	(120)
Increase (decrease) in operating liabilities:
Deposits from customers	600
Balances due to other banks	(200)
Net cash from operating activities before income tax	3,440
Income taxes paid	(100)
Net cash from operating activities		$3,340
Cash flows from investing activities:
Proceeds from disposal of subsidiary Y	50
Dividends received	200
Interest received	300
Proceeds from sales of nontrading securities	1,200
Purchase of investment property	(600)
Purchase of property, plant, and equipment	(500)
Net cash from investing activities		650
Cash flows from financing activities:
Issuance of equity capital	1,000
Issue of preference shares by subsidiary undertaking	800
Dividends paid	(1,600)
Net cash from financing activities		200
Effects of exchange rate changes on cash and cash equivalents		600
Net increase in cash and cash equivalents		4,790
Cash and cash equivalents at beginning of period		4,050
Cash and cash equivalents at end of period		$8,840

Disclosure Requirements for Banks and Similar Institutions

Contingencies and commitments including off-balance-sheet items.

Contingent liabilities are possible obligations that arise from past events whose existence will be confirmed only by the ultimate outcome of one or more uncertain future events that are not wholly within the control of the enterprise. Contingent liabilities could also be present obligations that arise from past events but are not recognized either because it is not probable that an outflow of resources will be required or because the amount of the obligation cannot be measured reliably. Generally, the accounting for and disclosure of provisions and contingent liabilities has been addressed by IAS 37. Exceptions have been made in certain cases; for instance, liabilities of life insurance companies arising from insurance policies issued by them and other entities, such as retirement benefit plans, have been specifically excluded from the scope of IAS 37. However specific contingent liabilities relating to the banking industry (see list below) are required to be disclosed in accordance with the provisions of IAS 30, since provisions or contingent liabilities of banking or similar financial institutions have not specifically been excluded from the purview of IAS 37.

This means that the general principles of recognizing provisions or disclosing contingent liabilities as set forth in IAS 37 will differ for the banking industry compared to other commercial enterprises. This has raised some eyebrows, and for good reason. The often asked questions on this issue are the following: If the general principles of disclosure of contingent liabilities as set out in IAS 37 are equally applicable to banks and other similar institutions as they are applicable to other commercial enterprises, then why does IAS 30 still address this area? Is it a case of redundancy or is it there for a purpose that is not obvious? These queries are amply clarified by IAS 30, Paragraph 27, which states

...This standard is of particular relevance to banks because banks often engaged in transactions that lead to contingent liabilities and commitments, some revocable and others irrevocable, which are frequently significant in amount and substantially larger than those of other commercial enterprises.

The disclosures required in this regard are the following:

The nature and amount of commitments to extend credit that are irrevocable because they cannot be withdrawn at the discretion of the bank without incurring significant penalty or expenses
The nature and amount of contingencies and commitments arising from off-balance-sheet items, including those relating to
1. Direct credit substitutes, which include general guarantees of indebtedness, bank acceptances, and standby letters of credit, which serve as financial backup for loans and securities
2. Transaction-related contingencies, which include performance bonds, bid bonds, warranties, and standby letters of credit related to particular transactions
3. Trade-related contingencies, which are self-liquidating and short-term trade-related contingencies arising from the movement of goods, such as documentary credit wherein the underlying goods are used as security for the bank credit; sometimes referred to as trust receipts, or simply as TR
4. Sales and repurchase agreements that are not reflected or recognized on the bank's balance sheet
5. Interest and foreign exchange rate related items, which include items such as options, futures, and swaps
6. Other commitments, including other off-balance-sheet items such as revolving underwriting facilities and note issuance facilities

It is important for the users of the bank's financial statements to be cognizant about the contingencies and irrevocable commitments because these may have an effect in the future on the liquidity and solvency of the bank. For instance, undrawn facilities, to which the bank is irrevocably committed, could serve as a good example of what could happen to a bank's liquidity position if a majority of the customers utilize them at the same time, for example, when there is a sudden shortage of funds in the market, due to economic reasons or otherwise. Thus, disclosing such irrevocable commitments and contingencies, in the footnotes or elsewhere, is of paramount importance to the user of the bank's financial statements.

