HSBC Holdings Regulatory News (HSBA)

6 Mar 2006 08:15

HSBC Holdings PLC06 March 2006 From 1 January 2005, deferred tax relating to fair value re-measurement of available-for-sale investments and cash flow hedges, which are charged or credited directly to equity, is also credited or charged directly to equity and is subsequently recognised in the income statement when the deferred fair value gain or loss is recognised in the income statement. r Pension and other post-retirement benefits The group operates a number of pension plans which include both defined benefitand defined contribution plans. Payments to defined contribution plans and state-managed retirement benefitplans, where the group's obligations under the plans are equivalent to a definedcontribution plan, are charged as an expense as they fall due. The costs recognised for funding defined benefit plans are determined using theprojected unit credit method, with annual actuarial valuations performed on eachplan. Actuarial differences that arise are recognised in shareholders' equityand presented in the statement of changes in equity in the period they arise.Past service costs are recognised immediately to the extent the benefits arevested, and are otherwise recognised on a straight-line basis over the averageperiod until the benefits are vested. The current service costs and any pastservice costs together with the expected return on plan assets less theunwinding of the discount on the plan liabilities are charged to operatingexpenses. The net defined benefit asset recognised in the balance sheet represents theexcess of the fair value of plan assets over the present value of the definedbenefit obligations adjusted for unrecognised past service costs. The asset islimited to unrecognised past service costs plus the present value of availablerefunds and reductions in future contributions to the plan. The group implemented HK SSAP 34 (which is materially equivalent to HKAS 19) inrelation to the accounting for pensions in 2003, and adopted the corridorapproach for the recognition of actuarial gains and losses. The group haschanged its policy in 2005 to recognise in full actuarial gains and losses inthe statement of changes in equity. s Share based payments The group grants shares of HSBC Holdings plc to certain employees under variousvesting conditions and the group has the obligation to acquire HSBC Holdings plcshares to deliver to the employees upon vesting. The group's liability undersuch arrangements is measured at fair value at each reporting date. The changesin fair value are recognised as an expense in each period. The main kinds ofawards in this category are as follows: - shares awarded to an employee to join HSBC that are made available immediately, with no vesting period attached to the award, are expensed immediately; - when an inducement in the form of shares is awarded to an employee on commencement of employment with HSBC, and the employee must complete a specified period of service before the inducement vests, the expense is spread over the period to vesting; - discretionary bonuses awarded in respect of service in the past, are expensed over the vesting period which, in this case, is the period from the date the bonus is announced until the award vests. For share options granted to employees of the group directly by HSBC Holdingsplc, the compensation expense to be spread over the vesting period is determinedby reference to the fair value of the options on grant date, and the impact ofany non-market vesting conditions such as option lapses. The expense isrecognised over the vesting period. The corresponding amount is credited to'Other reserves'. t Foreign currencies (i) Items included in each of the group's entities are measured using the currency of the primary economic environment in which the entity operates ('the functional currency'). The group's financial statements are presented in Hong Kong dollars. Transactions in foreign currencies are recorded in the functional currency at the rate of exchange prevailing on the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the functional currency at the rate of exchange ruling at the balance sheet date. Any resulting exchange differences are included in the income statement. Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated into the functional currency using the rate of exchange at the date of the initial transaction. Non-monetary assets and liabilities measured at fair value in a foreign currency are translated into the functional currency using the rate of exchange at the date the fair value was determined. (ii) The results of branches, subsidiaries and associates not reporting in Hong Kong dollars are translated into Hong Kong dollars at the average rates of exchange for the reporting period. Exchange differences arising from the retranslation of opening foreign currency net investments and exchange differences arising from retranslation of the result for the reporting period from the average rate to the exchange rate prevailing at the period-end are accounted for in a separate foreign exchange reserve. Exchange differences on a monetary item that is part of a net investment in a foreign operation are recognised in the income statement of the separate subsidiary financial statements. In the consolidated financial statements these exchange differences are recognised in the foreign exchange reserve in shareholders' equity. On disposal of a foreign operation, exchange differences relating thereto and previously recognised in reserves are recognised in the income statement. u