Understanding the Annual Report of a bank

      Introduction of  Reporting Entity

Eg:

…………. Bank of Ceylon PLC (the ‘Bank’) is a public limited liability company listed on the Colombo Stock Exchange, incorporated on June .., ….., (and domiciled) in Sri Lanka. It is a Licensed Commercial Bank regulated under the Banking Act No. 30 of 1988 and amendments thereto. The Bank was re-registered under the Companies Act No. 07 of 2007. The registered office of the Bank is situated at ‘……………..’, No. ........ Street, ……., Sri Lanka. The ordinary shares of the Bank have a primary listing on the Colombo Stock Exchange.

The staff strength of the Bank as at December 31, 2010 was 4,321 (4,071 as at December 31, 2009).

      Consolidated Financial Statements

The Consolidated Financial Statements of the Bank for the year ended December 31, 2010, comprise the Bank (Parent Company) and its Subsidiaries (together referred to as the ‘Group’), and the Group’s interest in its Associates. The Financial Statements of all companies in the Group have a common financial year which ends on December 31.

      Approval of Financial Statements by Board of Directors

The Financial Statements for the year ended December 31, 2010 were authorized for issue on February 15, 2011.

      Principal Activities and Nature of Operations

Bank

The Bank provides a comprehensive range of financial services encompassing accepting deposits, personal banking, trade financing, off-shore banking, resident and non-resident foreign currency operations, travel-related services, corporate and retail credit, syndicated financing, project financing, development banking, lease financing, rural credit, issuing of local and international credit cards, issuing of debit cards, telebanking facilities, internet banking, money remittance facilities, dealing in Government Securities and treasury-related products, salary remittance package, bullion trading, export and domestic factoring, pawning, margin trading, e-banking services and Bank assurance etc

      Responsibility for Financial Statements

The Board of Directors is responsible for the preparation and presentation of the Financial Statements of the Bank and its Subsidiaries as per the provisions of the Companies Act No. 07 of 2007 and the Sri Lanka Accounting Standards.

The Board of Directors acknowledges this responsibility as set out in the ‘Annual Report of the Board of Directors’, “Statement of Directors’ Responsibility” and in the statement following the Balance Sheet respectively.

      These Financial Statements include the following components:

•an Income Statement providing the information on the financial performance of the Group and the Bank for the year under review;

•a Balance Sheet providing the information on the financial position of the Group and the Bank as at the year-end;

•a Statement of Changes in Equity depicting all changes in shareholders’ equity during the year under review of the Group and the Bank;

•a Cash Flow Statement providing the information to the users, on the ability of the Group and the Bank to generate cash and cash equivalents and the needs to utilization of those cash flows; and

•Notes to the Financial Statements comprising Accounting Policies used and other Notes.

      Statement of Compliance

The Consolidated Financial Statements of the Group and the Separate Financial Statements of the Bank, which comprise the components mentioned above have been prepared and presented in accordance with the Sri Lanka Accounting Standards laid down by The Institute of Chartered Accountants of Sri Lanka and in compliance with the requirements of the Companies Act No. 07 of 2007, and the Banking Act No. 30 of 1988 and amendments thereto, provide appropriate disclosures as required by the Listing Rules of the Colombo Stock Exchange.

The Group and the Bank did not adopt any inappropriate accounting treatments which are not complying with the requirements of the Sri Lanka Accounting Standards and other laws and regulations governing the preparation and presentation of Financial Statements.

      Basis of Preparation

Bases of Measurement

The balances reflected in the Financial Statements of the Group are measured under the historical cost convention, except Government Treasury Bills, Bonds and Other Securities, which are categorized under the Trading Portfolio, Dealing Securities and Land & Buildings which are stated at valuations as explained in Notes 17, 18 and 23 respectively, to the Financial Statements. Assets and liabilities are grouped by nature and listed in an order that reflects their relative liquidity and maturity pattern. Where appropriate, the Significant Accounting Policies are disclosed in the succeeding Notes. No adjustments have been made for inflationary factors affecting the Financial Statements.

These Financial Statements are prepared in Sri Lankan Rupees which is the Group’s Functional Currency unless otherwise stated.

The information presented in US Dollars in the section on ‘Stewardship’ does not form part of the Financial Statements and is solely for the convenience of stakeholders.

      Review of Impairment Losses on Other Assets

The Group assesses whether there are any indicators of impairment for an asset or a cash-generating unit at each reporting date or more frequently, if events or changes in circumstances necessitate to do so. This requires the estimation of the ‘value in use’ of such individual assets or the cash-generating units.