Also, off-balance-sheet items, such as letters of credit (LC), guarantees, acceptances, and so on, constitute an important part of the bank's business and thus should be disclosed in the financial statements, since without knowing about the magnitude of such items, a fair evaluation of the bank's financial position is not possible (mostly because it adds significantly to the level of business risk the bank is exposed to at any given point of time).

Certain items which are typically not included in the balance sheet are commonly referred to as memoranda accounts, and less frequently are called contra items. These are often interrelated items which are both contingent assets and contingent liabilities, such as bills held for collection for customers, that if and when collected will in turn be remitted to the customer and not retained by the bank. The logic is that since the asset and liability both have contingent aspects, and since the bank is effectively only acting as an agent on behalf of a customer, it is valid to exclude both elements from the statement of financial condition. The existence of such items, however, generally must be disclosed even if not formally recognized.

Example of disclosure of contingencies and commitments

	2003	2002
At December 31, 2003 and 2002, the contingent liabilities and commitments were the following (in 000s of US dollars):
Letters of credit	$10,000	$ 9,000
Guarantees	11,000	8,000
Acceptances	12,000	11,000
Bills for collection	13,000	12,000
Commitments under undrawn lines of credit	15,000	12,000
	$61,000	$52,000

Maturities of Assets and Liabilities

Information about maturities of assets and liabilities is the most important disclosures required of banks, since it gives users a concise picture of the bank's liquidity. Well managed banks typically exhibit closely aligned maturities of assets, such as loans and investments, and liabilities, such as time deposits. To the extent these are mismatched, it not only raises a liquidity (or even solvency) question, but also in periods of changing interest rates it places the bank at risk of having its normal "spread" (the difference between interest earned and interest paid) become diminished or turn negative. Since even an otherwise healthy institution, having positive net worth, can have mismatches in some of the maturities, potential problems are identified through the schedule of asset and liability maturities which would not otherwise be apparent from the financial statements.

Maturity groupings applied to assets and liabilities differ from bank to bank, and IAS 30 does not prescribe the periods but only gives examples of periods that are used in practice, as follows:

Up to one month
From one month to three months
From three months to one year
From one year to five years
From five years and above

It is imperative that the maturity periods adopted by a bank should be the same for assets and liabilities. This ensures that the maturities are matched and brings to light dependency, if any, on other sources of liquidity.

Maturities could be expressed in more than one way, for instance, by remaining period to the repayment date or by the original period to the repayment date. IAS 30 recommends that the maturity analysis of assets and liabilities be presented by the remaining period to the repayment date, as this provides the best basis to evaluate the liquidity of the bank.

In some countries time deposits could be withdrawn even on demand, and advances given by the bank may be repayable on demand, in which case, maturities according to the contractual dates should be used for the purposes of this analysis since it reflects the liquidity risks attaching to the bank's assets and liabilities.

Certain assets do not have a contractual maturity date. In all such cases the period in which these assets are assumed to mature is usually taken to be the expected date on which the assets will be realized. For instance, in the case of fixed assets that have no maturity date as such, as in the case of a certificate of deposit, the authors are of the opinion that their remaining useful lives as of the balance sheet date could be used as a measure of the maturity profile of these assets.

Example of disclosure of maturities of assets and liabilities

The maturity profile of assets and liabilities at December 31, 2003, was as follows:

		($ in thousands)
	Up to 3 months	3 months to 1 year	1 year to 5 years	Over 5 years
Assets
Cash and short-term funds	$ 10,157	$ --	$ --	$ -
Deposits with banks	298,771	--	--	-
Investments—available-for-sale	101,013	--	--	-
Trading investments	113,109	76,173
Investments—held-to-maturity	--	--	--	284,281
Accrued interest and other assets	9,919	18,681	2,150	--
Investment property	--	--	366,259	-
Fixed assets	--	--	--	57,997
Total assets	$532,269	$ 94,854	$368,409	$ 342,278
Liabilities
Deposits from banks	$105,492	$ 18,400	$ --	$ --
Customer deposits	36,062	1,033	130,127	--
Accrued interest and other payable	38,882	9,952	30,865	--
Medium-term facilities	--	250,000	330,000	--
Total liabilities	$180,436	$279,385	$490,992	$ --