Provisions Provisions for liabilities and charges are recognised when it is probable that an outflow of economic benefits will be required to settle a present legal or constructive obligation arising from past events and a reliable estimate can be made of the amount of the obligation. v Insurance contracts From 1 January 2005 Through its insurance subsidiaries, the group issues contracts to customers thatcontain insurance risk, financial risk, or a combination thereof. A contractunder which the group accepts significant insurance risk from another party, byagreeing to compensate that party on the occurrence of a specified uncertainfuture event, is classified as an insurance contract. An insurance contract mayalso transfer financial risk, but is accounted for as an insurance contract ifthe insurance risk is significant. Insurance contracts are accounted for as follows: Premiums Gross insurance premiums for general insurance business are reported as incomeover the term of the insurance contract attributable to the risks borne duringthe accounting period. The unearned premium or the proportion of the businessunderwritten in the accounting year relating to the period of risk after thebalance sheet date is calculated on a daily or monthly pro-rata basis. Premiums for life assurance are accounted for when receivable, except inunit-linked business where premiums are accounted for when liabilities areestablished. Reinsurance premiums are accounted for in the same accounting period as thepremiums for the direct insurance to which they relate. Claims and reinsurance recoveries Gross insurance claims for general insurance business include paid claims andmovements in outstanding claims reserves. The outstanding claims reserves arebased on the estimated ultimate cost of all claims that have occurred but notsettled at the balance sheet date, whether reported or not, together withrelated claim handling costs and a reduction for the expected value of salvageand other recoveries. Reserves for claims incurred but not reported ('IBNR') are made on an estimated basis, using appropriate statistical techniques. Gross insurance claims for life assurance reflect the total cost of claimsarising during the year, including claim handling costs and any policyholderbonuses allocated in anticipation of a bonus declaration. The technical reservesfor non-linked liabilities (long-term business provision) are calculated by eachlife assurance operation based on local actuarial principles. The technicalreserves for linked liabilities are at least the element of any surrender ortransfer value which is calculated by reference to the relevant fund or funds orindex. Some insurance contracts may contain discretionary participation featureswhereby the policyholder is entitled to additional payments whose amount and/ortiming is at the discretion of the issuer. The discretionary element of thesecontracts is included in 'Liabilities under insurance contracts issued'. Reinsurance recoveries are accounted for in the same period as the relatedclaim. Value of long-term assurance business A value is placed on insurance contracts that are classified as long-termassurance business, and are in force at the balance sheet date. The value of in-force long-term assurance business is determined by discountingfuture earnings expected to emerge from business currently in force, usingappropriate assumptions in assessing factors such as recent experience andgeneral economic conditions. Movements in the value of in-force long-termassurance business are included in 'Other operating income' on a gross of taxbasis. w Investment contracts Customer liabilities under unit-linked investment contracts and the linkedfinancial assets are designated at fair value, and the movements in fair valueare recognised in the income statement in 'Net income from financial instrumentsdesignated at fair value'. Premiums receivable and amounts withdrawn are accounted for as increases ordecreases in the liability recorded in respect of investment contracts. Investment management fees receivable are recognised in the income statementover the period of the provision of the investment management services. The incremental costs directly related to the acquisition of new investmentcontracts or renewal of existing investment contracts are capitalised andamortised over the period of the provision of the investment managementservices. x Dividends Dividends proposed or declared after the balance sheet date are disclosed as aseparate component of shareholders' equity. y Debt securities in issue and subordinated liabilities From 1 January 2005 Debt securities issued for trading purposes or designated at fair value arereported under the appropriate balance sheet captions. Other debt securities inissue and subordinated liabilities are measured at amortised cost using theeffective interest rate method and are reported under 'Debt securities in issue'or 'Subordinated liabilities'. From 1 January 2004 to 31 December 2004 Debt securities in issue were measured at cost adjusted for amortised premiumsand discounts, and were reported under 'Debt securities in issue' or'Subordinated liabilities'. z Cash and cash equivalents For the purpose of the cash flow statement, cash and cash equivalents includehighly liquid investments that are readily convertible to known amounts of cashand which are subject to an insignificant risk of change in value. Suchinvestments comprise cash and balances with banks maturing within one month, andtreasury bills and certificates of deposit with less than three months' maturityfrom the date of acquisition. aa Share capital From 1 January 2005 Shares are classified as equity when the group has the unconditional right toavoid transferring cash or other financial assets. From 1 January 2004 to 31 December 2004 Share capital included preference shares issued by the group. These have beenreclassified as liabilities upon the adoption of HKAS 32. 