      Materiality and Aggregation

Each material class of similar items is presented separately in the Financial Statements. Items of dissimilar nature or function are presented separately unless they are immaterial as permitted by the Sri Lanka Accounting Standard No. 3 - (Revised 2005) on ‘Presentation of Financial Statements’.

      Offsetting

Assets and liabilities and income and expenses are not set-off unless permitted by the Sri Lanka Accounting Standards.

      Rounding

The amounts in the Financial Statements have been rounded-off to the nearest Rupees thousands, except where otherwise indicated as permitted by the Sri Lanka Accounting Standard No. 3 - (Revised 2005) on ‘Presentation of Financial Statements’.

      Assets and Bases of Their Valuation

Cash and Short Term Funds (Cash and Cash Equivalents)

Cash and short term funds include cash in hand, balances with banks, placements with banks and loans at call and at short notice. They are brought to Financial Statements at the face value or the gross value, where appropriate. There were no cash and cash equivalent balances held by the Group companies that were not available for use by the Group.

Details of the cash and short term funds are given in Note 15 to the Financial Statements.

      Balances with Central Banks

The Monetary Law Act requires that all commercial banks operating in Sri Lanka to maintain a statutory reserve equal to 7% on all deposit liabilities denominated in Sri Lankan Rupees (7% in 2009). The Bank’s Bangladesh operation is required to maintain the statutory liquidity requirement of 19% on time and demand liabilities, inclusive of 6% Cash Reserve Requirement and the balance 13% by way of foreign currency and/or in the form of unencumbered securities held with the Bangladesh Bank.

Details of the Balances with Central Banks are given in Note 16 to the Financial Statements.

      Government Treasury Bills, Bonds and Other Securities

 Investments in Government Treasury Bills and Treasury Bonds Held for Trading

Investments in Government Treasury Bills and Treasury Bonds in the trading portfolio are those investments that the Group acquires principally for the purpose of selling or holds as part of a portfolio that is managed for short term profit. These investments are initially recognised at prices that prevail at the date of acquisition and subsequently marked to market and carried at that market value in the Balance Sheet. Gains and losses on marked to market valuation are dealt through the Income Statement.

      Investments in Government Treasury Bills and Treasury Bonds Held to Maturity

Investments in Government Treasury Bills and Bonds held to maturity are reflected at the value of the Bills/Bonds purchased and the discount/premium accrued thereon and carried at these values till their maturity in the Balance Sheet. Discount received/premium paid is taken to the Income Statement based on a pattern reflecting a constant periodic rate of return.

      Investments in Central Bank Securities Held to Maturity

These Securities are purchased primarily with the intention of holding them to maturity and are stated at cost and carried at these values till their maturity in the Balance Sheet.

      Securities Purchased under Resale Agreements

These are advances collateralised by purchase of Government Treasury Bills and Treasury Bonds from the public, subject to an agreement to resell them at a predetermined price. Such Securities remain on the Balance Sheet of the Bank and the asset is recorded in respect of the consideration paid.

The difference between the aforesaid predetermined price and the purchase price represents interest income and is recognised in the Income Statement over the period of the Resale Agreement based on a pattern reflecting a constant periodic rate of return.

Value of the Securities Purchased under Resale Agreements is given on the face of the Balance Sheet.

      Investments

Dealing Securities

These are marketable securities acquired and held with the intention of resale over a short period of time. Such securities are initially measured at cost and subsequently measured at the market value as at the Balance Sheet date. Adjustment for changes in market values is accounted for in the Income Statement.

      Investments Held for Sale

These are investments classified as held for sale as at the Balance Sheet date. The Bank intends to recover the value of these assets principally through a sale transaction rather than continuing to hold. These assets are available for immediate sale in its present condition subject only to terms that are usual and customary for sale of such assets and its sale is highly probable.

      Investment Securities

These are acquired and held for yield or capital growth in the medium to long term with the positive intent and ability to hold until maturity. Such securities are recorded at cost and any unpaid interest/dividend accrued thereon up to the date of purchase is reported under Interest and Fees Receivable. Details of the Investment Securities are given in Note 19 to the Financial Statements.

      Loans and Advances to Customers

Loans and advances to customers which include Bills of Exchange, Lease Receivable and Loans & Advances are stated in the Balance Sheet net of provisions for possible loan losses and net of interest in suspense, which is not accrued to revenue.

