Statement of changes in capital and reserves. Notes to financial statements 6-124

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1 KOMERCIJALNA BANKA AD SKOPJE Financial statements for the year ended 31 December 2010

2 Summary Page Independent auditor s report Income statement Balance sheet Statement of changes in capital and reserves Cash flow statement Notes to financial statements

3 Independent auditor s report To the Shareholders and Supervisory Board of Komercijalna Banka AD - Skopje Report on financial statements We have audited the accompanying financial statements of Komercijalna Banka AD - Skopje, which comprise the balance sheet as of 31 December 2010 and the income statement, statement of changes in equity and cash flows for the year then ended and a summary of significant accounting policies and other explanatory notes. Management s responsibility for the financial statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with the accounting law regulations applicable in the Republic of Macedonia. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of the financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditor s responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 2

4 Financial statements for the year ended 31 December 2010 Opinion In our opinion, the accompanying financial statements give a true and fair view of the financial position of Komercijalna Banka AD Skopje as of 31 December 2010, and of its financial performance and its cash flows for the year than ended in accordance with the law regulations applicable in the Republic of Macedonia. Manager Ljube Gjorgjievski Chartered auditor Skopje Ljube Gjorgjievski 25 February 2011

5 Financial statements for the year ended 31 December 2010 Income Statement for the period from to Note in thousands of MKD current year 2010 previous year 2009 Interest income ,928,194 Interest expense ( ) (1,612,749) Net - interest income/(expense) ,315,445 Fee and commission income ,103 Fee and commission expense ( ) (145,201) Net - fee and commission income/(expense) ,902 Net-trading income 8 (733) 16,468 Net-income from other financial instruments recorded at fair value Net-foreign exchange gains/(losses) ,317 Other operating income ,458 Share in profit of affiliates ,326 Value adjustment of financial assets, on a net basis 12 ( ) (604,855) Impairment losses upon non-financial assets, on a net basis 13 (14.417) - Costs for employees 14 ( ) (940,363) Depreciation 15 ( ) (195,826) Other operating expense 16 ( ) (709,788) Share in loss of affiliates 24 (4.074) (3,076) Profit/(loss) before taxation ,074,008 Income tax 17 (7.758) - Profit/(loss) for the financial year from continouos activity ,074,008 Profit/(loss) from assets held for sale * - - Profit/(loss) for the financial year ,074,008 Profit/(loss) for the period that belongs to*: Bank shareholders - - Minority share - - Earnings per share 41 basic earning per share (in MKD) diluted earnings per share (in MKD)

6 Financial statements for the year ended 31 December 2010 Balance sheet as at Note in thousands of MKD current year 2010 previous year 2009 Assets: Cash and cash equivalents ,595,011 Assets for trading ,591 Financial assets at fair value via the income statement determined as such at initial recognition Derivative assets held for risk management Placements with and loans to banks ,330,614 Placements with and loans to other clients ,851,929 Investments in securities ,875 Investments in affiliates (recorded by accounting as per "method of principal") ,799 Income tax receivables (current) ,226 Other receivables ,397 Collateralized assets Foreclosed assets ,139,601 Intangible assets ,864 Property and equipment ,681,290 Deferred tax assets Non-current assets held for sale and group for sale Total assets ,712,197 Liabilities Trading payables Financial liabilities at fair value via the income statement determined as such at initial recognition Derivative liabilities held for risk management Deposits from banks ,100 Deposits from other clients ,040,428 Issued debt securities Loans payable ,587,233 Subordinated debt Special reserve and provisions ,469 Income tax payables (current) ,975 Deferred tax liabilities Other liabilities ,660 Liabilities directly related to group of assets for sale Total liabilities ,755,865 Equity and reserves Subscribed capital ,014,067 Share premia ,027 Registered shares - - Capital component of hybrid financial instruments - - Other equity instruments - - Revalued reserves - - Other reserves ,759,230 Retained earnings/(accumulated loss) ,074,008 Total equity and reserves that belong to Bank shareholders ,956,332 Minority share* - - Total equity and reserves ,956,332 Total liabilities and equity and reserves ,712,197 Contingent liabilities ,969,262 Contingent assets