2. Effect of changes in accounting policies A description of the significant changes from accounting policies previouslyapplied by the group together with estimates, to the extent practicable, of theamounts involved are set out below. Changes in accounting policies have generally been applied retrospectively,except as noted below. Retrospective application of a new accounting policyinvolves restating the comparative figures and restating the opening balancesheet as at 1 January 2004 as if the new policy had always been applied. Some standards specify transitional provisions governing the initial applicationof the standard. In some cases transitional provisions restrict the extent towhich a change in accounting policy may be applied retrospectively. The mostsignificant exception to retrospective application is HKAS 39. a HKAS 32 - Financial instruments: disclosure and presentation Application of HKAS 32 has resulted in the reclassification of preference shares issued by the group from share capital to liabilities. This has had the effect of increasing liabilities and reducing equity at 31 December 2005 by HK$71,980 million (2004: HK$55,602 million). In addition, dividends payable on those preference shares have been reclassified as interest expense whereas they were previously dealt with as an appropriation of retained earnings. This has reduced net interest income and operating profit in 2005 by approximately HK$3,010 million (2004: HK$1,540 million). HKAS 32 also requires that financial assets and liabilities may only be offset in the circumstances described in section 1 - Accounting policies Note (l). This resulted in a grossing up of assets and liabilities by approximately HK$57,718 million at 31 December 2005 (2004: HK$52,157 million). This adjustment had no effect on reported profit or equity. b HKAS 39 - Financial instruments: recognition and measurement HKAS 39 sets requirements for the classification, recognition, measurement and derecognition of financial instruments as well as hedge accounting. These requirements affect the measurement and timing of income and expense associated with many of the activities of the group as well as the carrying values of financial assets and liabilities in the balance sheet. The new accounting policies resulting from the application of HKAS 39 are set out in section 1 above. Where the accounting policies have changed as a result of the application of HKAS 39, the previous policies have also been disclosed. The transitional provisions of HKAS 39 prohibit full retrospective application of the standard and instead require the adjustments to the carrying values of all financial instruments on initial application of the standard to be made in the opening balance sheet at 1 January 2005. This means that the recognition and measurement of certain financial instruments, together with associated income and expense, for 2005 is not necessarily consistent with the amounts reported for 2004. The more significant changes in the 2005 financial statements resulting from HKAS 39 include (but are not limited to) the following: - Effective interest rate method (section 1 - Accounting policies Notes (a)&(b)) HKAS 39 requires the use of the effective interest rate method for calculating interest income and the amount of amortisation of premiums, discounts and transaction costs associated with debt instruments. This affects the timing of recognition of certain types of fee income and expense as well as their reclassification to 'Net interest income'. - Derivatives and hedging (section 1 - Accounting policies Note (j)) HKAS 39 requires all derivatives to be recognised on the balance sheet at fair (market) value regardless of the purpose for which they are held. In addition, the rules for applying hedge accounting under HKAS 39 are more restrictive than the policies previously applied by the group. This results in fewer transactions qualifying for hedge accounting in 2005 compared to previously, while the gains and losses on the derivatives are now generally recognised in 'Net trading income'. - Acceptances and endorsements HKAS 39 requires that assets and liabilities associated with acceptances and endorsements related to trade finance should be recognised on the balance sheet. This results in an increase in both 'Other assets' and 'Other liabilities' of HK$22,744 million. Under the previous accounting policy, these items had been disclosed as off-balance sheet contingent liabilities and commitments. This change has no effect on profit for the year. - Fair value measurement HKAS 39 generally requires treasury bills and debt securities intended to be held on a continuing basis to be carried at fair value in the balance sheet. Unless the securities are designated under the 'fair value option' (see below), then the changes in fair value are recognised in equity until the securities are sold. These securities were previously carried at cost. In addition, the group has early-adopted the 'Amendment to HKAS 39 - The fair value option' in 2005. This allows financial assets and liabilities, under certain restricted circumstances, to be designated at fair value with changes in fair value being recognised in the income