AUSTRALIAN FINANCIAL INSTITUTIONS AUDITORS ASSOCIATION IMPLEMENTATION OF IFRS June 2005

2. AUSTRALIAN FINANCIAL INSTITUTIONS AUDITORS ASSOCIATION • IMPLEMENTATION OF IFRS • June 2005

3. Major Changes since May 2004 • Effective Interest rate method • Related Direct costs = Transaction Costs • Loan Honeymoon rate discounts • Initial application under IFRS 1 • Exempt from disclosure of comparatives, but • retrospective calculation for opening balances

4. Major Changes since May 2004 • AASB 139 Financial Instruments • IAS Exposure draft to remove option of fair value for Loans & Receivables (unless an embedded derivative)

5. Major Changes since May 2004 • Securitised Loans • De-recognition tests satisfied • Consolidation SIC12 / UIG112 satisfied • Fees for service taken as revenue

6. Major Changes since May 2004 INVESTMENTS IN EQUITY INSTRUMENTS • that do not have a quoted market price in an active market andwhose fair value cannot be reliably measured • must be valued if possible • IF NO VALUE - Are measured at cost

7. Major Changes since May 2004 • INVESTMENTS IN EQUITY INSTR • Disclose under AASB 132. 90 • description their carrying amount • explanation of why fair value cannot be measured reliably • Estimated value range - if possible

8. Materiality AASB 124 • Omissions or misstatements of items are material if they could, individually or collectively, • influence the economic decisions of users taken on the basis of the financial report.

9. Materiality AASB 124 • Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. • The size or nature of the item, or a combination of both, could be the determining factor.

10. Materiality AASB 124 • Material because of their nature • transactions occur between an entity and parties who have a fiduciary responsibility in relation i.e. AASB 124 Related party

11. Materiality AASB 124 • an amount which is equal to or greater than 10 per cent of the appropriate base amount may be presumed to be material unless there is evidence or convincing argument to the contrary;

12. Materiality AASB 124 • an amount which is equal to or less than 5 per cent of the appropriate base amount may be presumed not to be material unless there is evidence, or convincing argument, to the contrary.

13. Major areas of impact • 1. Effective interest rate • 2. Provisions for impairment • 3. Related parties

14. Effective Interest rate method AASB 139 & 118 • These fees are an integral part of generating an ongoing involvement with the resultant financial instrument and, • together with the related direct costs (Transaction Costs, FAS 91 USA ), • are deferred and recognised as an adjustment to the effective yield. • Amortised over the effective life of the asset using the cumulative amortisation

15. Effective Interest rate method • FAS 91 .6 & 7 • Direct loan origination costs • include only • that portion of the employees' total compensation and payroll-related fringe benefits directly related to time spent performing those activities for that loan and other costs related to those activities that would not have been incurred but for that loan.

16. Effective Interest rate method • 40. The Board concluded that costs associated with loan origination that are incurred by the lender in transactions with independent third parties should be deferred. The Board recognizes that this decision…, if that solicitation were performed by the lender's employees, paragraph 7 would proscribe the deferral of those costs. FAS 91.40

17. Effective Interest rate method • When origination activities are being performed by an independent third party, the Board believes that the lender is not in a position to determine the portion of time spent by the third party on each of the activities and therefore is unable to determine the amount of cost applicable to the origination activities. FAS 91. 40

18. Effective Interest rate method • CONCLUSION? • FAS 91 WORRIED ABOUT MANIPULATON OF DIRECT COSTS THEREFORE DENIED INTERNAL COSTS • IAS application of FAS 91 to suit the banks wanting to list in U.S.

19. Effective Interest rate method • Example in FAS 91 Loan principal $100,000 Origination fees (3,000) Direct loan origination costs 1,000 Carrying amount of loan $ 98,000

20. Effective Interest rate method FAS 91 example

21. Effective Interest rate method • ICAA comment re direct costs • this it pretty much a dead issue from the Banks perspective there are still some fringe issues relating to early repayment charges and package product fees. • The big issue really is the how to calculate average loan life.

22. Interest Income Amortised fees &Transaction costs Fee Income Loan origination fees deferred Loan Balance – Less Deferred Fees Plus Deferred Transaction costs Interest Expense Fees & direct loan expenses Transaction costs deferred Other operational & admin expenses Effective Interest rate method

23. Effective Interest rate method • Accounting for deferred Fees component • Debit the fee to the loan • Credit deferred income account (B/S in lieu of Income) • Determine the expected period of loan (average of similar types of loans).

24. Effective Interest rate method Workshop Results • Issues of Interest • How to calculate the estimated life • Average 2 year for PL • Average 3 – 4 years for ML • Impact on Reserves < 1% • Impact after 1 Jul 05 < 1%

25. Effective Interest rate method • Estimated Life ? • Loan Principal • start of year + % funded in year • Divided by • Loan repayments • In year less interest • Less also redraws allowance.