      Non-Performing Loans and Advances

Loans and advances which are in arrears of due capital and/or interest are classified as non-performing as per the Direction No. 3 of 2008 on ‘Classification of Loans and Advances, Income Recognition and Provisioning’, as amended by the Direction No. 9 of 2008 on ‘Amendments to Directions on Classification of Loans and Advances, Income Recognition and Provisioning for Licensed Commercial Banks in Sri Lanka’ of the Central Bank of Sri Lanka.

      Provision for Loan Losses

Provision for possible loan losses is made on the basis of a continuous review of all loans and advances to customers in accordance with the Sri Lanka Accounting Standard No. 23 on ‘Revenue Recognition and Disclosures in the Financial Statements of the Banks’ and the Directions issued by the Central Bank of Sri Lanka as detailed below.

      Specific Provisions

Specific provisions for possible loan losses are made in accordance with the aforesaid Directions issued by the Central Bank of Sri Lanka and disclosures are made as required by the Sri Lanka Accounting Standard No. 23 on ‘Revenue Recognition and Disclosures in the Financial Statements of Banks’. As per the above Directions, the Banks are required to make specific provisions as shown in the table below. However, the Bank’s provisioning policy is more stringent than the minimum specific provisions required by the Central Bank of Sri Lanka, since the Bank makes a full provision, based on the net exposure upon classification of loans and advances as substandard.

      Finance Leases (Bank as a Lessor)

Assets leased to customers which transfer substantially all the risks and rewards incidental to the ownership other than legal title are classified as finance leases in accordance with the Sri Lanka Accounting Standard No. 19 (Revised 2005) on ‘Leases’.

      Credit Card Receivable

Amounts receivable on Credit Cards are included in loans and advances at the amounts expected to be recovered.

      Pawning Receivable

The Bank provides pawning facilities with two different maturity periods, namely, 6 months and 12 months. Amounts receivable on pawning are included in Loans and Advances at the amounts expected to be recovered.

      Provision for Pawning Receivable

A 100% specific provision is made on Pawning Receivable after discounting the value of the security, where no payment is received within one month from the contractual maturity date.

      Property, Plant & Equipment

The Group applies the requirements of the Sri Lanka Accounting Standard No. 18 (Revised 2005) on ‘Property, Plant & Equipment’ in accounting for its owned assets which are held for and use in the provision of services, for rental to others or for administrative purposes and are expected to be used during more than one year.

Liabilities and Provisions

      Deposits from Customers

Deposits from customers include non-interest bearing deposits, savings deposits, term deposits, deposits payable at call and certificates of deposit. They are stated in the Balance Sheet at amounts payable. Interest paid/payable on these deposits is charged to the Income Statement.

      Dividends Payable

Provision for dividends payable is recognised at the time the dividend is recommended and declared by the Board of Directors and approved by the shareholders.

      Borrowings

Borrowings include refinance borrowings, call money borrowings, credit balances in Nostro Accounts and borrowings from financial institutions and are shown at the gross value of the outstanding balance. They too are stated in the Balance Sheet at amounts payable. Interest paid/payable on these borrowings is charged to the Income Statement.

      Securities Sold under Repurchase Agreements

These are borrowings collateralised by sale of Treasury Bills and Treasury Bonds held by the Bank to the counterparty from whom the Bank borrowed, subject to an agreement to repurchase them at a predetermined price. Such securities remain on the Balance Sheet of the Bank and the liability is recorded in respect of the consideration received.

      Debentures

These represent the funds borrowed by the Bank for long term funding requirements. These are recorded in the Balance Sheet at amounts expected to be payable at the Balance Sheet date.

      Derivative Instruments

The Bank in its ordinary course of business enters into transactions such as interest rate and foreign exchange contracts and uses derivative instruments to manage exposure to interest rates, foreign currencies, commodity price volatility, including exposure arising from forecast transactions. In order to account for such transactions, the Bank applies hedge accounting principles based on best accounting practices which are discussed below.

      Accounting for Hedging Transactions

At inception of hedging transactions, the Bank formally documents the relationship between the underlying hedged item and the hedging instrument including the nature of the risk, the objective and the strategy for undertaking the hedge and the method used to assess the effectiveness of the hedging relationship.