Concentration of Assets, Liabilities and Off-Balance-Sheet Items

Banks are required to disclose any significant concentrations of its assets, liabilities, and off-balance-sheet items. Such disclosures are a means of identification of potential risks, if any, that are inherent in the realization of the assets and liabilities (the funds available) to the bank.

Concentration of assets, liabilities, and off-balance-sheet items could be disclosed in the following ways:

By geographical areas such as individual countries, group of countries, or regions within a country
By customer groups such as governments, public authorities, and commercial enterprises
By industry sectors such as real estate, manufacturing, retail, and financial
Other concentrations of risk that are appropriate in the circumstances of the bank

Example of disclosure of concentration of assets, liabilities, and off-balance-sheet items

	($ in thousands)
	2003			2002
	Assets	Liabilities	Off-balance-sheet	Assets	Liabilities	Off-balance-sheet
Geographical region
North America	$ 679,829	$26,103	$ 57,479	$ 681,958	$ 86,267	$ 146,099
Europe	662,259	778,470	621,316	574,699	662,690	1,117,110
Middle East	93,003	184,485	114,984	71,328	216,486	98,236
Other	279	--	--	10,525	370	198,138
Total	$1,395,370	$989,058	$793,779	$1,338,510	$965,813	$1,559,583

	($ in thousands)
	2003			2002
	Assets	Liabilities	Off-balance-sheet	Assets	Liabilities	Off-balance-sheet
Industry sector
Banking and finance	$ 314,563	$866,483	$715,141	$ 482,874	$846,513	$1,484,248
Food processing	40,535	--	--	40,777	--	--
Luxury merchandise	336,966	3,797	11,811	224,829	--	1,649
Retail	356,879	--	--	315,554	--	--
Real estate	96,743	--	63,871	68,744	--	72,947
Manufacturing and services	153,151	--	--	124,366	--	--
Other	96,533	118,779	2,956	81,366	119,300	739
Total	$1,395,370	$989,058	$793,779	$1,338,510	$965,813	$1,559,583

Losses on Loans and Advances

Loans and advances to customers may sometimes become uncollectable, and in those circumstances the bank would have to suffer losses on loans, advances, and other credit facilities. The amount of losses that are specifically identified and the potential losses not specifically identified should both be recognized as expenses and deducted from the carrying amount of the loans and advances. The assessment of these losses is dependent on management judgment and it is essential that it should be applied consistently from one period to another. Any amounts are set aside in excess of the foregoing provision for losses on loans and advances, if required by local circumstances or legislation, should be treated as an appropriation of retained earnings and are not to be included in the determination of net profit or loss for the period. Similarly, any credits resulting in the reduction of such amounts are to be credited to retained earnings.

A number of disclosure requirements are prescribed by IAS 30 in this regard, as summarized below.

The accounting policy describing the basis on which uncollectable loans and advances are recognized as an expense and written off.
Details of movements in the provision for losses on loans and advances during the period: These details should include the amount recognized as an expense in the period on account of losses on loans and advances, the amount charged in the period for loans and advances written off, and the amount credited in the period resulting from the recovery of the amounts previously written off.
The aggregate amount of the provision for losses on loans and advances at the balance sheet date.
The aggregate amount included in the balance sheet as loans and advances on which no interest has been accrued (referred to in some countries as "interest in suspense" or "reserved interest") and the basis used to determine the carrying amount of such loans and advances.