statement as they arise. This is described in section 1 - Accounting policies Note (f). There was no such category in 2004. Upon initial application of HKAS 39 in 2005, the following financial assets and liabilities were designated at fair value under the 'fair value option': Fair value at 01Jan05 HK$m Assets Customer advances 3,807 Treasury bills 1,318 Debt securities 15,976 Equity shares 14,971 36,072 Liabilities Customer deposits 1,252 Deposits by banks 1 1,253 Effect of HKAS 39 on the income statement To the extent practicable, management has estimated the effect of applying HKAS 39 on the group's income statement in 2005 as follows: Estimated effect of applying HKAS 39: HK$m Increase in net interest income 1,076 Decrease in net fee income (298) Decrease in net trading income (957) Net income from financial instruments designated at fair value 372 Increase in gains less losses from financial investments 139 Decrease in dividend income (105) Increase in impairment charges and other credit risk provisions (53) Increase in net operating income 174 Decrease in operating expenses 193 Increase in profit before tax 367 c HKFRS 4 - Insurance contracts HKFRS 4 introduced a formal definition of the term 'Insurance contract'. Application of this standard has materially affected the financial statements in the manner set out below. - Certain contracts issued by the group which have the legal form of insurance contracts do not meet the definition of insurance contracts in HKFRS 4. The assets, liabilities, income and expense associated with such contracts are dealt with as investment contracts and from 1 January 2005, are accounted for under HKAS 39. - Reclassification of items relating to the insurance business - Financial assets held by insurance subsidiaries were previously reported as 'Other assets'. These financial assets have been disaggregated and classified into their respective categories. Measurement of such assets is also in accordance with HKAS 39 with effect from 1 January 2005. - The income statement captions 'Net earned insurance premiums' and 'Net insurance claims incurred and movement in policyholders' liabilities' now include only the amounts relating to insurance contracts as defined under HKFRS 4. Income and expense relating to contracts which are, in substance, investment contracts are included in other income statement captions according to their nature. Income from related assets is included in 'Net interest income' and 'Net income from financial instruments designated at fair value'. The related assets are included in the balance sheet under 'Financial assets designated at fair value' and 'Financial investments'. The liabilities related to these contracts are included in 'Financial liabilities designated at fair value'. - Previously all income and expense related to the insurance business was included in 'Other operating income'. The comparative figures disclosed in the financial statements have been reclassified to show net earned insurance premiums and net insurance claims incurred. However, in accordance with the transitional provisions of HKAS 39, the comparative figures have not been remeasured. These reclassifications have no impact on operating profit. d HKFRS 2 - Share-based payment HKFRS 2 requires an expense to be recognised by the group where employees are awarded options over shares in HSBC Holdings plc and where the group awards shares to employees in compensation for services rendered to the group. The group recognises an expense in all cases where equity instruments of HSBC Holdings plc are granted to employees for services rendered to the group, regardless of whether the equity instruments are granted directly by HSBC Holdings plc or by the group. The expense is recognised over the vesting period relevant to each type of award. Details of the new accounting policy are set out in section 1 - Accounting policies Note (s). Prior to the adoption of HKFRS 2, share options that were awarded by HSBC Holdings plc directly to employees of the group were not recognised in the group's financial statements. When the group awarded its employees shares of HSBC Holdings plc the amount payable by the group to acquire the shares was recorded as an expense. In accordance with the transitional rules of HKFRS 2, the group has applied the new accounting policy retrospectively to all share-based payment transactions where the grant date was after 7 November 2002 and which had not vested by 31 December 2004. The change in accounting policy has resulted in share-based payment expenses being recognised in 2005 of HK$876 million (2004: HK$466 million). At 31 December 2005 the reserve arising from the grant of share options to the group's employees was HK$629 million (2004: HK$322 million) and the liability recognised for share awards made by the group was HK$576 million (2004: HK$211 million). e HKAS 17 - Leases HKAS 17 requires leasehold land to be classified as held under operating leases. With some exceptions, as described in section 1 - Accounting policies Note (o), this has resulted in the remeasurement of certain interests in land (principally held in Hong Kong) from a fair value basis to a historical cost basis. Such interests in land have been removed from 'Property, plant & equipment' and reclassified as 'Other assets'. This has resulted in a decrease in assets and a decrease in previously reported revaluation reserves. If the previous accounting policy had been applied in 2005, total assets and equity would have been increased by approximately HK$15,061 million and HK$12,425 