HSBC 2015 Annual Report Download - page 356

Notes on the Financial Statements (continued)
1 – Basis of preparation and significant accounting policies
HSBC HOLDINGS PLC
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In the consolidated financial statements, the assets and liabilities of branches, subsidiaries, joint ventures and associates whose
functional currency is not US dollars are translated into the Group’s presentation currency at the rate of exchange at the
balance sheet date, while their results are translated into US dollars at the average rates of exchange for the reporting period.
Exchange differences arising from the retranslation of opening foreign currency net assets, and the retranslation of the results
for the reporting period from the average rate to the exchange rate at the period end, are recognised in other comprehensive
income. Exchange differences on a monetary item that is part of a net investment in a foreign operation are recognised in the
income statement of the separate financial statements and in other comprehensive income in consolidated financial
statements. On disposal of a foreign operation, exchange differences previously recognised in other comprehensive income are
reclassified to the income statement as a reclassification adjustment.
(i) Loans and advances to banks and customers
These include loans and advances originated by HSBC, not classified as held for trading or designated at fair value. They are
recognised when cash is advanced to a borrower and are derecognised when either the borrower repays its obligations or the
loans are sold or substantially all the risks and rewards of ownership are transferred. They are initially recorded at fair value
plus any directly attributable transaction costs and are subsequently measured at amortised cost using the effective interest
method, less impairment allowance.
Loans and advances are reclassified to ‘Assets held for sale’ when they meet the criteria presented in Note 23, though their
measurement remains in accordance with this policy.
HSBC may commit to underwrite loans on fixed contractual terms for specified periods of time. When the loan arising from the
lending commitment is expected to be held for trading, the commitment to lend is recorded as a derivative. On drawdown, the
loan is classified as held for trading. When HSBC intends to hold the loan, a provision on the loan commitment is only recorded
where it is probable that HSBC will incur a loss. On inception, the loan to be held is recorded at its fair value and subsequently
measured at amortised cost. For certain transactions, such as leveraged finance and syndicated lending activities, the cash
advanced may not be the best evidence of the fair value of the loan. For these loans, where the initial fair value is lower than
the cash amount advanced, the difference is charged to the income statement in other operating income. The write-down is
recovered over the life of the loan through the recognition of interest income, unless the loan becomes impaired.
(j) Impairment of loans and advances and available-for-sale financial assets
Critical accounting estimates and judgements
Impairment of loans and advances
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 estimates when calculating loan impairment allowances on
both individually and collectively assessed loans and advances. See the ‘Movement in impairment allowances by industry sector and by
geographical region’ table on page 134 for a breakdown of individual and collective impairment allowances.
Collective impairment allowances are subject to estimation uncertainty, in part because it is not practicable to identify losses on an individual
loan basis due to the large number of individually insignificant loans in the portfolio. The estimation methods include the use of statistical
analyses of historical information, supplemented with significant management judgement, to assess whether current economic and credit
conditions are such that the actual level of incurred losses is likely to be greater or less than historical experience.
Where changes in economic, regulatory or behavioural conditions result in the most recent trends in portfolio risk factors being not fully
reflected in the statistical models, risk factors are taken into account by adjusting the impairment allowances derived solely from historical
loss experience.
Risk factors include 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 level of interest rates, portfolio seasoning, account
management policies and practices, changes in laws and regulations and other influences on customer payment patterns. Different factors
are applied in different regions and countries to reflect local economic conditions, laws and regulations. The methodology and the
assumptions used in calculating impairment losses are reviewed regularly in the light of differences between loss estimates and actual loss
experience. For example, roll rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual
outcomes to ensure they remain appropriate.
For individually assessed loans, judgement is required in determining whether there is objective evidence that a loss event has occurred and,
if so, the measurement of the impairment allowance. In determining whether there is objective evidence that a loss event has occurred,
judgement is exercised in evaluating all relevant information on indicators of impairment, including the consideration of whether payments
are contractually past-due and the consideration of other factors indicating deterioration in the financial condition and outlook of borrowers
affecting their ability to pay. A higher level of judgement is required for loans to borrowers showing signs of financial difficulty in market
sectors experiencing economic stress, particularly where the likelihood of repayment is affected by the prospects for refinancing or the sale
of a specified asset. For those loans where objective evidence of impairment exists, management determine the size of the allowance
required based on a range of factors such as the realisable value of security, the likely dividend available on liquidation or bankruptcy, 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.
HSBC might provide loan forbearance to borrowers experiencing financial difficulties by agreeing to modify the contractual payment terms of
loans in order to improve the management of customer relationships, maximise collection opportunities or avoid default or repossession.
Where forbearance activities are significant, higher levels of judgement and estimation uncertainty are involved in determining their effects
on loan impairment allowances. Judgements are involved in differentiating the credit risk characteristics of forbearance cases, including