RBS 2003 Annual Report Download - page 189

187
Annual Report and Accounts 2003
Notes on the accounts
actuary. US GAAP prescribes the method of actuarial
valuation and also requires assets to be assessed at fair
value and the assessment of liabilities to be based on
current interest rates. Additionally, under US GAAP a
minimum additional liability must be recognised if the
accumulated benefit obligation exceeds the fair value of
plan assets and the Group has recorded a prepaid
pension cost or has an accrued liability that is less than the
unfunded accumulated benefit. This minimum additional
liability represents the underfunding of the scheme on an
accumulated benefit obligation basis, together with an
amount equal to the pension prepayment. Movements in
the minimum additional liability, together with the related
deferred tax, are recognised through other comprehensive
income as a deduction from equity.
(h) Long-term assurance business
The shareholders’ interest in the long-term assurance fund
is valued as the discounted value of the cash flows
expected to be generated from in-force policies together
with net assets in excess of the statutory liabilities. Under
US GAAP, for traditional business, premiums are
recognised as revenue when due from the policyholders.
Costs of claims are recognised when insured events occur.
A liability for future policy benefits is established based
upon the present value of future benefits less the present
value of future net premiums. Acquisition costs for
traditional business contracts are charged to the profit and
loss account in proportion to premium revenue recognised.
For unit-linked business, premiums and front-end load-type
charges receivable from customers and acquisition costs
relating to the acquisition of new contracts are capitalised
and depreciated in proportion to the present value of
estimated gross profits. Costs of claims are recognised
when insured events occur.
(i) Extinguishment of liabilities
Under UK GAAP, recognition of a financial liability ceases
once any transfer of economic benefits to the creditor is no
longer likely. Under US GAAP, a financial liability is
derecognised only when the creditor is paid or the debtor
is legally released from being the primary obligator under
the liability, either judicially or by the creditor.
(j) Leasing
In accordance with UK GAAP, the Group’s accounting
policy for finance lease income receivable is to allocate
total gross earnings to accounting periods so as to give a
constant periodic rate of return on the net cash investment,
and certain operating lease assets are depreciated on a
reverse-annuity basis. Under US GAAP, finance lease
income is recognised so as to give a level rate of return on
the investment in the lease but without taking into account
the associated tax flows, and all operating lease assets are
depreciated on a straight-line basis.
(k) Securities
Under UK GAAP, the Group’s debt securities and equity
shares are classified as being held as investment
securities or for dealing purposes. Investment securities
are stated at cost less provision for any permanent
diminution in value. Premiums and discounts on dated debt
securities are amortised to interest income over the period
to maturity. Securities held for dealing purposes are carried
at fair value with changes in fair value recognised in the
profit and loss account. Under US GAAP, securities held by
the Group’s private equity business are considered to be
held by investment companies and are carried at fair value,
with changes in fair value being reflected in net income.
The Group’s other investment debt securities and
marketable investment equity shares are classified as
available-for-sale securities with unrealised gains and
losses reported in a separate component of equity.
(l) Derivatives and hedging activities
SFAS 133 ‘Accounting for Derivative Instruments and
Hedging Activities’ was effective for the Group’s US GAAP
information from 1 January 2001. The Group has not made
changes in its use of non-trading derivatives to meet the
hedge criteria of SFAS 133. As a result, from 1 January
2001, for US GAAP purposes, the Group’s portfolio of non-
trading derivatives has been remeasured to fair value and
changes in fair value reflected in net income. Under UK
GAAP, these derivatives continue to be classified as non-
trading and accounted for in accordance with the underlying
transaction or transactions being hedged. SFAS 133 does
not permit a non-derivative financial instrument to be
designated as the hedging instrument in a fair value hedge
of the foreign exchange exposure of available-for-sale
securities. The Group’s UK and US GAAP reconciliations
also reflect transition adjustments on initial application of
SFAS 133. These adjustments were: a cumulative-effect-
type adjustment increasing net income by £45 million (£65
million less tax of £20 million); and a cumulative-effect-type
adjustment decreasing other comprehensive income by
£51 million (£73 million less tax of £22 million). SFAS 133
also requires derivatives embedded in other financial
instruments to be accounted for on a stand-alone basis if
they have economic characteristics and risks that differ
from those of the host instrument.
US GAAP does not permit a profit or loss to be recognised
on transacting a derivative unless its valuation is based on
observable market data. There is no similar requirement
under UK GAAP. Inception profits and losses reflecting the
application of the Group’s usual pricing methodologies are
recognised as they arise.
(m) Software development costs
Under UK GAAP, most software development costs are
written off as incurred. Under US GAAP, certain costs
relating to software developed for own use that are
incurred after 1 January 1999 are capitalised and
depreciated over the estimated useful life of the software.
(n) Stock-based compensation
Under UK GAAP, no compensation expense is recognised
for the Group’s executive share option schemes, under
which options are granted at the higher of nominal value
and market value on the date of grant and for the Group’s