RBS 2011 Annual Report Download - page 325

RBS Group 2011 323
26. Cash and cash equivalents
In the cash flow statement, 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.
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. Such objective evidence,
indicative that a borrower’s financial condition has deteriorated, can
include for loans that are individually assessed: the non-payment of
interest or principal; debt restructuring; probable bankruptcy or
liquidation; significant reduction in the value of any security; breach of
limits or covenants; and deteriorating trading performance and, for
collectively assessed portfolios: the borrowers’ payment status and
observable data about relevant macroeconomic measures.
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 2011, loans and advances to customers classified as
loans and receivables totalled £427,805 million (2010 - £482,710 million;
2009 - £671,037 million) and customer loan impairment provisions
amounted to £19,760 million (2010 - £18,055 million; 2009 - £17,126
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 estimates and consequently
actual losses incurred may differ from those recognised in these financial
statements.
Collective component - this is made up of two elements: loan impairment
provisions for impaired loans that are below individual assessment
thresholds (collectively assessed provisions) and for loan losses that
have been incurred but have not been separately identified at the balance
sheet date (latent loss provisions). Collectively assessed provisions are
established on a portfolio basis using a present value methodology taking
into account the level of arrears, security, past loss experience, credit
scores and defaults based on portfolio trends. The most significant
factors in establishing these provisions are the expected loss rates and
the related average life. These portfolios include credit card receivables
and other personal advances including mortgages. The future credit
quality of these portfolios is subject to uncertainties that could cause
actual credit losses to differ materially from reported loan impairment
provisions. These uncertainties include the economic environment,
notablyinterest rates and their effect on customer spending, the
unemployment level, payment behaviour and bankruptcy trends. Latent
loss provisions are held against estimated impairment losses in the
performing portfolio that have yet to be identified as at the balance sheet
date. To assess the latent loss within its portfolios, the Group has
developed methodologies to estimate the time that an asset can remain
impaired within a performing portfolio before it is identified and reported
as such.