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Disclosure of financial performance, financial position and accounting policies

Category: Corporate Governance

Disclosure of financial position provides information on the bank’s ability to meet its obligations and commitments. It is a picture of the nature and amount of assets, liabilities, shareholders’ funds by type. It typically includes the balance sheet, information about an off-balance sheet items and statement of changes in shareholders’ equity.

Information about the accounting policies that have been employed in the preparation of financial reports should also be disclosed. Accounting policies, practices and procedures differ not only between countries, but also between banks in the same country. Accordingly, users of accounting information need to understand how items are being measured to properly interpret the information.

Disclosure of significant accounting policies on which financial reporting is based enables users to make reliable assessments of the bank’s reported position and performance.

Disclosure of accounting policies may include a general accounting principles, changes in accounting policies/practices, principles of consolidation, policies and methods for determining when assets are impaired, recognizing losses on impaired assets and losses on non-performing credits, policies to establish specific and general loan loss allowances, income recognition, valuation policies (trading securities, investment securities, loans, tangible fixed assets, intangible fixed assets, liabilities, etc.), recognition/derecognition policies, securitizations, foreign currency translations, loan fees, premiums and discounts, repurchase agreements, securities lending, premises/fixed assets, income taxes, and derivatives (hedging, non-hedging, losses on derivatives).


Below is the example of the accounting policy for determining the provision for loan losses as described in 2002 annual report of HSBC Bank.

It is HSBC’s policy that each operating company will make provisions for bad and doubtful debts promptly where required and on a prudent and consistent basis. Loans are designated as non-performing as soon as management has doubts as to the ultimate collectability of principal or interest or when contractual payments of principal or interest are 90 days overdue. When a loan is designated as non-performing, interest will be suspended and a specific provision made if required. However, the suspension of interest may be deferred for up to 12 months past due in the following situations:

where cash collateral is held covering the total of principal and interest due and the right of set-off is legally sound; or

where the value of net realisable tangible security is considered more than sufficient to cover the full repayment of all principal and interest due and credit approval has been given to the rolling-up or capitalisation of interest payments.

There are two basic types of provision, specific and general, each of which is considered in terms of the charge and the amount outstanding. Specific provisions

Specific provisions represent the quantification of actual and expected losses from identified accounts and are deducted from loans and advances in the balance sheet.

Other than where provisions on smaller balance homogenous loans are assessed on a portfolio basis, the amount of specific provision made is assessed on a case by case basis. The amount of specific provision raised is HSBC’s conservative estimate of the amount needed to reduce the carrying value of the asset to the expected ultimate net realisable value, and in reaching a decision consideration is given, among other things, to the following factors:

the financial standing of the customer, including a realistic assessment of the likelihood of repayment of the loan within an acceptable period and the extent of HSBC’s other commitments to the same customer;

the realisable value of any security for the loan;

the costs associated with obtaining repayment and realisation of the security; and

if loans are not in local currency, the ability of the borrower to obtain the relevant foreign currency.

Where specific provisions are raised on a portfolio basis, the level of provisioning takes into account management’s assessment of the portfolio’s structure, past and expected credit losses, business and economic conditions, and any other relevant factors. The principal portfolios evaluated on this basis are credit cards and other consumer lending products.

International Accounting Standard No. 30 «Disclosures in the financial statements for banks and similar financial institutions» and NBU instruction No. 545 dated 26.12.2001 «On preparation of annual financial statements» provide detailed guidance on the format and content of the components of the financial statements of a bank.

Disclosure is the principal mechanism for achieving transparency. But disclosure has its limitations. Disclosure does not equal transparency. Transparency depends upon the existence of a rigorous and comprehensive disclosure framework and upon a committed response by the private sector to these requirements.

Furthermore, the market demands more than disclosure and looks for some form of independent verification of the disclosed information. Investors must be able to feel confident about the numbers. Financial statements have to represent a true and fair statement of the health and wealth of companies. Accounting and audit firms have a key role in ensuring that this happens.

Regulation of the audit profession is important to ensure accounting standards are properly adhered to. In many countries regulations on auditor independence were revised, targeting potential conflicts of interest by requiring that audit firms should not provide non-audit services where this would compromise the auditor’s ability to take an independent view.

Particularly, after Enron scandal, the auditors’ independence has been heavily criticized. Until recently, in some countries like USA, audit fees comprised only about 25% of large audit firms. More money, more interesting work and more growth lay in the consulting area that accounting firms can gain once they receive the audit work from the client. As a result, the audit was blamed to become an industry rather than a profession because auditors’ ability to say ‘no’ to the client was diminished.


