NBC Bank OJSC International Financial Reporting Standards Financial Statements and Independent Auditor s Report For the year ended 31 December 2012
CONTENTS INDEPENDENT AUDITOR S REPORT FINANCIAL STATEMENTS Statement of Financial Position... 1 Statement of Comprehensive Income... 2 Statement of Changes in Equity... 3 Statement of Cash Flows... 4 Notes to the Financial Statements...5-67
INDEPENDENT AUDITORS REPORT To the Shareholders and the Board of Directors of NBC Bank OJSC: Report on the Financial Statements We have audited the accompanying financial statements of NBC Bank OJSC, which comprise the statement of financial position as at 31 December 2012, and the statement of comprehensive income, statement of changes in equity and statement of cash flow 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 International Financial Reporting Standards, 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. 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 ( ISA ). 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.
Opinion In our opinion, the financial statements present fairly, in all material respects the financial position of NBC Bank OJSC as at 31 December 2012, and its financial performance and cash flows for the year then ended in accordance with International Financial Reporting Standards. Baku, Azerbaijan 10 May, 2013
Statement of Financial Position As at 31 December 2012 In Azerbaijani Manats Note 31 December 2012 31 December 2011 ASSETS Cash and cash equivalents 6 1,731,105 1,702,456 Mandatory reserves in Central Bank of Azerbaijan Republic 1,263,485 531,052 Due from other banks and financial institutions 7 2,191 1,888 Loans and advances to Customers 8 71,023,308 52,176,763 Investment securities available-for-sale 9 760,005 372,552 Investments in associates 10 19,021 19,861 Premises and equipment 11 7,353,385 5,320,869 Intangible assets 11 53,255 53,801 Other financial assets 12 491,591 143,210 Other assets 13 374,384 2,540,009 TOTAL ASSETS 83,071,730 62,862,461 LIABILITIES Due to other banks 14 818,203 2,642,653 Other borrowed funds 15 12,844,379 11,071,183 Customer accounts 16 44,588,557 30,518,855 Financial lease obligation 17 76,659 77,449 Deferred income tax liability 24 74,440 57,756 Other financial liabilities 18 693,279 297,215 Other liabilities 19 2,592,380 42,517 TOTAL LIABILITIES 61,687,897 44,707,628 EQUITY Share capital 20 19,533,916 16,390,251 Retained earnings 1,849,917 1,764,582 TOTAL EQUITY 21,383,833 18,154,833 TOTAL LIABILITIES AND EQUITY 83,071,730 62,862,461 Signed and approved for issue on behalf of the Management Board on 10 May 2013. Chairman of the Management Board Chief Accountant The notes on pages 5-67 form an integral part of these financial statements. 1
Statement of Comprehensive Income For the Year Ended 31 December 2012 In Azerbaijani Manats Note 2012 2011 Interest income 21 11,004,521 8,168,527 Interest expense 21 (5,540,574) (4,176,925) Net interest income 5,463,947 3,991,602 Provision for loan impairment 8 (1,394,417) (366,354) Net interest income after provision for loan impairment 4,069,530 3,625,248 Foreign exchange translation gain less losses 397,478 286,187 Fee and commission income 22 593,618 476,818 Fee and commission expense 22 (157,586) (114,918) Administrative and other operating expenses 23 (5,260,305) (4,106,421) Provision for other asset impairment (18,187) - Share of loss of associate (840) (1,023) Other expense (8,589) (11,649) Dividend Income on Investments 696,685 - Profit before income tax 311,804 154,242 Income tax expense 24 (83,986) (10,397) NET LOSS/PROFIT FOR THE YEAR 227,818 143,845 Other comprehensive income: Loss from disposal of fixed assets - - Income from associates - - Other comprehensive income for the year - - TOTAL COMPREHENSIVE INCOME FOR THE YEAR 227,818 143,845 Earnings per share for profit attributable to the equity holders of the Bank (expressed in AZN per share) 25 1.52 0.97 Signed and approved for issue on behalf of the Management Board on 10 May 2013. Chairman of the Management Board Chief Accountant The notes on pages 5-67 form an integral part of these financial statements. 2
Statement of Changes in Equity For the Year Ended 31 December 2012 In Azerbaijani Manats Notes Share capital Retained earnings Total equity Balance at 1 January 2011 16,071,433 1,939,555 18,010,988 Share capital increase of: - ordinary shares 318,818 (318,818) - Total comprehensive income 143,845 143,845 Balance at 31 December 2011 16,390,251 1,764,582 18,154,833 Share capital increase of: - ordinary shares 3,143,665 (142,483) 3,001,182 Total comprehensive income 227,818 227,818 Balance at 31 December 2012 19,533,916 1,849,917 21,383,833 Signed and approved for issue on behalf of the Management Board on 10 May 2013. Chairman of the Management Board Chief Accountant The notes on pages 5-67 form an integral part of these financial statements. 3
