Public Joint-Stock Company VS Bank. Financial statements and Independent auditor s report Translation from Ukrianian original.

Transcription

1 Public Joint-Stock Company VS Bank Financial statements and Independent auditor s report Translation from Ukrianian original 31 December 2016

2 Financial statements and Independent auditors report CONTENTS Independent Auditor s Report Financial Statements Statement of financial position... 1 Income statement... 2 Statement of comprehensive income... 3 Statement of changes in equity... 4 Statement of cash flows (under direct method)... 5 Notes to the Financial Statements 1 Introduction Operating environment and political situation in Ukraine Basis of preparation and significant accounting policies Critical accounting estimates and judgements in applying accounting policies Adoption of new or revised standards and interpretations New accounting pronouncements not yet effective Cash and cash equivalents Mandatory reserve balance with the National Bank of Ukraine Due from other banks Loans and advances to customers Investment securities available-for-sale Premises, equipment and intangible assets Investment property Other financial and non-financial assets Due to banks Due to individuals and corporate customers Other financial and non-financial liabilities Subordinated debt Share capital and earnings per share Interest income and expense Fee and commission income and expense Net gains arising from trading in foreign currencies and revaluation of monetary assets and liabilities in foreign currencies Operating expenses Income taxes Segment analysis Financial risk management Commitments and contingencies Fair value of financial instruments Related party transactions Capital adequacy ratio Events after the reporting period... 74

3 Ernst & Young Audit Services LLC 19A Khreshchatyk Street Kyiv, 01001, Ukraine Tel: +380 (44) Fax: +380 (44) Ukrainian Chamber of Auditors Certificate: ТОВ «Ернст енд Янг Аудиторськi послуги» вул. Хрещатик, 19А Киïв, 01001, Украïна Тел.: +380 (44) Факс: +380 (44) Свiдоцтво Аудиторськоï Палати Украïни: 3516 INDEPENDENT AUDITOR S REPORT To the Shareholders and Managing Board of PUBLIC JOINT STOCK COMPANY VS BANK Opinion We have audited the financial statements of PUBLIC JOINT STOCK COMPANY VS BANK (the Bank), which comprise the statement of financial position as at 31 December 2016, and the statement of profit or loss, statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies. In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Bank as at 31 December 2016, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs). Basis for opinion We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor s responsibilities for the audit of the financial statements section of our report. We are independent of the Bank in accordance with the International Ethics Standards Board for Accountants Code of Ethics for Professional Accountants (IESBA Code) together with the ethical requirements that are relevant to our audit of the financial statements in Ukraine, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA Code. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Material uncertainty related to going concern We draw attention to Note 2 in the financial statements, which describes the operating environment in Ukraine. As further discussed in the Going concern section of Note 3, the circumstances referred to in Note 2 combined with external factors, which emerged in March 2017 as discussed in Note 31, indicate that a material uncertainty exists that may cast significant doubt on the Bank s ability to continue as a going concern. Our opinion is not modified in respect of this matter. Key audit matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. In addition to the matter described in the Material uncertainty related to going concern section of our report, we have determined the matter described below to be the key audit matter to be communicated in our report. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For the matter below, our description of how our audit addressed the matter is provided in that context. We have fulfilled the responsibilities described in the Auditor s responsibilities for the audit of the financial statements section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the accompanying financial statements. A member firm of Ernst & Young Global Limited (i)

