RBS 2007 Annual Report Download - page 132

RBS Group • Annual Report and Accounts 2007
130
Accounting policies continued
Financial statements
17. Netting
Financial assets and financial liabilities are offset and the net
amount presented in the balance sheet when, and only when,
the Group currently has a legally enforceable right to set off
the recognised amounts; and it intends either to settle on a net
basis, or to realise the asset and settle the liability
simultaneously. The Group is party to a number of
arrangements, including master netting agreements, that give it
the right to offset financial assets and financial liabilities but
where it does not intend to settle the amounts net or
simultaneously and therefore the assets and liabilities
concerned are presented gross.
18. Capital instruments
The Group classifies a financial instrument that it issues
as a financial asset, financial liability or an equity instrument
in accordance with the substance of the contractual
arrangement. An instrument is classified as a liability if it is
a contractual obligation to deliver cash or another financial
asset, or to exchange financial assets or financial liabilities
on potentially unfavourable terms. An instrument is classified
as equity if it evidences a residual interest in the assets of
the Group after the deduction of liabilities. The components
of a compound financial instrument issued by the Group are
classified and accounted for separately as financial assets,
financial liabilities or equity as appropriate.
19. Derivatives and hedging
Derivative financial instruments are recognised initially, and
subsequently measured, at fair value. Derivative fair values are
determined from quoted prices in active markets where
available. Where there is no active market for an instrument,
fair value is derived from prices for the derivative’s components
using appropriate pricing or valuation models.
A derivative embedded in a contract is accounted for as a
stand-alone derivative if its economic characteristics are not
closely related to the economic characteristics of the host
contract; unless the entire contract is carried at fair value
through profit or loss.
Gains and losses arising from changes in the fair value of a
derivative are recognised as they arise in profit or loss unless
the derivative is the hedging instrument in a qualifying hedge.
The Group enters into three types of hedge relationship:
hedges of changes in the fair value of a recognised asset or
liability or firm commitment (fair value hedges); hedges of the
variability in cash flows from a recognised asset or liability or a
forecast transaction (cash flow hedges); and hedges of the net
investment in a foreign operation.
Hedge relationships are formally documented at inception. The
documentation includes identification of the hedged item and
the hedging instrument, details the risk that is being hedged
and the way in which effectiveness will be assessed at
inception and during the period of the hedge. If the hedge is
not highly effective in offsetting changes in fair values or cash
flows attributable to the hedged risk, consistent with the
documented risk management strategy, hedge accounting is
discontinued.
Fair value hedge – in a fair value hedge, the gain or loss on the
hedging instrument is recognised in profit or loss. The gain or
loss on the hedged item attributable to the hedged risk is
recognised in profit or loss and adjusts the carrying amount of
the hedged item. Hedge accounting is discontinued if the
hedge no longer meets the criteria for hedge accounting or if
the hedging instrument expires or is sold, terminated or
exercised or if hedge designation is revoked. If the hedged
item is one for which the effective interest rate method is used,
any cumulative adjustment is amortised to profit or loss over
the life of the hedged item using a recalculated effective
interest rate.
Cash flow hedge – where a derivative financial instrument is
designated as a hedge of the variability in cash flows of a
recognised asset or liability or a highly probable forecast
transaction, the effective portion of the gain or loss on the
hedging instrument is recognised directly in equity. The
ineffective portion is recognised in profit or loss. When the
forecast transaction results in the recognition of a financial
asset or financial liability, the cumulative gain or loss is
reclassified from equity in the same periods in which the asset
or liability affects profit or loss. Otherwise the cumulative gain
or loss is removed from equity and recognised in profit or loss
at the same 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.