Statement of Cash Flows For the Year Ended 31 December 2012 In Azerbaijani Manats Notes For the year ended 31 December 2012 For the year ended 31 December 2011 CASH FLOWS FROM OPERATING ACTIVITIES Profit before income tax 311,804 154,242 Adjustments for: Provision/ impairment losses on interest bearing assets 8 1,394,417 366,354 Write-off loans 18,187 - Income from associates 10 840 1,023 Amortization and depreciation expense 11 660,115 526,250 Gain on transactions in foreign currencies (397,478) (286,187) Change in interest accruals, net (443,720) (257,252) Cash flows from operating activites before changes in operating assets and liabilities 1,544,165 504,430 Changes in operating assets and liabilities (Increase)/decrease in operating assets: Mandatory reserves with CBAR (732,433) (476,852) Due from banks (303) 59 Loans to customers (19,420,309) (11,784,865) Other financial asstes (348,381) 28,249 Other assets 2,165,625 (2,380,521) Increase/(decrease) in operating liabilities: Due to banks (1,824,450) (20,348) Other borrowed funds 1,542,121 4,524,518 Customer accounts 13,905,654 10,758,240 Financial lease obligation (787) 40,935 Other financial obligations 396,064 59,532 Other obligations 2,482,561 (22,563) Cash inflow/(outflow) from operating activites before taxation: Income tax paid (290,473) - 1,230,814 - Net cash inflow/(outflow) from operating activities (290,473) 1,230,814 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of premises and equipment 11 (2,708,055) (530,068) Write-off of premises and equipment 11 26,000 40,000 Purchase of intangible assets 11 (10,030) (4,012) Write-off of intangible assets 11 - - Redemption of investment securities available-for-sale - - Purchase of investment secutiries available-for-sale (387,453) - Net cash (outflow)/inflow from investing activities (3,079,538) (494,080) CASH FLOWS FROM FINANCING ACTIVITIES Increase of share capital 3,001,182 - Net cash inflow from financing activities 3,001,182 - Effect of changes in foreign exch. rate on cash and cash eq. 397,478 14,280 NET INCREASE/(DECREASE) IN CASH AND CASH EQV. 28,649 751,014 CASH AND CASH EQUIVALENTS, beginning of the year 6 1,702,456 951,442 CASH AND CASH EQUIVALENTS, end of the year 6 1,731,105 1,702,456 Signed and approved for issue on behalf of the Management Board on 10 May 2013. Chairman of the Management Board Chief Accountant The notes on pages 5-67 form an integral part of these financial statements. 4
1 Introduction These consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards for the year ended 31 December 2012 for ( the Bank ). Organization and its principal activity Open Joint-Stock Bank NBC Bank (the Bank ) was established as a limited liability partnership on 30 December 1992. The Bank is regulated by the Central Bank of Azerbaijan (the CBA ) and conducts its business under the general banking license #112. The Bank s primary business consists of appropriate banking services: payments and money transfers, trading with foreign currencies, originating loans and other commercial activities. The Bank had 11 branches within the Republic of Azerbaijan as at 31 December 2012 (31 December 2011: 9 branches). Registered address and place of business The Bank s official registered address M.Narimanov Street, district no 2054, Baku, Azerbaijan Republic. Shareholders of the Bank As at 31 December 2012 and 2011, the following shareholders owned the issued ordinary shares of the Bank: Shareholders 31 December 2012,% 31 December 2011, % Aliyev Nuru Yashar 45.88 45.88 Akhmedov Surkhay Tofig 10.70 10.70 Nurgun Group LLC 9.56 9.56 Rustamov Ogtay İzzat 8.37 8.37 Sefiyeva Nushaba Yashar 8.15 8.15 Rustamova Jamila Yashar 8.14 8.14 Sefiyev Müshfig Ali 4.88 4.88 Caspian Insurance Co LTD LLC 4.32 4.32 Total 100.00 100.00 Presentation currency These consolidated financial statements are presented in thousands of Azerbaijani Manats ( AZN ). 2 Operating Environment of the Bank The Azerbaijan Republic displays certain characteristics of an emerging market, including the existence of a currency that is not freely convertible in other countries, restrictive currency controls, relatively high inflation and economic growth. 5