7 Financial statements for the year ended 31 December 2010 Statement of changes in capital and reserves for the period from 1 January 2009 до 31 December 2009 in thousands of MKD Subscribed capital Share premia Registered shares Equity Other reserves Revalued reserves Retained earnings Capital component of hybrid financial instruments Other equity instruments Statutory reserve Other reserves Revalued reserve for assets available for sale Reserve for protection against risk Foreign exchange gains/losses reserves Other revalued reserves available for distribution to shareholders limited for distribution to shareholders Accumulated los Total capital and reserves that belong to Bank shareholder Minority share* Total capital and reserves As at January 1, ,014, , ,813 2,359, ,377, ,263,494-6,263,494 Adjustments to initial balance As at January adjusted 2,014, , ,813 2,359,997 1,377,590 6,263, ,263,494 Changes in fair value of assets available for sale Changes in fair value of protection against cash flow risk Changes in fair value of protection against risk of net investment in international operations Foreign exchange gains/losses recognized in equity Deferred tax (assets)/liabilities recognized in equity Other Total unrealized profit/(loss) recognized in equity Issued shares within the period Profit/(loss) for the financial year ,074, ,074,008-1,074,008 Allocation of statutory reserve Allocation of other reserves , (996,420) Dividends (381,170) - - (381,170) - (381,170) Purchase of registered shares Sold registered shares Other changes in capital and reserves As at December ,014, , ,813 3,356, ,074, ,956,332-6,956,332 As at January 1, Changes in fair value of assets available for sale Changes in fair value of protection against cash flow risk Changes in fair value of protection against risk of net investment in international operations Foreign exchange gains/losses recognized in equity Deferred tax (assets)/liabilities recognized in equity Other Total unrealized profit/(loss) recognized in equity Issued shares within the period Profit/(loss) for the financial year Allocation of statutory reserve Allocation of other reserves ( ) Dividends ( ) - - ( ) - ( ) Purchase of registered shares Sold registered shares Other changes in capital and reserves (37.941) - - (37.941) - (37.941) As at December

8 Financial statements for the year ended 31 December 2010 Statement of cash flows for the period from to Operating cash flows Note current year 2010 in thousands of MKD previous year 2009 Profit/(Loss) before taxation ,074,008 Adjusted for: Minority share, included in the consolidated income statement* Depreciation of: ,826 Intangible assets ,020 Property and equipment ,806 Capital gain from: (1.775) (6,095) Sale of intangible assets - - Sale of property and equipment (1.767) (6,008) Sale of foreclosed assets (8) (87) Capital loss from: ,864 Sale of intangible assets - - Sale of property and equipment Sale of foreclosed assets ,077 Interest income ( ) (3,928,194) Interest expense ,612,749 Net-trading income 733 (16,468) Value adjustment of financial assets, on a net basis ,855 Additional value adjustment ( ) (3,224,007) Release of value adjustment ,619,152 Impairment losses of non-financial assets, on a net basis Additional impairment losses Release of impairment losses - - Special reserves (35.800) (92,040) Additional provisions ( ) (290,942) Release of provisions ,982 Income from dividend (4.132) (12,903) Share in profit/(loss) of affiliates (18.802) (17,250) Other adjustments ,459 Interest receipts ,795,370 Interest paid ( ) (1,506,437) Operating profit before changes in operating assets ,713,744 (Increase)/Decrease of operating assets: Trading assets ( ) 150,158 Derivative assets held for risk management - - Placements with and loans to banks ,618 Placements with and loans to other clients ( ) (4,302,295) Collateralized assets - - Foreclosed assets ( ) (380,390) Mandatory reserve in foreign currency ( ) (530,738) Mandatory deposit to NBRM according to special regulations - 150,786 Other receivables (71.082) (185,170) Deferred tax assets - - Non-current assets held for sale and group for sale (18.179) -

9 Statement of cash flows (continue) for the period from to Note in thousands of MKD in thousands of MKD Increase/(Decrease) of operating liabilities: current year 2010 previous year 2009 Trading liabilities - - Derivative liabilities held for risk management - - Deposits from banks (332,628) Deposits from other clients ,518,718 Other liabilities ,441 Liabilities directly related to group of assets for sale - - Net operating cash flows before taxation ,244 (Paid)/Return on income tax (7.690) (89,319) Net operating cash flows ,925 Cash flows from investing activities (Investments in securities) (15.755) - Inflows from sale of investments in securities ,802 (Outflows for investments in subsidiaries and affiliates) - (8,992) Inflows from sale of investments in subsidiaries and affiliates - - (Acquisition of intangible assets) (37.107) (36,056) Inflows from sale of intangible assets - - (Acquisition of property and equipment) ( ) (306,060) Inflows from sale of property and equipment ,903 (Outflows for non-current assets held for sale) - - Inflows from non-current assets held for sale - - (Other outflows from investing activities) - - Other inflows from investing activities ,903 Net cash flows from investing activities ( ) (272,500) Cash flows from financing activities (Repayment of issued debt securities) - - Inflows from issued debt securities - - (Repayment of loan payables) ( ) (12,065,946) Increase in loan payables ,668,904 (Repayment of issued subordinated debt) - - Inflows from issued subordinated debt - - Inflows from issued shares/equity instruments within the period - - (Acquisition of registered shares) - - Sold registered shares - - (Paid dividends) ( ) (381,819) (Other outflows from financing activities) - - Other inflows from financing activities - - Net cash flows from financing activities ,139 Effects from adjustment of value of cash and cash equivalents - 1,089 Effects from foreign exchange gains/losses of cash and cash equivalents - (17,631) Net-increase/(decrease) of cash and cash equivalents ,022 Cash and cash equivalents as at January ,818,470 Cash and cash equivalents as at December ,660,492 * only for consolidated financial statements 4