4 Allowance for loan impairment The appropriateness of allowance for loan impairment is a key area of judgement for management. In addition, the balance of allowance for loan impairment of UAH 1,257,625 thousand is material to the financial statements. The identification of impairment and the determination of the recoverable amount are inherently uncertain processes involving various assumptions and factors including expected future cash flows, fair value of collateral, haircut and time necessary for forced sale of collateral and loss identification period. The use of different assumptions could produce significantly different estimates of allowance for loan impairment. Associated disclosures in Note 11 to the financial statements are complex and dependent on the data quality. We assessed and tested the design and operating effectiveness of the Bank s internal controls over loan impairment calculations including the quality of underlying data and systems. For allowance for loan impairment calculated on a collective basis, we tested the underlying models. We also tested the appropriateness and accuracy of the inputs to those models, such as probability of default and recovery rates. For allowance for loan impairment calculated on an individual basis, we assessed the assumptions underlying the impairment identification and quantification including forecasts of future cash flows and valuation of underlying collateral. We analysed associated disclosures in Note 11 to the financial statements in respect of allowance for loan impairment. Other Information included in the Bank s 2016 Annual Report Other information consists of the information included in the Annual Report of PUBLIC JOINT STOCK COMPANY VS BANK, other than the financial statements and our auditor s report thereon. Management is responsible for the other information. The Annual Report of PUBLIC JOINT STOCK COMPANY VS BANK is expected to be made available to us after the date of this auditor s report. Our opinion on the financial statements does not cover the other information and we will not express any form of assurance conclusion thereon. In connection with our audit of the financial statements, our responsibility is to read the other information identified above when it becomes available and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. Responsibilities of management and the Supervisory Board for the financial statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with IFRSs, and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. In preparing the financial statements, management is responsible for assessing the Bank s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Bank or to cease operations, or has no realistic alternative but to do so. The Supervisory Board is responsible for overseeing the Bank s financial reporting process. (ii) A member firm of Ernst & Young Global Limited

5 Auditor s responsibilities for the audit of the financial statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit 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 Bank s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Bank s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor s report. However, future events or conditions may cause the Bank to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. We communicate with the Supervisory Board regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide the Supervisory Board with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with it all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. (iii) A member firm of Ernst & Young Global Limited

6 From the matters communicated with the Supervisory Board, we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. The partner in charge of the audit resulting in this independent auditor s report is Oleksandr Svistich. (iv) A member firm of Ernst & Young Global Limited

7 Statement of financial position In thousands of Ukrainian hryvnia Notes 31 December December 2015 ASSETS Cash and cash equivalents 7 1,655,348 1,061,777 Mandatory reserves with the National Bank of Ukraine 8 38,343 34,235 Securities designated at fair value through profit or loss 176,356 Due from banks 9 40,933 45,956 Loans and advances to customers 10 1,407,176 1,710,260 Investment securities available-for-sale , ,471 Premises, equipment and intangible assets , ,931 Investment property 13 2,952 3,144 Advance payments for income tax 31,200 Other financial assets 14 4,386 2,646 Other non-financial assets 14 2,093 47,236 TOTAL ASSETS 3,909,258 3,666,012 LIABILITIES Due to banks 15 1,665,917 1,475,771 Due to individuals , ,259 Due to corporate customers , ,936 Other borrowed funds 261 Current income tax liability 17,883 Deferred income tax liability 24 31,669 42,507 Other financial liabilities 17 19,435 24,777 Other non-financial liabilities 17 1,375 5,872 Subordinated debt , ,289 TOTAL LIABILITIES 3,010,205 2,814,555 EQUITY Share capital , ,000 Share premium 42,000 42,000 Reserve funds 39,230 35,403 Revaluation reserve for office premises 80,184 99,363 Retained earnings 317, ,691 TOTAL EQUITY 899, ,457 TOTAL LIABILITIES AND EQUITY 3,909,258 3,666,012 Approved for issue and signed on behalf of the Management Board on 19 April 2017: Performer: R.V. Mykhalchuk, tel The notes on pages 6 to 74 are an integral part of these financial statements 1

8 Income statement In thousands of Ukrainian hryvnia Notes Year ended 31 December 2016 Year ended 31 December 2015 Interest income , ,151 Interest expense 20 (126,956) (99,078) Payments to Individuals Deposits Guarantee Fund 20 (3,829) (3,648) Net interest income 218, ,425 Net allowance charge for loan impairment 9, 10 (107,676) (128,475) Net interest income after allowance for loan impairment 110,594 94,950 Fee and commission income 21 65,205 51,213 Fee and commission expense 21 (5,332) (5,600) Net gains arising from securities designated at fair value through profit or loss 20,912 72,100 Net losses arising from investment securities available-for-sale (5) Net gains arising from trading in foreign currencies and revaluation of monetary assets and liabilities in foreign currencies 22 33,650 12,807 (Loss)/gain on investment property revaluation 13 (192) 331 Loss on initial recognition of financial instruments (4,704) (5,103) Net charge of allowance for other assets impairment 14 (2,007) (235) Reversal/(charge) of allowance for other liabilities 3,752 (4,066) Other operating income 13,069 17,603 Operating income 234, ,000 Operating expenses 23 (150,522) (132,547) Profit before tax 84, ,453 Income tax expense 24 (20,838) (24,924) Profit for the year 63,582 76,529 Basic and diluted earnings per ordinary share (UAH) Approved for issue and signed on behalf of the Management Board on 19 April 2017: Performer: R.V. Mykhalchuk, tel The notes on pages 6 to 74 are an integral part of these financial statements 2