2 Operating Environment of the Bank (Continued) The tax, currency and customs legislation within the Azerbaijan Republic is subject to varying interpretations and frequent changes. The future economic direction of the Republic of Azerbaijan is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory, and political developments. Going Concern According to the Board decision of Central Bank of Azerbaijan Republic dated July 25, 2012, the total Share Capital of the Banks should be increased to AZN 50,000,000. The new minimum of Share Capital becomes effective on January 01, 2014. As at December 31, 2012, the Bank s Share Capital amounts to AZN 20,984,715 which constitutes 42% of the new minimum level.in order to meet the Central Bank s criteria on the Share Capital, the Bank should increase its Share Capital by 58% until January 01, 2014. The Bank s management states, that the General Meeting of Shareholders of NBC Bank OJSC has been convened in 2012. During the meeting the Bank s Strategic Plan for the period of 2013 was approved. In accordance to the Strategic Plan, for the purposes of meeting the Central Bank s capital requirements till Janury 01, 2014, the decision was made to increase the total share capital by issuing the new shares by existing Shareholders starting from October 2012 and continuing during the 2013. According to plan, new shares with total value of AZN 3,001,181 and AZN 3,000,000 have been issued durign the 4 quarter of 2012 and January 2013 respectively. Furthermore, the Bank has capitalized the part of net income at the amount of AZN 142,485 to share capital and consequently the Bank s share capital became AZN 22,535,096 as at 13 January 2013. In accordance with the strategic plan, increasing in the Bank s share capital during the 2013 year is expected to to happen as shown in the following table: The expected increase of share capital for Amount January - February - March 4,000,000 April - May 4,000,000 June - July 4,000,000 August September 4,000,000 October November 5,000,000 December - If the Bank fails to meet the criteria of increasing the shareholders capital it will face an issue of going concern. The Financial Statements stated above have not been adjusted for uncertainities rised as a result of these issues. 6
3 Summary of Significant Accounting Policies Basis of Preparation. These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ) under the historical cost convention, except for the revaluation of premises and equipment, investment properties, available-for-sale financial assets and held-fortrading financial assets. 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 (Refer to Note 5). The Management Board is able to make changes in these consolidated financial statements after they have been signed. All such changes must be approved by the Management Board. Consolidated financial statements. Associates are entities over which the Bank has significant influence (directly or indirectly), but not control, generally accompanying a shareholding of between 20 and 50 percent of the voting rights. Investments in associates are accounted for using the equity method of accounting and are initially recognized at cost. The carrying amount of associates includes goodwill identified on acquisition less accumulated impairment losses, if any. The Bank s share of the post-acquisition profits or losses of associates is recorded in the income statement, and its share of post-acquisition movements in reserves is recognized in reserves. When the Bank s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the Bank does not recognize further losses, unless it has incurred obligations or made payments on behalf of the associate. Unrealized gains on transactions between the Bank and its associates are eliminated to the extent of the Bank s interest in the associates; unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Goodwill represents the excess of the cost of an acquisition over the fair value of the acquirer s share of the identifiable assets, liabilities and contingent liabilities of the acquired associate at the date of exchange. Goodwill on acquisitions of associates is included in the investment in associates. Goodwill is carried at cost less accumulated impairment losses, if any. Financial instruments - key measurement terms. Depending on their classification financial instruments are carried at fair value, or amortized cost as described below. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. Fair value is the current bid price for financial assets and current asking price for financial liabilities which are quoted in an active market. For assets and liabilities with offsetting market risks, the Bank may use mid-market prices as a basis for establishing fair values for the offsetting risk positions and apply the bid or asking price to the net open position as appropriate. 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 such as discounted cash flows models or models based on recent arms length transactions or consideration of financial data of the investees are used to fair value certain financial instruments for which external market pricing information is not available. 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. 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. 7
3 Summary of Significant Accounting Policies (Continued) