HSBC 2009 Annual Report Download - page 63

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Critical accounting policies
(Audited)
Introduction
The results of HSBC are sensitive to the accounting
policies, assumptions and estimates that underlie the
preparation of its consolidated financial statements.
The significant accounting policies used in the
preparation of the consolidated financial statements
are described 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 results and financial position, in terms
of the materiality of the items to which the policy
is applied, and which involve a high degree of
judgement including the use of assumptions and
estimation, are discussed below.
Impairment of loans and advances
HSBC’s accounting policy for losses arising from
the impairment of customer loans and advances is
described in Note 2g on the Financial Statements.
Loan impairment allowances represent
management’s best estimate of losses incurred
in the loan portfolios at the balance sheet date.
Management is required to exercise judgement
in making assumptions and estimations when
calculating loan impairment allowances on both
individually and collectively assessed loans and
advances. Of the Group’s total loans and advances
to customers before impairment allowances of
US$922 billion (2008: US$957 billion),
US$14.8 billion or 2 per cent (2008: US$7.9 billion;
1 per cent) were individually assessed for
impairment, and US$907 billion or 98 per cent
(2008: US$949 billion; 99 per cent) were
collectively assessed for impairment.
The most significant judgemental area is the
calculation of collective impairment allowances.
HSBC’s most significant geographical area of
exposure to collectively assessed loans and advances
is North America, which comprised US$219 billion
or 24 per cent (2008: US$271 billion; 29 per cent)
of HSBC’s total collectively assessed loans and
advances. Collective impairment allowances in
North America were US$13.0 billion, representing
68 per cent (2008: US$15.9 billion; 77 per cent) of
the total collectively assessed loan impairment
allowance.
HSBC uses two alternative methods to calculate
collective impairment allowances on homogeneous
groups of loans that are not considered individually
significant:
• when appropriate empirical information is
available, HSBC utilises roll-rate methodology.
This methodology employs statistical analysis
of historical data and experience of delinquency
and default to estimate the likelihood that loans
will progress through the various stages of
delinquency and ultimately prove irrecoverable.
The estimated loss is the difference between the
present value of expected future cash flows,
discounted at the original effective interest rate
of the portfolio, and the carrying amount of the
portfolio; and
• when the portfolio size is small or when
information is insufficient or not reliable
enough to adopt a roll-rate methodology, HSBC
adopts a basic formulaic approach based on
historical loss rate experience.
Both methodologies are subject to estimation
uncertainty, in part because it is not practicable to
identify losses on an individual loan basis because
of the large number of individually insignificant
loans in the portfolio.
In addition, the use of statistically assessed
historical information is supplemented with
significant management judgement to assess whether
current economic and credit conditions are such that
the actual level of inherent losses is likely to be
greater or less than that suggested by historical
experience. In normal circumstances, historical
experience provides the most objective and relevant
information from which to assess inherent loss
within each portfolio. In certain circumstances,
historical loss experience provides less relevant
information about the inherent loss in a given
portfolio at the balance sheet date, for example,
where there have been changes in economic,
regulatory or behavioural conditions which result in
the most recent trends in the portfolio risk factors
being not fully reflected in the statistical models. In
these circumstances, such risk factors are taken into
account when calculating the appropriate levels of
impairment allowances by adjusting the impairment
allowances derived solely from historical loss
experience.
This key area of judgement is subject to
uncertainty and is highly sensitive to factors such as
loan portfolio growth, product mix, unemployment
rates, bankruptcy trends, geographical concentrations,
loan product features, economic conditions such as
national and local trends in housing markets, the