HSBC 2005 Annual Report Download - page 101

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Critical accounting policies
(audited information)
Introduction
The results of HSBC are sensitive to the accounting
policies, assumptions and estimates that underlie the
preparation of its consolidated financial statements.
The accounting policies used in the preparation of
the consolidated financial statements are described in
detail in Note 2 on the Financial Statements.
When preparing the financial statements, it is
the directors’ responsibility under UK company law
to select suitable accounting policies and to make
judgements and estimates that are reasonable and
prudent.
The accounting policies that are deemed critical
to HSBC’s IFRSs results and financial position, in
terms of the materiality of the items to which the
policy is applied, or which involve a high degree of
judgement and estimation, are discussed below.
Impairment of loans
HSBC’s accounting policy for losses in relation to
the impairment of customer loans and advances is
described in Note 2(f) on the Financial Statements.
Losses in respect of impaired loans are reported
in HSBC’s income statement under the caption
‘Loan impairment charges and other credit risk
provisions’. Any increase in these losses has the
effect of reducing HSBC’s profit for the period by a
corresponding amount (while any decrease in
impairment charges or reversal of impairment
charges would have the opposite effect).
Losses for impaired loans are recognised
promptly when there is objective evidence that
impairment of a loan or portfolio of loans has
occurred. Impairment losses are calculated on
individual loans and on loans assessed collectively.
Losses expected from future events, no matter how
likely, are not recognised.
Individually assessed loans
At each balance sheet date, HSBC assesses on a
case-by-case basis whether there is any objective
evidence that a loan is impaired. This procedure is
applied to all accounts that are considered
individually significant. In determining impairment
losses on these loans, the following factors are
considered:
• HSBC’s aggregate exposure to the customer;
• the viability of the customer’s business model
and the capacity to trade successfully out of
financial difficulties and generate sufficient cash
flow to service debt obligations;
• the amount and timing of expected receipts and
recoveries;
• the likely dividend available on liquidation or
bankruptcy;
• the extent of other creditors’ commitments
ranking ahead of, or pari passu with, HSBC and
the likelihood of other creditors continuing to
support the company;
• the complexity of determining the aggregate
amount and ranking of all creditor claims and
the extent to which legal and insurance
uncertainties are evident;
• the realisable value of security (or other credit
mitigants) and likelihood of successful
repossession;
• the likely deduction of any costs involved in
recovery of amounts outstanding;
• the ability of the borrower to obtain, and make
payments in, the currency of the loan if not local
currency; and
• when available, the secondary market price of
the debt.
Impairment losses are calculated by discounting
the expected future cash flows of a loan at its
original effective interest rate, and comparing the
resultant present value with the loan’s current
carrying amount. The carrying amount of impaired
loans on the balance sheet is reduced through the use
of an allowance account.
HSBC’s policy requires a review of the level of
impairment allowances on individual facilities above
materiality thresholds at least half-yearly, or more
regularly when individual circumstances require.
This will normally include a review of collateral held
(including re-confirmation of its enforceability) and
an assessment of actual and anticipated receipts.
Collectively assessed loans
Impairment is assessed on a collective basis in two
different scenarios:
• for loans subject to individual assessment, to
cover losses which have been incurred but have
not yet been identified; and
• for homogeneous groups of loans that are not
considered individually significant.