10 Note 1 Note 2 Risk management 2.1 Credit risk 2.2 Liquidity risk 2.3 Market risk Risk of change in the interest rates in the banking book Currency risk Other market risks 2.4 Operational risk 3 Capital adequacy 3.1 Determination of the adequacy of capital 4 Reporting according to segments 5 Fair value of financial assets and liabilities Profit and loss account 6 Net interest income / (expenses) 7 Net fees and commissions income / (expenses) 8 Net trading incomes 9 Net income from other financial instruments recorded at fair value 10 Foreign exchange gains/(losses) 11 Other operating income 12 Impairment loss of non-financial assets, on net-basis 13 Costs for employees 14 Depreciation 15 Other operating expense 16 Income tax Balance sheet Assets 18 Cash and cash equivalents 19 Trading assets 20 Financial assets at fair value via the income statement determined as such at initial recognition 21 Derivative assets and liabilities held for risk management 22.1 Placements with and loans to banks 22.2 Placements with and loans to other clients 23.1 Investments in financial assets available for sale 23.2 Investments in financial assets held to maturity 24 Investment in subsidiaries and affiliates 25 Other receivables 26 Collateralized assets 27 Foreclosed assets 28 Intangible assets 29 Property and equipment 30 Current and deffered tax assets and liabilities 31 Non-current assets held for sale and group for sale Liabilities, capital and reserves 32 Trading liabilities 33 Financial liabilities at fair value through the profit and loss determined as such at initial recognition 34 Deposits 34.1 Deposits from banks 34.2 Other deposits 35 Issued debt securities 36 Borrowings 37 Subordinated liabilities 38 Special reserves and provisions 39 Other liabilities 40 Subscribed capital Other disclosures 41 Earnings per share 42 Contingent liabilities and contingent assets 42.1 Contingent liabilities 42.2 Contingent assets 43 Operations on behalf and for account of third parties/commission operations 44 Related party transactions 45 Lease 46 Share based payments 5

11 1. NOTE а) General information Komercijalna Banka AD - Skopje (hereinafter the Bank ), is a shareholding company having its registered office in the Republic of Macedonia. The Bank is listed on the Macedonian Stock Exchange A.D. Skopje, under the code KMB. The Bank is authorized to perform all banking activities pursuant to the Banking law and its main activities are corporate lending and lending to citizens, deposit operations, foreign currency transactions, services for domestic and international payment operations and alike. In addition, it provides favourable trade-finance climate for the companies performing export-import operations. Address of the registered office of the Bank Is as follows: Kej Dimitar Vlahov Skopje Republic of Macedonia These financial reports are approved for disclosure by the Supervisory Board of the Bank on 24 February b) Base of the financial statements Financial statements of Komercijalna Banka AD Skopje (individual) have been prepared in accordance with: the Companies Act (Official Journal of RM No. 28/2004), Banking Law, law regulation passed by NBRM, and the Decision on Methodology on recording and valuation of the accounting items and on preparation of the financial statements (Official Journal of RM No. 118/2007) and are expressed in thousand Macedonian denars (MKD) The reporting and functional currency of the Bank is the Macedonian denar MKD. Preparation of the individual financial statements is in accordance with the generally accepted accounting policies and requires use of assessments and assumptions having influence on the presented assets and liabilities, potential assets and liabilities as at the date of the financial statements and the presented amounts of income and expenses during the reporting period. These assessments are based on the best knowledge of the management about the current events and activities. 6