million respectively at 31 December 2005 (2004: HK$10,746 million and HK$9,352 million respectively). The deferred tax liability would have been increased by HK$2,636 million (2004: HK$1,394 million). In addition, operating profit in 2005 would have been reduced by the additional depreciation charge attributable to the revaluation of approximately HK$420 million (2004: HK$245 million). In the group's interim news release for the six months ended 30 June 2005, leases of land exceeding 500 years to expiry at inception were recognised as finance leases and were included in the balance sheet as 'Property, plant & equipment' at fair value less accumulated depreciation. Following the publication of a summary of a meeting of the International Financial Reporting Interpretations Committee in December 2005, at which a related issue had been discussed, the group considered it would be appropriate to classify all leases of land as operating leases, regardless of the length of the lease, unless the specific conditions described in section 1 - Accounting policies Note (o) are met. f HKAS 40 - Investment properties (section 1 - Accounting policies Note (o)(iii)) HKAS 40 requires unrealised revaluation gains and losses on investment properties to be recognised directly in the income statement as they arise. Prior to the implementation of this standard, revaluation gains on investment properties were recognised in equity until the investment properties were sold, at which point the cumulative revaluation gains or losses would be included in the calculation of the gain or loss on disposal. The new policy increases operating profit for 2005 by HK$1,167 million. In accordance with the transitional provisions of HKAS 40, the 2004 income statement has not been restated to conform to the new accounting policy. g HKFRS 3 - Business combinations HKFRS 3 has been applied with effect from 1 January 2004, in accordance with the transitional provisions of the standard. The principal effect of this is that previously recognised goodwill has been frozen at its carrying value (cost less accumulated amortisation and impairment) as at 1 January 2004. Thereafter, goodwill is not amortised, but is tested annually for impairment. Prior to this change of accounting policy, goodwill was amortised over its estimated useful life. HKFRS 3 also requires intangible assets to be recognised upon acquisition of a subsidiary or an associate. As a result of this, intangible assets have been reclassified from goodwill. No impairment losses have been recognised as a result of applying the new policy for 2004 and 2005. The comparative figures for 2004 have been restated to comply with the new policy. The cessation of goodwill amortisation has resulted in an increase in profit before tax for 2005 of HK$145 million (2004: HK$43 million). The carrying amount of goodwill in the balance sheet has therefore not been reduced by the same amount. The net effect of ceasing the amortisation of goodwill and the additional amortisation charged on intangible assets leads to a decrease in profit before tax of HK$44 million in 2005. For 2004, the net effect was an increase in profit before tax of HK$43 million. h HKAS 38 - Intangible assets The application of HKAS 38 has resulted in the recognition of internally developed software as an asset in 2005 of approximately HK$628 million. Under the group's previous accounting policy, software development costs were recognised as expenses as they were incurred. The effect of the new policy is to increase operating profit for 2005 by approximately HK$590 million, representing the capitalised internally developed software, less amortisation for the year. 3. Critical accounting estimates and judgements in applying accounting policies The preparation of financial statements requires the group to make certainestimates and to form judgments about the application of its accountingpolicies. The most significant areas where estimates and judgments have beenmade are set out below. Fair value estimation As disclosed in section 1 - Accounting policies, a significant proportion of thegroup's financial assets and liabilities are stated in the balance sheet at fairvalue. Fair value is defined as the amount for which an asset could beexchanged, or a liability settled, between knowledgeable, willing parties in anarm's length transaction. Where there is an active market for financial assets and liabilities and quotedprices are available, then such prices are the best indicator of fair value. Inthe normal course of business, however, the group also holds financial assetsand liabilities, including certain non-exchange traded derivatives, where quotedprices in an active market are not available. The group uses valuationtechniques to determine the fair value of such financial instruments. Thevaluation techniques used for different financial instruments are selected toreflect how the market would be expected to price the instruments, using inputsthat reasonably reflect the risk-return factors inherent in the instruments.Depending upon the characteristics of the financial instruments concerned,observable market factors are available for use in most valuations, while othersinvolve a greater degree of judgment and estimation. In the case of trading assets and liabilities, derivatives, and financial assetsand liabilities designated at fair value, the estimation of fair value at thereporting date affects profit for the year. The group has, and maintains, asubstantial pool of expertise in the valuation of financial instruments andvaluation estimates