26. Effective Interest rate method • Issues of Interest • Future impact will be felt where • Fees increase in value • Increase in Volume • Transaction costs increase • Transaction costs are expensed

27. Effective Interest rate method • Issues of Interest FAS 91 • Commitment fees deferred over life or period of commitment • Credit Card fees deferred over period • Restructuring fees deferred if adding to the loan eg top up • Prepayments to reduce period must be reliable and for large homogenous type loans

28. Effective Interest rate method • Issues of Interest APRA • What to report in D2A for • loan interest for classes in ARF 330-1 (for amortised fees & costs) and • Loan balances re ARF 323, 112-1; 220-3 (for unamortised fees & costs)

29. PROVISIONS ON LOANS • APRA • Requires a General Provisions to be held as a General Reserve for Credit Losses • Consistent with the AASB 130 and 139 requirements

30. PROVISIONS ON LOANS • Opening 2006 accounts • Transfer the general provision to a Reserve • Account for movements as Appropriations of Retained earnings • Need to report 2005 comparatives (no AASB1 Exemption for AASB130)

31. SPECIFIC PROVISIONS ON LOANS • AG92. Formula -based approaches or statistical methods may be used to determine impairment losses in a group of financial assets • If they meet the tests in AASB 139 and AG guidance.

32. PROVISIONS ON LOANS • Must assess the loss events as at balance date • not give rise to an impairment loss on initial recognition of a financial asset.

33. PROVISIONS ON LOANS • Any model used would • incorporate the effect of the time value of money, [only if no interest earned] • consider the cash flows for all of the remaining life of an asset (not only the next year), • consider the age of the loans within the portfolio and

34. PROVISIONS ON LOANS • AG88. IMPAIRMENT LOSSES ON A LOAN • any losses on individually impaired assets in a group, those assets are removed from the group. • Apply discounted cash flow approach to any individual loans assessed.

35. PROVISIONS ON LOANS • STEP 1 ASSESS EACH LOAN FOR IMPAIRMENT • Use Arrears reports to consider all credit exposures, not only those of low credit quality. AG 85 • assessment may result either in a single amount or in a range of possible amounts. AG 86

36. PROVISIONS ON LOANS • WORKSHOP RESULTS • INDIVIDUAL LOANS • How to calculate Discounted cash flow. • Formula ? • Evidence to evaluate APRA Model

37. PROVISIONS ON LOANS • APRA Model _ Results for 30 credit unions • Compare bad debts to APRA provisions • On average the specific provisions from the APRA Model had a high correlation to bad debts in following year • BUT individual deviations were large • We need to have the proof for each entity

38. PROVISIONS ON LOANS • Step 2 APRA Model – results to date • Understates • Up to 90 days for loans in arrears • Other events (bankrupts; economic factors) • Loans with increasing arrears, or become bad debts • possible falling security values exposures

39. PROVISIONS ON LOANS • APRA Model – results to date • Overstates • Category 4 overlimits (14 Days) • Secured loans (if included in Cat 2 or 3) • Loans which improve performance

40. PROVISIONS ON LOANS • Evidence to evaluate APRA Model • History of bad debts compared to Specific Provision • Take a start point and for a sample of loans track the changes in impairment.

41. PROVISIONS ON LOANS • Results to date • FOR CAT 3 OK • FOR CAT 4 TOO HIGH for overlimits for facilities • OK for savings overdrawn

42. PROVISIONS ON LOANS • APRA Issues • What to do if AASB 139 provision is lower than AGN 220-3. • Another appropriation account to show as reserve and apply to provision in APRA return?

43. RELATED PARTY TRANSACTIONS • AASB 1017 • Applied to directors • Class Order provided some relief for relatives

44. RELATED PARTY TRANSACTIONS • AASB 124 • Applies to Key Management Personnel (KMP) • Disclose the names of directors • Disclose the compensation for KMP (in aggregate) not banded No Relief expected

45. RELATED PARTY TRANSACTIONS • Other Transactions • Applies to • KMP • Close family of KMP • Former KMP • Other related entities

46. RELATED PARTY TRANSACTIONS • Key Management Personnel KMP • Are • Directors and • associated directors and • specified executives

47. RELATED PARTY TRANSACTIONS • KMP • Is a person Directly accountable and responsible for the (setting and implementation of) strategic direction and operationalmanagement of the entity,

48. RELATED PARTY TRANSACTIONS • Specified KMP executives are • persons with the delegated authority to manage the entity (i.e. operations) • Limited to 5 most senior executives

49. RELATED PARTY TRANSACTIONS • KMP definition applicable to Mgt • Has the person • the authority to direct and control activities of the entity (as a whole or a significant component) , • the responsibility for directing and controlling those activities

50. RELATED PARTY TRANSACTIONS • AASB 130. 58 - State • Policy of granting loans to KMP & Close family • Loan balances • Loan funded, repayments, interest • Loan provisions for impairment • Loan bad debts