9 Statement of comprehensive income In thousands of Ukrainian hryvnia Notes Year ended 31 December 2016 Year ended 31 December 2015 Profit for the year recognised in the income statement 63,582 76,529 Components of other comprehensive income Revaluation of office premises - (Losses)/gains on revaluation of office premises (20,196) 58,763 - Deferred income tax 24 4,210 (10,272) Other comprehensive income that will not be reclassified to income statement in subsequent periods (15,986) 48,491 Investment securities available-for-sale - Gains on revaluation of investment securities available-for-sale - Deferred income tax 24 Other comprehensive income to be reclassified to income statement in subsequent periods Total components of other comprehensive income for the year, net of tax (15,986) 48,491 Total comprehensive income for the year 47, ,020 Approved for issue and signed on behalf of the Management Board on 19 April 2017: Performer: R.V. Mykhalchuk, tel The notes on pages 6 to 74 are an integral part of these financial statements 3

10 Statement of changes in equity In thousands of Ukrainian hryvnia Notes Share capital Share premium Reserve funds Revaluation reserve for office premises Retained earnings Total Balance as at 31 December ,000 42,004 28,757 52, , ,437 Changes in equity for the year ended 31 December 2015 Transfer of the result of purchase of treasury shares (4) 4 Transfer of retained earnings to reserve funds 6,646 (6,646) Amortisation of revaluation reserve for office premises, net of tax (1,498) 1,498 Profit for the year 76,529 76,529 Other comprehensive income 48,491 48,491 Total comprehensive income for the year 48,491 76, ,020 Balance as at 31 December ,000 42,000 35,403 99, , ,457 Changes in equity for the year ended 31 December 2016 Transfer of retained earnings to reserve funds 3,827 (3,827) Amortisation of revaluation reserve for office premises, net of tax (3,193) 3,193 Profit for the year 63,582 63,582 Other comprehensive income (15,986) (15,986) Total comprehensive income for the year (15,986) 63,582 47,596 Balance as at 31 December ,000 42,000 39,230 80, , ,053 Approved for issue and signed on behalf of the Management Board on 19 April 2017: Performer: R.V. Mykhalchuk, tel The notes on pages 6 to 74 are an integral part of these financial statements 4

11 Statement of cash flows (under direct method) In thousands of Ukrainian hryvnia Notes Cash flows from operating activities Interest received 338, ,861 Interest paid (94,950) (84,274) Payments to Individuals Deposits Guarantee Fund (3,847) (3,486) Fees and commissions received 68,816 54,588 Fees and commissions paid (5,332) (5,600) Net gains from trading in foreign currencies 24,813 25,250 Other operating income received 3,468 5,265 Operating expenses paid (149,628) (121,815) Income tax paid (76,549) (2,275) Cash flows from operating activities before changes in operating assets and liabilities 105, ,514 Changes in operating assets and liabilities: Net increase in mandatory reserves with the National Bank of Ukraine (4,108) (3,633) Net decrease in securities designated at fair value through profit or loss 195,672 Net decrease in due from banks 5,446 64,660 Net decrease in loans and advances to customers 364, ,491 Net decrease/(increase) in other assets 1,609 (1,627) Net decrease in due from banks (4,764) (3,000) Net decrease in due to individuals (12,997) (131,056) Net (decrease)/increase in due to corporate customers (12,810) 197,260 Net increase/(decrease) in other liabilities 3,723 (1,949) Net cash from operating activities 641, ,660 Cash flows from investing activities Purchase of investment securities available-for-sale (6,702,000) (5,458,000) Proceeds from repayment of investment securities available-for-sale 6,540,000 5,236,000 Purchase of premises, equipment and intangible assets 12 (11,506) (4,925) Proceeds from disposal of premises, equipment and intangible assets Proceeds from disposal of investment property 670 Net cash used in investing activities (173,505) (225,352) Cash flows from financing activities Redemption of other borrowed funds (261) (438) Repayment of interest on other borrowed funds (18) (100) Repayment of interest on subordinated debt (22,040) (9,855) Net cash used in financing activities (22,319) (10,393) Effect of exchange rate changes on cash and cash equivalents 147, ,581 Net increase in cash and cash equivalents 593, ,496 Cash and cash equivalents at the beginning of the year 1,061, ,281 Cash and cash equivalents as at the end of the year 7 1,655,348 1,061,777 Approved for issue and signed on behalf of the Management Board on 19 April 2017: Performer: R.V. Mykhalchuk, tel The notes on pages 6 to 74 are an integral part of these financial statements 5