In the United States, the Sarbanes-Oxley Act, which became law in July 2002 contains a number of provisions to improve accounting, audit independence and disclosure rules. To bolster independence of external auditors, it prohibited external audit firms from providing certain internal audit and other consulting services to their clients. As a result, large audit firms had to dispose of their consulting divisions (PricewaterhouseCoopers Consulting was sold to IBM, Andersen Consulting became known as Accenture, BearingPoint was formerly KPMG-Consulting etc).

The explosive growth of investing and raising capital in the       global markets has put new emphasis on the development of international accounting, auditing, and ethical standards. The worldwide accountancy profession, together with issuers of financial statements, users, regulators, and other bodies, have been putting a great effort in the development of high-quality standards that can be implemented in the global as well as the domestic capital markets. The harmonization of these standards is receiving greater and greater attention by the participants in these markets.

International standards on auditing are promulgated by the International Auditing Practices Committee (IAPC) of the International Federation of Accountants. A codified core set of international standards on auditing were completed and released in 1994. The release of the core set has led to a growing acceptance of the standards by national standards setters and auditors involved in global reporting and cross-border financing transactions.

The benefits for the use of common global accounting standards by preparers of financial statements and common auditing standards by auditors of those statements have been debated for a number of years. Although the debate continues, there is strong support for the creation of a common set of standards for use in capital markets around the world, particularly for cross-border financing transactions.

Two important sets of standards have emerged as candidates for widespread adoption: the accounting standards being developed by the International Accounting Standards Committee (IASC) and the auditing standards being developed by the International Auditing Practices Committee (IAPC) of the International Federation of Accountants (IFAC).

Since their release, there has been a growing acceptance of International Standards on Auditing (ISAs), particularly adoption and use of the standards by:

a number of the large international accounting firms as the basis for their worldwide auditing standards;

global public companies reporting outside their national borders;

companies involved in issuing securities in cross-border financing transactions;

companies issuing securities in domestic financing transactions;

regulatory bodies accepting financial statements audited using the ISAs for regulatory filings in their countries, or requiring the use of ISAs by including them in company law;

global organizations, such as the Organization for Economic Cooperation and Development, that have endorsed ISAs for use in auditing financial statements in their jurisdictions; and

national accountancy bodies that have used ISAs as the basis for their national auditing standards.

A 1998 survey of IFAC member bodies revealed some interesting information. First of all, of the 65 countries responding, the survey showed that eighteen (18) countries have completely adopted the ISAs as their national auditing standards. Of the remaining 47 countries, the survey showed that:

28 countries had no significant differences between the national standards and the ISAs;

9 countries had some significant differences, usually relating to reporting; and

10 countries had not identified whether there were any differences.

The Cabinet of Ministers of Ukraine and National Bank of Ukraine have declared the objective to adopt the ISA in Ukraine by 2004.

In May 2003, the Chamber of Auditors of Ukraine has made the decision to introduce the ISA as the national audit standards in Ukraine.

International Standards on Auditing comprise about 40 separate standards. In general, these standards cover the broad range of issues such as planning the audit, execution procedures, audit completion and reporting.

For example, the standards listed below have a particular relevance to the audit of banks and financial institutions:

«Communications of audit matters with those charged with governance»

«Audit of accounting estimates»;

«Auditing fair value measurements and disclosures»;

«Related parties»;

«Considering the work of internal auditing».

The exact role of external auditors varies from country to country. One constant, however, is the independent auditors’ requirement to provide an opinion on the truth and fairness of financial statements. It is also widely expected that external auditors will gain an understanding of a bank’s internal control system to the extent that it relates to the accuracy of the bank’s financial statements.

It is also generally expected that material weaknesses identified by the auditors would be reported to Supervisory Council and Management Board and, in many countries, to the bank supervision authority. In countries where external auditors have a close relationship with the supervision authority, they are often requested to give an opinion on the functioning and the quality of the internal audit department of a bank. Supervisory Council and the Management Board should ensure the implementation of remedial actions related to internal control weaknesses outlined in the reports of the external auditors.

The bank’s Supervisory Council has the ultimate responsibility for ensuring that Management board establishes and maintains an adequate and effective system of internal controls, a measurement system for assessing the various risks of the bank’s activities and appropriate methods for monitoring compliance with laws, regulations and internal policies.

Chapter summary

Transparency is the main element of sound corporate governance

To achieve full transparency a bank should provide detailed disclosures in the following areas:

basic business, management and corporate governance information

risk management strategies and practices;

risk exposures (credit risk, market risk, liquidity risk, operational and other risks);

financial performance;

financial position;

accounting policies;

Effectiveness of disclosures depends on existence of independent verification of disclosed information.

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