Example of disclosure of loans and advances

	2003	2002
Balance, beginning of the year	$500,000	$400,000
Provision during the year—against specific advances	50,000	50,000
Written off during the year	(10,000)	(20,000)
Balance, end of the year	$540,000	$430,000

Example of disclosure of interest in suspense

	2003	2002
Loans and advances on which interest is not taken to income	$2,000,000	$1,500,000
Changes in interest in suspense:
Balance, beginning of year	$ 500,000	$ 490,000
Reserved during the year	50,000	30,000
Released during the year	(10,000)	(20,000)
Balance, end of year	$ 540,000	$ 500,000

Related-Party Transactions

Parties are considered to be related if one has the ability to control the other or exercise significant influence over the other in making financial and operating decisions. IAS 24 requires that related-party transactions be disclosed. When a bank has entered into transactions with related parties, the nature of the relationship (e.g., director, shareholder, etc.), the type of transaction (loans and advances or off-balance-sheet financing, etc.), and the elements of the transaction should be disclosed. The elements that are to be disclosed include the bank's lending policy to related parties and, in respect of related-party transactions, the amount included in or the proportion of

Each of loans and advances, deposits and acceptances, and promissory notes; disclosures may include the aggregate amounts outstanding at the beginning and end of the year as well as changes in these accounts during the year
Each of the principal types of income, interest expense, and commissions paid
The amount of the expense recognized in the period for the losses on loans and advances and the amount of the provision at the balance sheet date
Irrevocable commitments and contingencies and commitments from off-balance-sheet items

Example of related-party disclosures

Note 5: Related-Party Transactions. The bank has entered into transactions in the ordinary course of business with certain related parties, such as shareholders holding more than 20% equity interest in the bank and with certain directors of the bank.

At December 31, 2003 and 2002, the following balances were outstanding in the aggregate in relation to those related-party transactions:

	2003	2002
Loans and advances	2,000,000	1,800,000
Customer deposits	750,000	600,000
Guarantees	3,000,000	1,500,000

For the years ended December 31, 2003 and 2002, the following income and expense items are included in the aggregate amounts arising from the above-related transactions:

	2003	2002
Interest income	300,000	270,000
Interest expense	40,000	35,000
Commissions	60,000	30,000

Disclosure of General Banking Risks

Based on local legislation or circumstances, a bank may need to set aside a certain amount each year for general banking risks, including future losses or other unforeseeable risks, in addition to the provision for losses on loans and advances explained earlier. The bank may also be required to earmark a certain amount each year as a contingency reserve, over and above the amounts accrued under IAS 10. All such amounts set aside should be treated as appropriations of retained earnings, and any credits resulting from the reduction of such amounts should be returned directly to retained earnings and not included in determination of net income or loss for the year.

Disclosure of Assets Pledged as Security

If the bank is required by law or national custom to pledge assets as security to support certain deposits or other liabilities, the bank should then disclose the aggregate amount of secured liabilities and the nature and carrying amount of the assets pledged as security.

Disclosure of Trust Activities

If a bank is holding in trust, or in any other fiduciary capacity, assets belonging to others, those assets should not be included on the bank's financial statements since they are being held on behalf of third parties such as trusts and retirement funds. If a bank is engaged in significant trust activities, this deserves disclosure of the fact and an indication of the extent of those trust activities. Such disclosure will take care of any potential liability in case the bank fails in its fiduciary capacity. The safe custody services that banks offer are not part of these trust activities.

Anticipated Revisions to IAS 30

When IAS 30 was promulgated, many of the now-extant standards had yet to be issued, and banking, as an important highly regulated industry with worldwide impact, was perhaps uniquely in need of standardized financial reporting guidance. However, by the late 1990s, many began to note that IAS 30 was in need of an overhaul, since there were growing instances of redundancies with other later standards, and in some particulars, a need for new or expanded coverage. Also, fundamental changes had been taking place in the financial services industries, and in the way in which financial institutions were managing their activities and their risk exposures.

The IASC added a project to its agenda to revise IAS 30 in 1999, and in 2000, appointed a steering committee for that purpose, including representatives of financial institutions, auditors, and bank and securities regulators. IASB has endorsed that undertaking and is continuing to use that steering committee, which has been expanded to include analysts and nonfinancial institutions, as an advisory group. While a review of IAS 30 is still a central mission, it has been tentatively concluded that the project should also consider disclosure and presentation issues that arise for all types of entities that engage in deposit taking, lending, or securities activities, whether or not regulated and supervised as banks. This is because, since IAS 30 was first released, there has been widespread dismantling of regulatory barriers in many countries, and increasing competition between banks and nonbank financial services firms and conglomerates in providing the same types of financial services. This, in turn, makes it inappropriate to limit the scope of this project to banks and similar financial institutions.