are benchmarked against actual outcomes, where practicable,to ensure that the valuation techniques reflect actual market activity. Accounting standards also require disclosure of the estimated fair value ofcertain financial instruments that are stated in the balance sheet at amortisedcost. These disclosures, which are made in the notes on the financialstatements, affect neither the profit for the year nor the carrying amounts ofany assets or liabilities in the balance sheet. The estimation of fair value ofsome of these classes of assets and liabilities is performed in the absence ofactive markets for instruments with similar characteristics. The amountsdisclosed, therefore, may involve a higher degree of judgment and estimationthan is the case for most of the assets and liabilities which are carried atfair value on the balance sheet. Loan impairment Application of the group's methodology for assessing loan impairment, as set outin section 1 - Accounting policies Note (d), involves considerable judgment andestimation. For individually significant loans, judgment is required in determining first,whether there are indications that an impairment loss may have already beenincurred, and then estimating the amount and timing of expected cash flows,which form the basis of the impairment loss that is recorded. For collectively assessed loans, judgment is involved in selecting and applyingthe criteria for grouping together loans with similar credit characteristics, aswell as in selecting and applying the statistical and other models used toestimate the losses incurred for each group of loans in the reporting period.The benchmarking of loss rates and the ongoing refinement of modellingmethodologies provide a means of identifying changes that may be required, butthe process is inherently one of estimation. Special purpose entities In the normal course of business, the group participates, in a variety of ways,in financial structures involving special purpose entities. Judgment is requiredin determining whether the rights and obligations taken on result in the grouphaving control of the special purpose entity and whether it should be includedin the consolidated financial statements as a subsidiary. Impairment of available-for-sale financial investments Judgment is required in determining whether or not a decline in fair value of anavailable-for-sale financial investment below its original cost is of such anature as to constitute impairment, and thus whether an impairment loss needs tobe recognised under HKAS 39. Liabilities under investment contracts Estimating the liabilities for long-term investment contracts where the grouphas guaranteed a minimum return involves the use of statistical techniques. Theselection of these techniques and the assumptions used about future interestrates and rates of return on equity, as well as behavioural and other futureevents, have a significant impact on the amount recognised as a liability. Insurance contracts Classification HKFRS 4 and HKAS 39 require the group to determine whether an insurance contractthat transfers both insurance risk and financial risk is classified as aninsurance contract under HKFRS 4, or as a financial instrument, or whether theinsurance and non-insurance elements of the contract should be accounted forseparately. This process involves judgment and estimation of the amounts ofdifferent types of risks that are transferred or assumed under a contract. Theestimation of such risks often involves the use of assumptions about futureevents and is thus subject to a degree of uncertainty. Present value of in-force long-term assurance business ('PVIF') The value of PVIF, which is recorded as an intangible asset, depends uponassumptions regarding future events. The assumptions are reassessed at eachreporting date and changes in the estimates which affect the value of PVIF arereflected in the income statement. Insurance liabilities The estimation of insurance claims liabilities involves selecting statisticalmodels and making assumptions about future events which need to be frequentlycalibrated against experience and forecasts. Income taxes The group is subject to income taxes in many jurisdictions and significantjudgment is required in estimating the group's provision for income taxes. Thereare many transactions and interpretations of tax law for which the final outcomewill not be established until some time later. The group recognises liabilitiesfor taxation based on estimates of whether additional taxes will be payable. Theestimation process includes seeking expert advice where appropriate. Where thefinal liability for taxation is different from the amounts that were initiallyrecorded, these differences will affect the income tax and deferred taxprovisions in the period in which the estimate is revised or the final liabilityis established. Held to maturity securities As indicated in section 1 - Accounting policies Note (g), certain debtinstruments within the 'Financial investments' category are classified asheld-to-maturity investments. In order to be able to use this classification,the group needs to exercise judgment upon initial recognition of the investmentsas to whether it has the positive intention and ability to hold them untilmaturity. A failure to hold these investments to maturity, in all but a limitednumber of circumstances, would result in the entire held-to-maturity categorybeing reclassified as 'available-for-sale'. They would then be measured at fairvalue. This information is provided by RNS The company news service from the London Stock Exchange