12 1 Introduction Public joint-stock company VS Bank (the Bank ) was established in accordance with the Ukrainian legislation and registered by the National Bank of Ukraine (the NBU ) on 10 October The Bank conducts its business under banking license #31 dated 20 December 2013 issued by the National Bank of Ukraine and general banking license #31-2 dated 3 February According to licenses, the Bank carries out all major banking transactions specified by the legislation, in particular: opening and keeping current accounts of customers and correspondent banks, including cash transfer from these accounts using the payment systems and entering cash thereto; provision of loans to legal entities and individuals; acceptance of placements (deposits) from legal entities and individuals; transactions with currency assets. The Bank s strategic goal is to remain an innovative bank preferred by customers. The strategy is aimed at the Bank s further development in accordance with Sberbank Europe AG Group standards. As at 31 December 2016, the Bank is a participant of the Individual Deposits Guarantee Fund according to Registration Certificate #047 issued on 9 January 2014, registration date 2 September 1999, registration entry #050. As at 31 December 2016, the management holds no shares in the Bank. The holder of material share in the Bank is Sberbank Europe AG (Austria) with 99.92% holding in the Bank s share capital. The Bank s highest level parent company, which prepares the publicly disclosed consolidated financial statements, is OJSC Sberbank of Russia (the Russian Federation). As at 31 December 2016, the Bank had 38 branches throughout Ukraine (2015: 38). The number of the Bank s employees as at 31 December 2016 was 521 persons (2015: 522 persons). Registered address and place of business. The Bank s Head Offices is located at the address: 11, Grabovskogo Str., Lviv, Ukraine. Presentation currency. These financial statements are presented in thousands of Ukrainian hryvnia ( UAH thousand ) unless otherwise stated. Ukrainian hryvnia is also the functional currency of the Bank. UAH exchange rates established by the NBU and used in the preparation of these financial statements are as follows: 31 December December 2015 USD EUR RUB

13 2 Operating environment and political situation in Ukraine The Bank conducts its operations in Ukraine. The Ukrainian economy while deemed to be of market status continues to display certain characteristics consistent with that of an economy in transition. These characteristics include, but are not limited to, low levels of liquidity in the capital markets, high inflation, and significant imbalances in the public finance and foreign trade. Following the significant deterioration in 2014 and 2015, the current political and economic situation in Ukraine remains unstable. The Ukrainian government continues to pursue a comprehensive structural reform agenda aiming at the removal of the existing imbalances in the economy, public finance and governance, fighting corruption, reforming judiciary system, etc. with the ultimate goal to secure conditions for the economic recovery in the country. The weakness of the national currency (UAH), which experienced more than triple devaluation against US dollar since the beginning of 2014, combined with cross border settlement restrictions, negative external trade balance, along with continued volatility in the country s traditional export commodity markets, and high inflation represent key risks to the stabilisation of the Ukrainian operating environment in the near future. The continued support from the IMF and other international donors is contingent upon the mentioned above structural reforms sustaining momentum. The deterioration of the relations between Ukraine and Russia, which began in 2014 and has been continuing, provokes adverse public attitude, increases regulatory pressure and creates uncertainty in respect of continuation of Russian banks, especially state-owned, operations in Ukraine, including the Bank. The known and estimable effects of the above factors on the financial position and performance of the Bank in the reporting period have been taken into account in preparing these financial statements including those occurred after the reporting date and specifically, those referred to in Note 31 Events after the reporting period. The management is monitoring the developments in the current environment and taking actions, where appropriate, to minimize any negative effect to the extent possible. Further adverse developments in the political, macroeconomic and/or international trade conditions may further adversely affect the Bank s financial position and performance in a manner not currently determinable. 3 Basis of preparation and significant accounting policies Basis of Preparation. These financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ) under the historical cost convention, as modified by the revaluation of office premises, investment property, available-for-sale financial assets and financial instruments at fair value through profit or loss. Going concern. The factors described in Note 2 to the financial statements continued to affect the financial position and performance of the Bank. Events and circumstances after the reporting date, as disclosed in Note 31 to the financial statements, extended the uncertainty regarding the Bank s ability to continue as going concern in the current environment. The Bank s management considers the available options to manage these risks, including, in particular, liquidation of the impaired assets and possibility of changing the Bank s ownership structure. Notwithstanding this, a significant uncertainty associated primarily with events and conditions after the reporting date exists, which may affect the Bank s ability to continue as a going concern and realize its assets and discharge its liabilities in the normal course of business. The carrying value of the Bank s assets and liabilities as presented in these financial statements does not include any adjustments relating to the Bank s assumptions about the future, and other major sources of uncertainty of factors in question. 7