Three types of changes to the existing requirements of IAS 30 are being examined. The first would be to eliminate apparent redundancies between IAS 30 and other mostly subsequent standards. For example, the guidance in IAS 30 on the offsetting of assets and liabilities may be duplicative of that now incorporated into IAS 1 and IAS 32. The disclosures about fair values are now addressed globally by IAS 32, as are matters pertaining to the disclosure of maturities of assets and liabilities. Related-parties disclosures are set forth by IAS 24, and information regarding concentrations of credit risk is required by IAS 32. Finally, the guidance about recognition of loan losses in IAS 30 may have been superfluous due to the later issuance of IAS 39.

A second category of revisions would be done in order to bring the existing requirement under IAS 30 up to date. According to IASB, financial services industry representatives have been positive about the guidance in IAS 30 relative to balance sheet and income statement presentation, but believe that further guidance would help eliminate remaining differences across countries in reporting formats which result in costs for financial institutions operating in several jurisdictions and difficulties for users in comparing financial statements across countries. Thus, there may be need for further more detailed guidance, which would reduce or eliminate remaining variations.

Finally, a third category of changes to IAS 30 would be undertaken to enhance the quality of disclosures. Two key areas are

Disclosures supplementing the balance sheet and income statement, and
Risk exposure information

The types of risk exposures to be considered in the project include financial risks (e.g., credit, liquidity, cash flow interest rate, and market risks), solvency risk and operational risks. The IASB believes that in recent years the techniques employed by entities for measuring and managing their business activities and risk exposures have evolved rapidly, and risk management concepts and approaches that were not used ten years ago have now gained acceptance. In addition, many public and private sector initiatives have proposed significant improvements in the disclosure framework for entities undertaking deposit taking, lending and securities activities, including the original and the second Basel Capital Accords. Thus, there may be a need to consider expanding the already comprehensive set of disclosure requirements found in IAS 30.

IASB has tentatively decided that an "activity-based" approach will be followed in developing a new or revised standard; thus, any type of entity engaging in the delineated activities (deposit taking, lending, and securities) would be subject to it, whether engaging in banking or not. For example, lending activities by manufacturers would be covered by the new standard (this follows closely the decision taken in the US, where a Statement of Position by the AICPA's accounting standard-setting arm dealt with all lending activities, including that arising in the context of normal trade receivables.)

IASB has tentatively decided that this project should not specify fixed reporting formats. Instead, it should consider prescribing line items or note disclosures related to deposit taking, lending, or securities activities that should be presented in the financial statements of any entity for which that item is material. There is a perceived need to coordinate with the IASB Reporting Performance Project. Also, it was agreed that the project should develop illustrative formats for the financial statements of an entity that carries out deposit taking, lending, or securities activities as its predominant business activities (e.g., a banks and financial conglomerates).

A draft ED is being developed, which has proposed (subject to further change, of course) that

Financial assets and financial liabilities arising from deposit taking, lending and securities activities be presented on the face of the balance sheet, in order of their relative liquidity
Income and expenses arising from such activities be classified by their nature—in particular, distinguishing interest, fees and commissions, and other gains and losses arising from financial assets and financial liabilities
Certain minimum line items are to be presented on the face of the balance sheet and on the face of the income statement.

The notion of prescribing specific financial statement line items is a controversial one. Given that the scope of the project is wider than was the scope of IAS 30, there is the likelihood of interaction with the requirements of IAS 1, 32, and 39. Those standards already require disclosure of similar amounts in the notes to the financial statements. This matter will obviously be receiving further attention.

