RBS 2005 Annual Report Download - page 144

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Accounting policies
Accounting policies continued
time as the hedged transaction. Hedge accounting is
discontinued if the hedge no longer meets the criteria for hedge
accounting; if the hedging instrument expires or is sold,
terminated or exercised; if the forecast transaction is no longer
expected to occur; or if hedge designation is revoked. On the
discontinuance of hedge accounting (except where a forecast
transaction is no longer expected to occur), the cumulative
unrealised gain or loss recognised in equity is recognised in
profit or loss when the hedged cash flow occurs or, if the
forecast transaction results in the recognition of a financial asset
or financial liability, in the same periods during which the asset
or liability affects profit or loss. Where a forecast transaction is
no longer expected to occur, the cumulative unrealised gain or
loss is recognised in profit or loss immediately.
Hedge of net investment in a foreign operation – where a
foreign currency liability hedges a net investment in a foreign
operation, the portion of foreign exchange differences arising
on translation of the liability determined to be an effective
hedge is recognised directly in equity. Any ineffective portion is
recognised in profit or loss.
19. Share-based payments
The Group grants options over shares in The Royal Bank of
Scotland Group plc to its employees under various share option
schemes. The Group has applied IFRS 2 ‘Share-based Payment’
to grants under these schemes after 7 November 2002 that had
not vested on 1 January 2005. The expense for these
transactions is measured based on the fair value on the date the
options are granted. The fair value is estimated using valuation
techniques which take into account the option’s exercise price, its
term, the risk free interest rate and the expected volatility of the
market price of The Royal Bank of Scotland Group plc’s shares.
Vesting conditions are not taken into account when measuring
fair value, but are reflected by adjusting the number of options
included in the measurement of the transaction such that the
amount recognised reflects the number that actually vest. The fair
value is expensed on a straight-line basis over the vesting period.
20. Investment property
Investment property comprises freehold and leasehold
properties that are held to earn rentals or for capital appreciation
or both. It is not depreciated but is stated at fair value based on
valuations by independent registered valuers. Fair value is
based on current prices in an active market for similar properties
in the same location and condition. Any gain or loss arising from
a change in fair value is recognised in profit or loss. Rental
income from investment property is recognised on a straight-line
basis over the term of the lease. Lease incentives granted are
recognised as an integral part of the total rental income.
21. Cash and cash equivalents
Cash and cash equivalents comprises cash and demand
deposits with banks together with short-term highly liquid
investments that are readily convertible to known amounts of
cash and subject to insignificant risk of change in value.
22. Shares in Group entities
The company’s investments in its subsidiaries are stated at cost
less any impairment.
Critical accounting policies and key sources of estimation
uncertainty
The reported results of the Group are sensitive to the
accounting policies, assumptions and estimates that underlie
the preparation of its financial statements. UK company law
and IFRS require the directors, in preparing the Group's
financial statements, to select suitable accounting policies,
apply them consistently and make judgements and estimates
that are reasonable and prudent. In the absence of an
applicable standard or interpretation, IAS 8 ‘Accounting
Policies, Changes in Accounting Estimates and Errors’,
requires management to develop and apply an accounting
policy that results in relevant and reliable information in the
light of the requirements and guidance in IFRS dealing with
similar and related issues and the IASB’s Framework for the
Preparation and Presentation of Financial Statements.
The judgements and assumptions involved in the Group’s
accounting policies that are considered by the Board to be the
most important to the portrayal of its financial condition are
discussed below. The use of estimates, assumptions or models
that differ from those adopted by the Group would affect its
reported results.
Loan impairment provisions
The Group’s loan impairment provisions are established to
recognise incurred impairment losses in its portfolio of loans
classified as loans and receivables and carried at amortised
cost. A loan is impaired when there is objective evidence that
events since the loan was granted have affected expected
cash flows from the loan. The impairment loss is the difference
between the carrying value of the loan and the present value
of estimated future cash flows at the loan's original effective
interest rate.
At 31 December 2005, gross loans and advances to
customers totalled £421,110 million (2004 – £351,419 million)
and customer loan impairment provisions amounted to £3,884
million (2004 – £4,168 million).
There are two components to the Group’s loan impairment
provisions: individual and collective.
Individual component – all impaired loans that exceed specific
thresholds are individually assessed for impairment. Individually
assessed loans principally comprise the Group's portfolio of
commercial loans to medium and large businesses. Impairment
losses are recognised as the difference between the carrying
value of the loan and the discounted value of management’s
best estimate of future cash repayments and proceeds from
any security held. These estimates take into account the
customer’s debt capacity and financial flexibility; the level and
quality of its earnings; the amount and sources of cash flows;
the industry in which the counterparty operates; and the
realisable value of any security held. Estimating the quantum
and timing of future recoveries involves significant judgement.
The size of receipts will depend on the future performance of
the borrower and the value of security, both of which will be
affected by future economic conditions; additionally, collateral
may not be readily marketable. The actual amount of future
cash flows and the date they are received may differ from these