12 Additional information is shown in the accounting policies and respective notes to the financial statements. c) Important accounting policies The main accounting policies applied at preparation of the financial statements are stated hereunder. Cash and cash equivalent For the needs of the cash flow, cash and cash equivalents comprise cash and deposits with NBRM, treasury bills and government bonds with maturity up to 90 days. Cash includes cash in the treasury and on the account as well as demand deposits. Foreign currency assets Assets and resources presented in foreign currency (monetary items) are expressed in denars at the mid-exchange rate of NBRM at the end of the calculating period. Nonmonetary items which are recorded at historic purchase value, denominated in foreign currency, are calculated at the foreign exchange rate on the date of transaction. Foreign exchange gains and foreign exchange losses (realized and not realized) occurred on these basis are included in the Profit and Loss Account. Foreign exchange rate: 31 December December 2009 MKD MKD USD 46,31 42,66 EUR 61,50 61,17 7

13 Financial instruments netting Financial assets and liabilities are netted and their net value is presented in the Balance Sheet on net basis if there are lawful applicable netting rights and possibility for presentation on net basis. Interest income and expenses Interest income and expenses are presented as calculated income and expenses on the basis of all interest bearing receivables and payables except for those being classified for trading or as financial assets at objective value through the Profit and Loss Account as such at the initial recognition. Interest income/expenses are recognized using the method of effective interest rate. The effective interest rate is the rate which exactly discounts the assessed future cash flows for the expected useful life of the financial instrument. Calculation includes all paid or received fees, transaction charges and premiums/discounts between the agreement parties. The interest income and expenses are calculated and collected in accordance with the law regulations of the Republic of Macedonia or subject to agreement between the creditor and the debtor. Correction is made when collection of the calculated interest is bad and doubtful. Income from fees and commission Income from fees and commission encompasses the calculated fees under loans, letters of guarantee, letters of credit and other banking services. Income from fees and commission are recognized in the Profit and Loss Account on calculation basis at the time of execution of the respective service. 8

14 Financial assets Classification Financial assets are classified in four groups: Financial assets by objective value through the Profit and Loss Account; Financial assets held to maturity; Financial assets available for sale; and Loans and claims Financial assets by objective value through the Profit and Loss Account Financial assets by objective value through the Profit and Loss Account are comprised of: assets for trading and; financial assets by objective value through the Profit and Loss Account defined as such at the initial recognition. Financial assets by objective value through the Profit and Loss Account are recognized initially by the objective value. Transaction charges of these assets do not include the amount according to which the instrument is initially measured. They are immediately recorded in the Profit and Loss Account in the position of Income/expenses from fees and commission. Assets for trading Assets for trading are the assets acquired by the Bank or occurred mainly for trading purposes, or to realize income from their sale on a short term and/or to realize income as a result of the occurred or expected short-term changes of the prices on the market. Financial assets are classified as held for trading if it is: acquired or occurred for the purposes of sale in near future; a part of the portfolio of identified financial instruments being managed in groups and for which there is evidence of recent, actual/real model of trading and realization of short-term profits; 9

15 Assets for trading are comprised of: government debt securities; treasury bills; ownership instruments with listed market price Net income from trading represents the realized and non-realized changes of the objective value at consequent measuring, profit or loss at sale, dividends, interest income and expenses of the assets for trading and liabilities for trading. Investments held to maturity Financial assets held to maturity are financial assets with fixed or definable payments and with fixed maturity, for which the bank has an intention and possibility to hold to maturity. If in the course of the financial year, or in the previous two financial years, the Bank had sold or reclassified more than insignificant amount of the investments held to maturity, before their maturity, the Bank must not use this category, i.e. the whole category is reclassified as available for sale. Investments held to maturity are measured by the amortized purchase value, applying the method of effective interest rate. Profits and losses are recognized in the Profit and Loss Account when the assets are derecognized or impaired and through the amortization process. Financial assets available for sale Financial assets available for sale are the assets being defined as available for sale and not classified as: loans and claims; financial assets held to maturity; or financial assets at objective value through the Profit and Loss Account After the initial recognition, the Bank measures the financial assets at their objective value, without reduction of the transaction charges that may occur at sale. Profits and losses from the consequent measuring at the objective value of financial assets available for sale are equal to the difference between the amortized purchase value and the objective value of the assets and they are directly included in the capital in the position of Revaluation reserves/differences from valuation of the assets available for sale. The impairment losses/correction of value and foreign exchange gains and losses of the financial instruments available for sale are recognized in the Profit and Loss Account for the current period. At the time of derecognition of the assets available for sale (e.g. the assets are sold or due), cumulative gains/losses which are previously recognized in the capital are derecognized from the capital and the net profits or losses are recognized in the Profit 10