With regard to disclosure about the composition of financial assets, financial liabilities, income and expenses resulting from deposit taking, lending and securities activities, IASB provided the following insights:

If the disclosure of certain subclassifications for line items presented on the face of the balance sheet is useful to understanding the credit quality of an entity's assets, it should be integrated with the other disclosures relating to credit risk; and
When an entity undertakes a securities activity for which it has fiduciary responsibilities, the aggregate amount of financial assets involved should be disclosed.

Concerning the disclosure of narrative information and quantitative data about the various financial risk exposures—pertaining to credit, liquidity, cash flow interest rate, and market risks—and risk management policies, IASB has tentatively agreed that

Principles should be developed and the relationship with IAS 32 should be assessed to avoid overlaps.
Disclosure should be provided in the financial statements (as opposed to outside the financial statements) if such information were to be required.

Such an approach would not necessarily preclude incorporating the information in the financial statements by way of reference in the financial statements to information provided in material accompanying the financial statements.

Also proposed is disclosure of a narrative description of an entity's risk management process, and quantitative data of the entity's exposure to each significant financial risk. The draft ED proposed that quantitative information would be disclosed "through the eyes of management," with certain minimum quantitative disclosures required for each of the risks. However, IASB has expressed concern over the volume of disclosures that could result in some circumstances. There are similarities in the areas of risks to be disclosed with the existing requirements of IAS 32, and accordingly the interaction between the proposed financial risk disclosures and the requirements of IAS 32 (and whether a common set of principles for disclosure could be developed for all entities to apply) will be given attention. Under such an approach, some of the disclosure requirements in IAS 32 might need revision or clarification, and some of the more detailed disclosures proposed in the project might form application guidance.

IASB has also indicated that

Disclosure of the extent to which an entity's exposure to credit risk is protected by collateral pledged as security or any other credit enhancements should not be required.
The Advisory Group should consider further whether to use expected or contractual maturity dates when disclosing minimum quantitative information about liquidity risk in light of the guidance in IAS 32.
The Advisory Group should reconsider the proposal to disclose the weighted average effective interest rate for each major currency in which financial instruments are denominated.

On the matter of potential disclosure of information about solvency risk, the IASB tentatively supported disclosure of information about regulatory capital requirements established by legislation or other regulation. A draft amendment to IAS 1 would require that all entities disclose a narrative description of their solvency risk exposure and their objectives and significant policies for managing the risk. Disclosure of certain additional information about significant self-imposed or externally imposed financial requirements with respect to solvency risk was also proposed. IASB thus has indicated that

Disclosure of compliance with imposed financial requirements relating to solvency risk may be more appropriate in a discussion by management outside the financial statements. The Advisory Group was asked to continue developing the disclosures for input to the topic of the financial aspects of Management's Discussion and Analysis, which is being considered by a partner national standard setter.
The distinction between solvency risk and liquidity risk requires clarification; and
Disclosure information about any self-imposed financial requirements relating to solvency risk (for example, internal rate of return for business units) should not be required. The Advisory Group should consider limiting the disclosure information about any externally imposed financial requirements to situations when a regulator imposes such requirements.

Another issue is the need for disclosure of information about operational risks. The IASB's draft amendment to IAS 1 proposed that all entities disclose a narrative description of their operational risk exposure, their objectives and significant policies for managing the risk, and, when operational risk is measured, summary quantitative data of their actual risk position as at the reporting date. IASB has indicated that

Disclosure of information about operational risk may be more appropriate in a discussion by management outside the financial statements. The Advisory Group was asked to continue developing the disclosures for input to the topic of the financial aspects of Management's Discussion and Analysis, which is being considered by a partner national standard setter; and
The definition of operational risk—the risk of loss due to inadequate or malfunctioning internal processes, people and systems, or due to external events—should be clarified in order to remove any possibility of overlap with the other types of risks.

IASB has indicated that an Exposure Document will be issued in early 2003, and that a final standard on presentation and disclosure will be produced in the latter part of the year.

^[1]IAS 18 specifically requires that interest income be recognized on a time proportion basis.

^[2]In some countries this is referred to as "interest in suspense" or "reserved interest."