14 3 Basis of preparation and significant accounting policies (continued) Changes in accounting policies. In 2016, the Bank approved new regulations on loans renegotiation in accordance with the parent company policy. Accordingly, the Bank changed approaches to determination and presentation of information on loans and advances to customers, the terms of which had been revised by the Bank. If the Bank had not used the approaches of the regulations on the renegotiation of loans in accordance with the parent company policy, Note 10 to the financial statements in terms of loans, the terms of which had been revised, would be as follows: (in thousands of Ukrainian hryvnias) Commercial loans to legal entities Specialised loans to legal entities Consumer and other loans to individuals Mortgage loans to individuals Credit cards and overdrafts Car loans to individuals 31 December 2016 Not past due collectively assessed loans 10,993 58,084 79,929 2, ,430 Renegotiated loans up to 90 days overdue 166,834 33,561 46, ,611 Renegotiated loans more than 90 days overdue 167, , ,869 21, ,567 Total renegotiated loans before allowance for loan impairment 345, , ,316 24,592 1,191,608 Total In 2016, the Bank changed approaches to measurement of fair value of financial instruments for the purposes of disclosing the information in Note 28 Fair Value of Financial Instruments. Had the Bank used previous approaches, the fair value of loans and advances to customers in Note 28 would be UAH 2,670,917 as at 31 December The principal accounting policies applied in the preparation of these financial statements are set out below. These policies have been consistently applied to all the periods presented, unless otherwise stated. Key measurement terms. Depending on their classification, financial instruments are carried at cost, fair value, or amortised cost as described below. The description of these measurement terms is provided below. Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition and includes transaction costs. Measurement at cost is only applicable to investments in equity instruments that do not have a quoted market price and whose fair value cannot be reliably measured, derivatives that are linked to and must be settled by delivery of such unquoted equity instruments and fixed assets except for office premises. Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial instrument. An incremental cost is one that would not have been incurred if the transaction had not taken place. Transaction costs include fees and commissions paid to agents (including employees acting as selling agents), advisors, brokers and dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and duties. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs. 8