16 and Loss Account in the position of Other income form operation/other expenses from operation. Loans and claims Loans and claims comprise all the claims under the transactions with clients and banks, those derive from the bank, as well as those purchased on a secondary market. Loans and claims are non-derivative financial assets with fixed or determined payments. The bank recognizes loans and claims in its Balance Sheet when the cash is directly approved to the credit user. Loans and claims initially are measured by its fair value, increased for the transaction costs directly related to the acquire or issue of the financial asset. Loans and claims are measured by amortized purchase value with use of the effective interest rate method. Impairment of financial assets Financial assets by amortized value At each date of the Balance Sheet the Bank makes assessment if there is an objective evidence that the financial assets or group of financial assets should be impaired. Financial assets or group of financial assets are impaired or a loss from impairment is made only if there is an objective evidence for impairment as a result of one or more cases that have occurred after the initial assets recognition ( case of loss ) and that the case of loss (or cases) influences over the estimated future cash flows from financial assets or group of financial assets that can be truly estimated. Criteria used by the bank for determination if there is an objective evidence for impairment of the financial assets comprise: significant financial difficulty of the financial instrument issuer or debtor; factual breach of the contract, such as default or delay of the payments under interest and principal; making a relief to the debtor by the creditor, due to financial difficulties of the debtor, that otherwise the creditor does not makes; big possibility that the debtor will enter a liquidation or in another type of financial reorganization; disappearance of an active market for a financial asset due to financial difficulties; or Data that indicate that there is a measurable decrease in the estimated future cash flows from a group of financial assets, from the initial recognition of those assets, although the decrease can not be individually related to the financial asset 11

17 including: - negative changes in the payment condition of the debtor (for example, increased number of delayed payments or increased number of debtors under credit cards that have reached the maximum allowed overdraft and that pay the minimum monthly amount; or - national or local economic conditions in rate to the impairment of assets (for example, increase of the unemployment rate in a geographical region of the debtor, decrease in property prices in the region, that serves as a collateral, decrease in oil prices for loans for the oil producers or negative changes in the industrial conditions that impact over the debtors). At first, the Bank makes estimation if the objective evidence for impairment exists for separate financial assets that have separate meaning and, separately or in group, for the financial assets that are not separately significant. If the bank states that there is no an objective evidence for impairment for the separately estimated financial assets, whether significant or not, it includes the assets in a group of financial assets with similar characteristics of credit risk and makes a group estimation for their impairment. Assets that are separately estimated for impairment and for which the impairment losses are or are continuing to be recognized, are not included in the common impairment estimation. When one loan can not be collected, it is written-off on the account of provisions for bad and doubtful loans. Such loans are written-off after all necessary procedures are taken and after the determination of the loss amount. If in each next period the losses amount from impaired assets is decreased and the decrease can be objectively related to an event occurred after the impairment recognition (such as improvement of the credit condition of the debtor), previously recognized impairment loss is booked as credit. Such amount is booked in the Profit and Loss Account. Calculated interest under impaired loans is ensured with provisions for impairment, recognized in Profit and Loss account (as part of transferred value of the loan, measured by depreciation charges). Financial assets classified as available-for-sale At each date of Balance Sheet, the Bank makes an estimation if there is an objective evidence that the financial assets or group of financial assets are impaired. In case of equity investments that are classified as available-for-sale, the significant or continuous decrease of the nominal value of the securities below the cost price it is reviewed during the determination whether the assets are impaired. If there is such evidence for the financial assets available-for-sale, cumulative loss-measured as a difference between the purchase price and tne current nominal value, decreased for the 12

18 eventual loss from impairment of such assets that have been previously recognized in the Profit and Loss Account-are deleted from the equity and are recognized in the Profit and Loss Account. Impairment losses recognized in Profit and Loss account for equity instruments, are not retrieved through Profit and Loss account. If in the next period, the nominal value of debt instruments classified as available-for-sale is increased and the increase can objectively be related to a event that occurred after the impairment loss recognition in the Profit and Loss account, then the impairment loss is retrived through Profit and Loss Account. Joined companies Joined company is a company where the Bank has significant impact in the process of decision-making on the financial and operative policies of the company, but without control over these policies. Financial statements include the share of the Bank in the total recognized profit and loss of the joined company, according to the method of principal, from the date the significant impact starts until the date the significant impact stops. When the Bank s share in the loss of the joined company is equal to or exceeds the investment accounting value, the investor usually stops including its share in further losses. The investment shall be reported as zero value. Additional loss shall be taken into account up to the extent to which the investor undertook obligations or effected payments in the name of the joined company guaranteed by the investor or otherwise undertaken as obligation. Immovables and equipment Immovables and equipment are material investments by the Bank, for carrying out the business, that are expected to have useful fife of more than one year. Initially, the immovables and the equipment are measured at the purchase value of the respective asset and other costs necessary for making the asset operative. The operative costs that are not part of the purchase value of the asset, arising before putting of the asset into operation, are recognized as expenditure in the Profit and Loss Account. The consequential expenses for the immovables and equipment shall be capitalized when the conditions for recognizing it as an asset have been fulfilled. The daily maintenance costs for the immovables and equipment shall not be recognized in the accounting value of the respective asset. After the initial recognition, the immovables and the equipment shall be measured according to their purchase value, decreased for the accumulated amortization and for the accumulated impairment loss. The total amount of amortization of the asset shall be distributed in accordance with its useful life. The amortization costs for each period shall be recognized in the Profit and Loss Account under the item Amortization. All assets of the same group are properly amortized. 13

