Geoff Steel Presentation on IAS

1
Application of International Accounting Standards
to Australian Banks
Geoff SteelGroup FinanceCommonwealth Bank of
Australia 1 July 2003
2
Disclaimer

• The material that follows is a presentation of
  general background information about Australian
  banking activities current at the date of the
  presentation, 1 July 2003. It is information
  given in summary form and does not purport to be
  complete. It is not intended to be relied upon as
  advice to investors or potential investors and
  does not take into account the investment
  objectives, financial situation or needs of any
  particular investor. These should be considered,
  with or without professional advice when deciding
  if an investment is appropriate.

3
Why Change to IAS?

• Financial Reporting Council decision to adopt IAS
  by 1 January 2005
• Increased globalisation of economies
• Consistency with European listed entities
• Probability of US aligning at a future point

4
Comparatives

• Financial year 2006 - first published IAS data
• Australia - one year comparatives
• US SEC Registrants - all major four banks - two
  years comparatives
• Full retrospective application from 1 July 2003

5
Areas of Major Impact

• Financial instruments
• Business combinations
• Intangible assets
• Pension accounting
• Insurance contracts
• Performance Reporting
• Goal is to minimise reported PL volatility
• RULES NOT YET FINALISED

6
AASB Key Decisions

• Early adoption
• BIG BANG approach
• Piecemeal adoption is prohibited except for
• AASB 1020 Income Taxes
• Share Based payments

7
Financial Instruments

• IASB objective Recognition and measurement of
  all risks associated with financial instruments,
  i.e. interest rate, FX, credit risk
• Outcome Prescriptive accounting rules based on
  designation of instrument. All derivatives on
  balance sheet.
• No new risks Australian banks already manage and
  report the risks addressed by this standard

8
Financial Instruments (continued)
Four categories of financial instruments are
identified, based on intention 1. Trading -
Valuation method - fair value - Treatment
consistent with current practice 2. Loans
originated - Valuation method - cost - Most
lending assets (including Interbank Receivables)
will quality as this category -
Treatment consistent with current practice
9
Financial Instruments (continued)
3. Held to maturity - Valuation method - cost
- Held to maturity have strict criteria to
qualify. No sales, no hedging 4. Available
for sale - Available for sale is a new
category - Valuation method - fair value -
Allows flexibility to sell assets - Movements
in value transferred to new Equity Reserve -
Profits on sale transferred from reserve to
profit - Hedging permitted
10
Hedges/Derivatives
All hedges are fair valued and brought on balance
sheet All hedges must be dealt with external
market Two types of hedges defined, with
different accounting implications 1. Fair Value
Hedges (fixed rates hedged into floating) -
FV both derivative and hedged item -
Correlation of hedges to be measured at least six
monthly (80-125 effectiveness range) -
Ineffective portion of hedge to PL
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Hedges/Derivatives (continued)
2. Cash Flow Hedges (floating rates hedged into
fixed) - FV derivatives but not underlying
instrument - FV changes taken to Equity
Reserve, then recycled to PL when hedged
item impacts PL - Ineffective portion of
hedge to PL
12
Equity

• Rules regarding definition of equity are more
  rigid - must be able to avoid redemption to be
  equity
• Less scope for hybrid instruments.
• Potential for technical breaches of debt
  covenants by some corporates
• APRA treatment not yet defined

13
Issues to be Addressed

• Available for Sale category
• Trading option
• Cash flow hedges easier to identify and maintain
  effectiveness
• Fair value hedges used where high degree of
  correlation
• Macro hedging now permitted
• Prepayment risk causes hedge ineffectiveness

14
Other Financial Instrument Issues

• Effective yield includes capitalised external
  costs
• Derecognition of assets - securitisation
• Loan impairment provisions
• Embedded derivatives, e.g. debt instrument return
  linked to ASX equity index movement
• Systems requirements

15
Business Combinations Intangible Assets

• Identifiable intangible assets on acquisition,
  e.g. core deposits, brand names- Finite or
  indefinite life
• No amortisation of goodwill
• Assess goodwill for impairment on cash
  generating unit / segment basis

16
Pension Accounting

• Defined benefit plans
• Recognise prepaid pension cost or fund surplus as
  asset
• Fluctuations in surplus / deficit taken to profit

17
Insurance Contracts

• Phase 1- 2005, Phase 2 - 2007
• Insurance contract - exposure to significant
  insurance risk- Apply existing Australian GAAP
• Unit linked products - no exposure to risk-
  Apply IAS 39 - investment contracts- Only
  capitalise external costs or market value
  business

18
Performance Reporting

• Early stages of development
• Greater categorisation of profit- Financial -
  Non-financial
• All value movements through PL - e.g. property
  revaluations
• Profit before re-measurements
• Re-measurements - e.g. increases in existing
  provisions, property revaluations, equity
  investments

19
Application of International Accounting Standards
to Australian Banks
Geoff Steel Group Finance Commonwealth Bank of
Australia 1 July 2003