15 3 Basis of preparation and significant accounting policies (continued) Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date on arm's length terms. The fair value measurement is based on the assumption that the transaction to sell the asset or transfer the liability takes place either: in the principal market for the asset or liability; or in the absence of a principal market, in the most advantageous market for the asset or liability. A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange or other institution and those prices represent actual and regularly occurring market transactions on an arm s length basis. Valuation techniques are used to fair value certain financial instruments for which external market pricing information is not available. Such valuation techniques include discounted cash flows models, generally accepted option pricing models, models based on recent arm s length transactions or consideration of financial data of the investees. Valuation techniques may require assumptions not supported by observable market data. Disclosures are made in these financial statements if changing any such assumptions to a reasonably possible alternative would result in significantly different profit, income, total assets or total liabilities. Amortised cost is the amount at which the financial instrument was recognised at initial recognition less any principal repayments, plus accrued interest, and for financial assets less any write-down (directly or through allowance account) for incurred impairment losses. Accrued interest includes amortisation of transaction costs deferred at initial recognition and of any premium or discount to maturity amount using the effective interest method. Accrued interest income and accrued interest expense, including both accrued coupon and amortised discount and premium (including fees deferred at origination, if any), are not presented separately and are included in the carrying values of the related statement of financial position items. The effective interest method is a method of allocating interest income or interest expense over the relevant period so as to achieve a constant periodic rate of interest (effective interest rate) on the carrying amount. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts (excluding future credit losses) through the expected life of the financial instrument or a shorter period, if appropriate, to the net carrying amount of the financial instrument. Premiums and discounts on variable interest instruments are amortised to the next interest repricing date except for premiums and discounts, which reflect the credit spread over the floating rate specified in the instrument, or other variables that are not reset to market rates. Such premiums or discounts are amortised over the entire expected life of the instrument. The present value calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate (refer to income and expense recognition policy). Initial recognition of financial instruments. Trading securities, other securities at fair value through profit or loss and derivatives are initially recorded at fair value. All other financial assets are initially recorded at fair value plus transaction costs. Fair value at initial recognition is best evidenced by the transaction price. A gain or loss on initial recognition is only recorded if there is a difference between fair value and transaction price, which can be evidenced by other observable current market transactions in the same instrument, or by a valuation technique, whose inputs include only data from observable markets. 9

16 3 Basis of preparation and significant accounting policies (continued) All purchases and sales of financial assets that require delivery within the time frame established by regulation or market convention ( regular way purchases and sales) are recorded at trade date, which is the date that the Bank commits to deliver a financial instrument. All other purchases and sales are recognised when the entity becomes a party to the contractual provisions of the instrument. Where the transaction price in a non-active market is different to the fair value from other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable markets, the Bank immediately recognises the difference between the transaction price and fair value (a Day 1 profit) in the income statement. In cases where use is made of data, which is not observable, the difference between the transaction price and model value is only recognised in the income statement when the inputs become observable, or when the instrument is derecognised. The difference between the amount of cash consideration given or received and the fair value of financial instrument issued at a below market interest rate is recognised in the income statement as loss or gain on initial recognition of financial instruments. Cash and cash equivalents. Cash and cash equivalents are items which are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Cash and cash equivalents include interbank deposits with original maturity up to 1 day. Amounts, which relate to funds that are of a restricted nature, are excluded from cash and cash equivalents. Mandatory reserves with the National Bank of Ukraine. Mandatory reserves with the National Bank of Ukraine are stated at amortized cost and represent interest-free reserve deposits, which are not available to finance the Bank s day-to-day operations. Thus, they are not considered to be cash and cash equivalents for the purpose of cash flow statement. Plastic cards settlements. Plastic cards settlements are accounted for on the accruals basis and are carried at amortised cost. Plastic cards settlements are recorded when the legal right to receive the payment or legal obligation to execute payment arise under the agreement. Securities designated at fair value through profit or loss. Securities designated at fair value through profit or loss are securities designated irrevocably, at initial recognition, into this category. Financial asset classified in this category are designated by management on initial recognition when the following criteria are met: The designation eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets or liabilities or recognising gains or losses on them on a different basis; or The assets are part of a group of financial assets, financial liabilities or both which are managed and their performance evaluated on a fair value basis, in accordance with a documented risk management or investment strategy; or The financial instrument contains an embedded derivative, unless the embedded derivative does not significantly modify the cash flows or it is clear, with little or no analysis, that it would not be separately recorded. 10