19 The amortization for the accounting purposes shall follow the useful life of the asset. The Bank is applying the straight method of amortization, which reflects the future economic benefit of the asset. The amortization of the asset shall start when it is available for use, and shall terminate on the date of derecognising or the date of reclassification of the asset, whichever is the first, as asset held for sale. The immovables and equipment shall be amortized by applying the annual amortization rates, arising from the assessed useful life of the used property. The amortization of the material assets is made by applying the proportional method during the year on monthly basis. The amortization is calculated for each material asset separately. The useful life of certain categories of immovables and equipment is as follows: Useful life Buildings Furniture and equipment 40 years 4-20 years Intangible assets An intangible asset is any non-monetary asset, without any physical content, that can be independently identified. The intangible assets include the capitalized costs for development, software and other nonmaterial assets, such as rights and licenses, which are protected by the law and the owner may not be deprived of, against his/her will (for example, patents, copyrights and other commercial rights). At the beginning, the intangible assets are measured at their purchase value. Consequently, intangible assets are measured at their purchase value decreased for the accumulated amortization and for the accumulated impairment loss. The amortization shall start when the asset is available for use. All assets of the same group are properly amortized. The amortization for the accounting purposes shall follow the useful life of the asset. The value of the asset remaining upon expiry of its useful life shall be assumed to be zero. The Bank shall assess the useful life of the intangible asset. For the intangible assets, the Bank shall define the following useful life: Useful life 14

20 Other intangible assets Software purchased 5 years 5 years Assets taken over under uncollected claims This category includes land, buildings (or parts of buildings), equipment and other valuables got in exchange for bad and doubtful claims. Certain asset shall be considered taken over at the moment of acquiring the legal basis for registration of the title thereon. At the date of taking over, the asset taken over shall be recognized in the bank s accounts at its initial accounting value. The initial accounting value shall be the lower amount of the assessed value and the purchase value of the asset taken over. For the needs of consequential measuring of the assets taken over, the assessed value shall be the amount of the lowest assessment made by three authorized evaluators. In case when the assessed value of the asset taken over is less than the purchase or accounting value, the Bank shall show impairment loss in the Profit and Loss Account, to the extent of the difference between both values. Special reserve and provisioning The provisioning are defined as obligations with uncertain maturity period or amount. The obligation is current commitment of the Bank, which arises from previous transactions or events, which amount may accurately be determined and which settlement is expected to result in outflow of Bank s resources. Employees benefits In the course of its operations, the Bank is making payments of compensations for pension and health insurance, employment and personal income tax, in favour of its 15

21 employees, calculated on the basis of gross salaries. The Bank is paying these contributions to the Pension and Disability Insurance Fund of the Republic of Macedonia and to the Health Insurance Fund of the Republic of Macedonia, calculated at the legally prescribed rates. These contributions paid shall comprise the employees costs for the current year. The costs for these compensations are presented in the Profit and Loss Account for the same period when the employees salaries costs are presented. The Bank is not performing any activities in the field of any pension schemes or plan for benefits after retirement, and consequently, does not have any obligations regarding the pensions. Income tax The income tax is calculated and paid in accordance with the provisions of the Law on Income Tax. Deposits from banks and other clients The deposits from banks are mainly comprised of: current accounts, time deposits of banks and transactions at money market, except those which are determined as liabilities under loans (including the transactions for repurchasing). In general, the deposits from other clients are: current accounts and time deposits from legal entities or individuals. The deposits of banks and clients are measured at their objective value, increased for the transaction costs, which are directly related to the undertaking or issuing of the financial obligation. The deposits from banks and clients shall consequently be measured according to their amortized value, by using the method of effective interest rate. Liabilities under loans The liabilities under loans are mainly comprised of transactions with other parties with which the Bank has loan agreements signed with. The liabilities under loans are initially measured at their objective value, increased for transaction costs, which are directly related by acquiring or issuing the financial liability. Liabilities under loans are consequently measured according to their amortized purchase value, by using the method of effective interest rate. 16