In addition, at the inception and on an ongoing basis, formal assessments are undertaken to ensure that the hedging instrument is expected to be highly effective in offsetting the designated risk in the hedged item. In situations where the hedged item is a forecast transaction, the Bank assesses whether the transaction is a highly probable one and evaluates the exposure to variations in cash flows that could ultimately affect the profit or loss for the period. The ineffective portion of the profit or loss of the hedging instrument is recognised immediately in the Income Statement.

      Employees’ Provident Fund

The Bank and employees contribute to the approved private Provident Fund at 12% and 8% on the salaries of each employee, respectively. Other entities of the Group and their employees contribute at the same percentages as above to the Employees’ Provident Fund managed by the Central Bank of Sri Lanka.

      Employees’ Trust Fund

The Bank and other entities of the Group contribute at the rate of 3.0% of the salaries of each employee to the Employees Trust Fund managed by the Central Bank of Sri Lanka.

      Commitments and Contingencies

All discernible risks are accounted for in determining the amount of other liabilities as explained in Note M 6. The Bank’s share of any Contingencies and Capital Commitments of a Subsidiary or an Associate for which the Bank is also liable severally or otherwise is included with appropriate disclosures.

Income Statement

Revenue Recognition

      Interest Income on Loans and Advances

In terms of the provisions of the Sri Lanka Accounting Standard No. 23 on ‘Revenue Recognition and Disclosures in the Financial Statements of Banks’, the interest receivable on loans and advances is recognised on accrual basis.

      Lease Income

In terms of the provisions of the Sri Lanka Accounting Standard No. 19 (Revised 2005) on ‘Leases’, the recognition of finance income on leasing is accounted, based on a pattern reflecting a constant periodic rate of return on capital outstanding.

      Revenue Recognition on Non-Performing Loans

When loans and advances are classified as non-performing based on criteria as set out in Note L 6.1, interest ceases to be recognised on such Loans and Advances. Thereafter, interest income on these Loans and advances is recognised on a cash basis, until the facility is reclassied as performing as is settled in full. Interest falling due on non-performing loans and advances is credited to interest in suspense account which is netted in the Balance Sheet against the relevant loans and advances.

      Income from Government Securities and Securities Purchased under Resale Agreements

Discounts/premiums on Treasury Bills and Treasury Bonds are amortised over the period to reflect a constant periodic rate of return. The coupon interest on Treasury Bonds is recognised on an accrual basis. The interest income on Securities Purchased under Resale Agreements are recognised in the Income Statement on an accrual basis over the period of the Agreement.

      Income on Discounting of Bills of Exchange

Income on discounting of Bills of Exchange is recognised on a cash basis.

      Fees and Commission Income

The Bank recognises Fees and Commission Income from a diverse range of services it provides to its customers on a cash basis. This includes fees and commission income arising on financial services provided by the Bank including Trade Finance, Travel, Investment Banking, e-banking, Legal Services, Derivative Transactions, etc.

      Dividend Income on Shares

Dividend Income on Shares is recognised on an accrual basis only when the Bank’s right to receive the dividend is established.

      Interest Income on Investments in Debentures and Trust Certificates

Interest Income on Investments in Debentures and Trust Certificates is recognised on an accrual basis.

      Interest and Fees Receivable on Credit Cards

Interest and Fees Receivable on Credit Cards are recognised on an accrual basis. Interest and fees cease to be taken into revenue when the recovery of minimum payment is in arrears for over three months. Thereafter, interest and fees are accounted for on a cash basis.

      Interest on Deposits, Borrowings, Securities Sold under Repurchase Agreements and Other Fund-Based Operations

In terms of the provisions of the Sri Lanka Accounting Standard No. 23 on ‘Revenue Recognition and Disclosures in the Financial Statements of Banks’, the Interest on Deposits and Borrowings and other fund-based expenses payable are recognised on an accrual basis in the Income Statement. The interest expenses on Securities Sold under Repurchase Agreements are recognised in the Income Statement on an accrual basis over the period of the agreement.

      Fees and Commission Expenses

The Bank recognises Fees and Commission Expenses on an accrual basis.

      Cash Flow Statement

The Cash Flow Statement has been prepared by using the ‘Direct Method’ of preparing cash flows in accordance with the Sri Lanka Accounting Standard No. 9 on ‘Cash Flow Statements’, whereby gross cash receipts and gross cash payments on operating activities, investing activities and financing activities are recognised. Cash and Cash Equivalents comprise of short term, highly liquid investments that are readily convertible to known amounts of cash and are subject to an insignificant risk of changes in value.