17 3 Basis of preparation and significant accounting policies (continued) Due from banks. Amounts due from banks are recorded when the Bank advances money to counterparty banks with no intention of trading the resulting unquoted non-derivative receivable due on fixed or determinable dates. Amounts due from banks are carried at amortised cost. Loans and advances to customers. Loans and advances to customers are recorded when the Bank advances money to purchase or originate an unquoted non-derivative receivable from a customer due on fixed or determinable dates and has no intention of trading the receivable. Loans and advances to customers are carried at amortised cost. Impairment of financial assets carried at amortised cost. Impairment losses on financial assets carried at amortised cost are recognised in profit or loss when incurred as a result of one or more events ( loss events ) that occurred after the initial recognition of the financial asset and which have an impact on the amount or timing of the estimated future cash flows of the financial asset or Bank of financial assets that can be reliably estimated. If the Bank determines that no objective evidence exists that impairment was incurred for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. The primary factors that the Bank considers when deciding whether a financial asset is impaired or not are (i) past due status of financial asset, (ii) financial position of underlying borrower, (iii) unsatisfactory debt servicing. A loan is considered past due when the borrower fails to make any payment due under the loan at the reporting date. In this case a past due amount is recognized as the aggregate amount of all amounts due from borrower under the respective loan agreement including accrued interest and commissions. As defined by the Bank for the purposes of internal credit risk assessment, loans fall into the non-performing category when a principal and/or interest payment becomes more than 90 days overdue. Impairment losses are recognised through an allowance account to write down the asset s carrying amount to the present value of expected future cash flows (which exclude future credit losses that have not been incurred) discounted at the original effective interest rate of the asset. The calculation of the present value of the estimated future cash flows of a collateralised financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral. Reversals of impairment. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as an improvement in the debtor s credit rating), the previously recognised impairment loss is reversed by adjusting the allowance account through profit or loss. Write-off of assets at amortised cost. Uncollectible assets are written off against the related allowance for impairment after all the necessary procedures to recover the asset have been completed and the amount of the loss has been determined. 11

18 3 Basis of preparation and significant accounting policies (continued) Impairment of loans and advances to customers. Estimating loan portfolio impairment provision for corporate loans involves the following steps: Identification of loans that are individually significant and contain signs of impairment, i.e., those loans, that, if fully impaired, would have a material impact on the Bank s expected average level of operating income. Determination of whether an individually significant loan shows objective evidence of impairment. This requires estimating the expected timing and amount of cash flows from interest and principal payments and other cash flows, including amounts recoverable from guarantees and collateral, and discounting them at the loan s original effective interest rate. A separate impairment loss is recorded on an individually significant impaired loan. Identification of loans that are individually insignificant and contain signs of impairment. Determination of whether an individually insignificant loan shows objective evidence of impairment. This requires estimating the amounts recoverable from loan in the form of guarantee and collateral, and discounting them at the loan s original effective interest rate. The amount of estimated cash flows from interest and principal payments and other cash flows from the loan are not taken into account. A separate impairment loss is recorded on an individually insignificant impaired loan. All remaining loans without objective evidence of impairment are assessed on a portfolio basis. The Bank applies the portfolio provisioning methodology prescribed by IAS 39, Financial Instruments: Recognition and Measurement, and creates the allowance for impairment losses in respect of a group of financial assets with similar credit risk characteristics, if there are no objective evidence of impairment each particular financial asset (regardless of its significance). Total impairment provisions may exceed the gross amount of individually impaired loans as a result of this methodology. For the purposes of credit risk measurement and analysis the Bank internally classifies loans depending on their quality. The quality of a corporate loan is monitored regularly on the basis of a comprehensive analysis of the borrower s financial position and includes analysis of liquidity, profitability and sufficiency of own funds. The capital structure, organisational structure, credit history and business reputation of the borrower are also taken into consideration. The Bank takes into account the customer s position in the industry and the region, production equipment and level of the technology used as well as the general efficiency of management. Upon analysis corporate borrowers are assigned internal ratings and classes. For the purpose of collective assessment of not past due loans and advances the Bank analyses loans of each class in terms of its historical loss and recovery rate. Past experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect past periods and to remove the effects of past conditions that do not exist currently. For the purpose of collective assessment of past due loans and advances the Bank analyses ageing of past due debts. Investment securities available-for-sale. This classification includes investment securities, which the Bank intends to hold for an indefinite period of time and which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. The Bank classifies investments as available-for-sale at the time of purchase. 12