22 Equity capital The capital is the remaining part of the share in the Bank s assets after deduction of all its liabilities. Issued capital The issued capital is the total subscribed and paid in capital of the Bank. Share premium The share premium is the difference between the nominal value and the market price of the shares. Preferred shares The preferred shares that are not purchasable by the Bank, and are traded at the Macedonian Stock Exchange AD Skopje, shall be presented as capital. Retained earning The retained earning/accumulated loss means retained earning or accumulated loss carried over from the previous years. Dividends The dividends are recognized as liabilities in the period of their disclosure. 17

23 d) Use of assessments and evaluations The Bank is making assessments and evaluations that have impact on the amounts in the assets and liabilities report for the next financial year. The evaluations and judgements are permanently evaluated and are based on previous experience and other factors, including expectations for future events which are believed to be accurate, in accordance with the current conditions. (a) Correction of value on loans approved The Bank is revising its credit portfolio on monthly basis, in order to make reassessment regarding the correction of value. When deciding whether any loss under correction of value is to be presented in the Profit and Loss Account, the Bank is making assessment whether there are any actual data that indicate that there is any quantified decrease of the future assessed cash flow, reflected on the credit portfolio as a whole, before the decrease is a result of an individual loan from that portfolio. These evaluations may arise from the deterioration of the creditability of the borrowers within the frames of the group, or from the national or local economic circumstances that correspond to the loss of the assets with the Bank. The Bank is using evaluations based on the experience from the previous loss of assets with characteristics of credit risk and objective indicators for corrections of value, similar to those of the portfolio. (b) Investments held to maturity The Bank holds to maturity the debt securities issued by the Republic of Macedonia, which are with nominal interest rate of 2% p.a., and are acquired as compensation when settling certain uncollectible claims. The principal amount under the government bonds issued for the so called frozen savings deposits is paid in 20 equal semi-annual instalments, starting from April 2002 until October The principal amount under the government bonds for denationalization (04) is paid in 10 equal annual instalments, starting from June 2006 until June 2015, and the principal amount under the government bonds for denationalization (05) is paid in 10 equal annual instalments, starting from June 2007 until June 2016, and the principal amount under the government bonds for denationalization (06) is paid in 10 equal annual instalments, starting from June 2008 until June As at 31 December 2010, the balance of these claims is in amount of MKD (2009: MKD ). e) Amendments of the accounting policies, accounting assessments and correction of errors The positions in the Financial Statements and the Notes to the Financial Statements for the current 2010 are presented in accordance with the Methodology for recording and evaluation of the accounting items and on preparation of the financial reports, 18

24 and for the previous year in accordance with the law regulations applicable in the Republic of Macedonia. f) Compliance with the law regulations One of the main principles the operation of the Bank is based upon is the compliance with the applicable law regulations. Although incorporated in the processes of operation of the Bank, this principle, pursuant to the Banking Law, is adhered to by establishing separate organizational unit - Operation Compliance Control and Money Laundering Prevention Department, which through its activities and competences contributes not only in adherence to this principle but also to the elimination, i.e. minimization of the incompliance in the operation with the applicable law regulations. This Operation Compliance Control and Money Laundering Prevention Department is permanently monitoring and following the new regulations and the amendments and supplements to the applicable ones, makes evaluation of their impact on the operation of the Bank, and especially in regards to the activities that have to be undertaken within the Bank, duly undertaking the necessary activities and providing regular reports to the Board fo Directors and other organizational units of the Bank. The Department takes active participation in the implementation of the regulations, and depending on the complexity of the regulations, it provides suggestions for their implementation and assistance in the process of implementation. The Department takes active participation in the creation of the internal regulations and especially from the aspect of their compliance with the external regulations, in the revision of the applicable regulations, makes initiatives for improvement of the operative processes, provides interpretations regarding the implementation of the law regulations and indicates the consequences and risk that may arise from late or improper implementation of the law regulations, default implementation of certain decisions, complaints, etc. These measures and activities, as well as other mechanisms provided through the corporate activities of the Bank, ensure operation of the Bank complied with the regulations prescribed by the National Bank of the Republic of Macedonia. In 2010, by the National Bank of the Republic of Macedonia to the Bank a measure written notice has been given. In accordance with this measure and the minutes for the determined conditions by the realised control in the Bank, an Action plan for unclosing of stated colliding has been made. For realisation of the action plan and the taken activities by the Bank, it is reported to National Bank of the Republic of Macedonia, and between the Bank and the National Bank of the Republic of Macedonia an Agreement for mismatches removal has been signed. g) Post balance sheet events With successful realization of the VI (sixth) issue of ordinary shares through a public offer, the number of Bank s ordinary shares increased by 265,000. The absolute value (amount) of sold shares in the public offer is MKD 927,500,000. After the new share issue the Bank s share capital comprises of 2,279,067 ordinary shares with nominal value of 1,000 MKD per share i.e. total nominal value of MKD 2,279,067,000. On 15 of February 2011 securities of the new issue have been registered with the Trade Registry and are allocated to the 19

