RBS 2003 Annual Report Download - page 62

Operating and financial review continued
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Operating and financial review
and ability to hold to maturity. Trading financial assets are held
for the purpose of selling in the near term. IFRS allows any
financial asset to be designated as fair value through profit and
loss on initial recognition. Unquoted debt financial assets that
are not classified as held-to-maturity, held for trading or
designated as fair value through profit or loss are categorised
as loans and receivables. All other financial assets are
classified as available-for-sale.
Effective interest rate and lending fees – under UK GAAP, loan
origination fees are recognised when receivable unless they
are charged in lieu of interest. IFRS requires origination fees to
be deferred and recognised as an adjustment to the effective
interest rate on the related financial asset. The effective interest
rate is the rate that discounts estimated future cash flows over
an instrument’s expected life to its net carrying value. It takes
into account all fees and points paid that are an integral part of
the yield, transaction costs and all other premiums and
discounts. Under IFRS, the carrying value of a financial
instrument held at amortised cost is calculated using the
effective interest method.
Loan impairment – under UK GAAP, provisions for bad and
doubtful debts are made so as to record impaired loans at their
ultimate net realisable value. IFRS require impairment losses
on financial assets carried at amortised cost to be measured
as the difference between the asset’s carrying amount and the
present value of estimated future cash flows discounted at the
asset’s original effective interest rate. Impairment must be
assessed individually for individually significant assets but can
be assessed collectively for other assets.
Financial instruments: financial liabilities – IFRS require all
financial liabilities to be measured at amortised cost except
those held for trading and those that were designated as fair
value through profit and loss on initial recognition. Under UK
GAAP, short positions in securities and trading derivatives are
carried at fair value, all other financial liabilities are recorded at
amortised cost.
Liabilities and equity – under UK GAAP, all issued shares are
classified as shareholders’ funds, and analysed between equity
and non-equity interests. There is no concept of non-equity
shares in IFRS. Instruments are classified between equity and
liabilities in accordance with the substance of the contractual
arrangements. A non-derivative instrument is classified as equity
if it does not include a contractual obligation either to deliver
cash or to exchange financial instruments with another entity
under potentially unfavourable conditions, and if the instrument
will or may be settled by the issue of equity, settlement does
not involve the issue of a variable number of shares.
Derivatives and hedging – under UK GAAP, non-trading
derivatives are accounted for on an accruals basis in
accordance with the accounting treatment of the underlying
transaction or transactions being hedged. If a non-trading
derivative transaction is terminated or ceases to be an effective
hedge, it is re-measured at fair value and any gain or loss
amortised over the remaining life of the underlying transaction
or transactions being hedged. If a hedged item is
derecognised the related non-trading derivative is remeasured
at fair value and any gain or loss taken to the profit and loss
account. Under IFRS, all derivatives are measured at fair value.
Hedge accounting is permitted for three types of hedge
relationship: fair value hedge – the hedge of changes in the
fair value of a recognised asset or liability or firm commitment;
cash flow hedge - the hedge of variability in cash flows from a
recognised asset or liability or a forecast transaction; and the
hedge of a net investment in a foreign entity. In a fair value
hedge the gain or loss on the derivative is recognised in the
profit and loss account as it arises offset by the corresponding
gain or loss on the hedged item attributable to the risk hedged.
In a cash flow hedge and in the hedge of a net investment in a
foreign entity, the element of the derivative’s gain or loss that is
an effective hedge is recognised directly in equity. The
ineffective element is taken to the profit and loss account.
Certain conditions must be met for a relationship to qualify for
hedge accounting. These include designation, documentation
and prospective and actual hedge effectiveness.
Offset – for a financial asset and financial liability to be offset,
IFRS require that an entity must intend to settle on a net basis
or to realise the asset and settle the liability simultaneously.
However, under UK GAAP an intention to settle net is not a
requirement for set off, although the entity must have the ability to
insist on net settlement and that ability is assured beyond doubt.
Leasing – under UK GAAP, finance lease income is recognised
so as to give a level rate of return on the net cash investment
in the lease. IFRS require a level rate of return on the net
investment in the lease. This means that under UK GAAP tax
cash flows are taken into account in allocating income but they
are not under IFRS.
US GAAP
For a discussion of recent developments in US GAAP relevant
to the Group, see Note 53 on the accounts.