19 3 Basis of preparation and significant accounting policies (continued) Investment securities available-for-sale are carried at fair value. Interest income on available-for-sale securities is calculated using the effective interest method and recognised in profit or loss. Dividends on available-for-sale equity instruments are recognised in profit or loss in other operating income when the Bank s right to receive payment is established and inflow of economic benefits is probable. Exchange differences arising on the settlement of debt investment securities available-for-sale or on recording of debt investment securities available-for-sale at rates different from those at which they were recorded on initial recognition during the period or in previous financial statements are recognised in profit or loss in the period in which they arise. All other elements of changes in the fair value are recognised in other comprehensive income until the investment is derecognised or impaired, at which time the cumulative gain or loss is reclassified to profit or loss. Impairment losses are recognised in profit or loss when incurred as a result of one or more events ( loss events ) that occurred after the initial recognition of investment securities available-for-sale. A significant or prolonged decline in the fair value of an equity security below its cost is an indicator that it is impaired. The cumulative impairment loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that asset previously recognised in profit or loss is reclassified from other comprehensive income and recognised in profit or loss. Impairment losses on equity instruments are not reversed through profit or loss. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through current period s profit or loss. The unrealised gains/(losses) on revaluation of investment securities available-for-sale other than impairment losses are presented in other comprehensive income as losses or gains on investment securities available-for-sale. If the Bank has both the intention and ability to hold investment securities available-for-sale to maturity, they may be reclassified as investment securities held to maturity. In this case the fair value of securities as at the date of reclassification becomes their new amortised cost. For instruments with a fixed maturity the revaluation reserve as at the date of reclassification is amortised to profit or loss during the period until maturity using the effective interest rate method. Derecognition of financial assets. The Bank derecognises financial assets when (a) the assets are redeemed or the rights to cash flows from the assets otherwise expired or (b) the Bank has transferred the rights to the cash flows from the financial assets or entered into a qualifying pass-through arrangement while (i) also transferring substantially all the risks and rewards of ownership of the assets or (ii) neither transferring nor retaining substantially all risks and rewards of ownership but not retaining control. Control is retained if the counterparty does not have the practical ability to sell the asset in its entirety to an unrelated third party without needing to impose additional restrictions on the sale. Refer to paragraph below on treatment of renegotiations which lead to derecognition of financial assets. Renegotiated financial assets. From time to time in the normal course of business the Bank performs restructuring of financial assets, mostly of loans and advances to customers. Accounting treatment of renegotiations which do not lead to derecognition of financial assets. If terms of an agreement are not materially modified, restructuring of financial instruments is determined through modifying future cash flows discounted at the original effective interest rate. 13

20 3 Basis of preparation and significant accounting policies (continued) Accounting treatment of renegotiations which lead to derecognition of financial assets. Material modifications of agreement terms lead to derecognition of a financial asset and recognition of a new asset at fair value. The following principal modifications in terms are considered to be material: Change of currency in which cash flows are denominated; Consolidation or separation of several financial instruments; In all cases if the restructuring of financial assets is due to financial difficulties of a borrower, financial assets are assessed for impairment before recognition of a renegotiation. Premises and equipment. Equipment, other than office premises, is stated at cost less accumulated depreciation. Office premises of the Bank are held at revalued amount subject to revaluation to market value on a regular basis. The revaluation gain is recognised in other comprehensive income. The frequency of revaluation depends upon the movements in the fair values of the premises being revalued. The revaluation reserve for office premises included in equity is transferred directly to retained earnings on a straight-line basis as the asset is used by the Bank. On the retirement or disposal of the asset the remaining revaluation reserve is immediately transferred to the retained earnings. Construction in progress is carried at cost less impairment (if applicable). Upon completion, assets are transferred to office premises, other premises or equipment at their carrying amounts. Construction in progress is not depreciated until the asset is available for use. Subsequent expenditure on premises and equipment is capitalised only when it is probable that future economic benefits associated with it will flow to the Bank and the cost can be measured reliably. All other repairs and maintenance costs are expensed when incurred. If premises are impaired, they are written down to the higher of their value in use and fair value less costs to sell. The decrease in carrying amount is charged to profit or loss to the extent it exceeds the previous revaluation surplus that is recognised in office premises revaluation reserve. Upward revaluation shall be recognised in profit or loss to the extent that it reverses a negative revaluation of the same asset previously recognised in profit or loss. The amount that exceeds negative revaluation previously charged to profit or loss shall be recognised in other comprehensive income. Gains and losses on disposal determined by comparing proceeds with carrying amount are recognised in profit or loss. Depreciation. Land is not depreciated. Depreciation and amortisation on other items of premises, equipment and intangible assets is calculated using the straight-line method to allocate cost or revalued amounts of premises, equipment and intangible assets to their residual values over the estimated remaining useful lives. The following annual rates are applied for the main categories of premises and equipment: Premises (office premises) 2%; Office and computer equipment 20%; Vehicles and other equipment 20-33%; Intangible assets 25%. 14