25 investor s accounts with the Central Securities Depositary. 2. Risk management The Bank s activities expose it to a variety of financial risks, so the adequate risk management is basic Bank s goal. The efforts to maintain adequate balance between accepted risk level and profitability are permanent. The Bank has established Strategy for undertaking and managing risks, adopted by the Supervisory Board of the Bank and it is revised regularly. The Strategy defines the main objectives and general directions in undertaking and managing risks, general approach to the risk management, general approach to the internal determining and assessment of the bank's necessary capital adequacy, general review of the business strategy of the bank, as well as the possible changes in the bank's business strategy and acceptable level of risk the bank can be exposed to during its operations. Compliance to the nature, size and complexity of the financial activities, the bank s system for managing the risks covers at least the following types of risks: credit risk, liquidity risk, currency risk, market risk, risk from changes of the interest rates in the portfolio of banking activities, operative risk, including the legal risk, reputation risk and strategic risk. 20

26 Risk management framework Bank s Shareholders Assembly appoints the members of the Supervisory Board and the Audit Committee. Supervisory Board has overall responsibility for the establishment and oversight of the Bank s risk management framework. Supervisory Board has established the Management Board, Credit Committee and Risk Management Committee. These bodies are responsible for monitoring and developing risk management policies in specific areas. Regarding the organizational structure of the Bank, the Risk Management and Planning Division is responsible for monitoring and reporting of global risk exposure, while the organizational units of the Bank which creates risk exposure are responsible for operative risk management. Internal audit, in the function of adequately monitoring and risk managementis responsible for the independent review of risk management processes. The Bank has established organizational structure, with clearly defined competences and responsibilities among organizational parts of the bank where credit risk is originated and where is managed. According to the Bank s risk management policies and procedures appropriate risk, identification, estimation, measurement, monitoring and contol are made on regular basis. 2.1 Credit risk Credit risk is a risk of loss for the bank due to the incapability of its client to settle its liabilities within agreed amount and/or periods. Credit risk is the most important risk of the Bank s business, so the Bank carefully manages its exposure to credit risk. Principally, credit exposure arises in the lending activities and investment activities Credit risk management The Bank has established organizational structure, with clearly defined competences and responsibilities given taking up and managing risks. The organization of the credit risk management is established on the following levels of hierarchy: 21

27 - Strategic level - the risk management function shall be performed by the members of Supervisory Board and the Board of Directors; Risk Management Board and Auditing Board; - Macro level - the function of the risk management risks at the level of business unit, or business line shall be performed by other persons with special rights and responsibilities performing managing function and/or by special organizational unit responsible for monitoring the management with all, or specific risks; Credit risk management at the level of business unit in the Bank mean each Division where the credit risk is undertaking and the persons with special rights and responsibilities who performs the management function in that Division. Duties of these organizational units in the Bank are regulated in the appropriate Policies adopted from the Bank s Supervisory Board. Special organizational unit in the Bank competent for credit risk management is Risk Management and Planning Division Credit Risk Management Department Credit risk valuation According Methodology, there is classification of the credit risk exposure: а) On individual basis, for all credit risk exposures which are considered individualy significant; б) On a group basis for retail portfolio and for similar financial instruments. а) Estimation of credit risk for the bank s clients which are individualy significant is by means of the tools from the bank s internal rating system. If total limit to a client is exceeding 0.007% of the total credit risk exposure of the Bank, its exposures are clasified as credit risk exposures on individual basis. cases: As an exeption, credit risk exposure on individual basis exists also in these If the Bank is exposed on credit risk to banks and equity investments; If exposures are classified as non-performing. The internal rating system is consistent to the nature, size and complexity of the 22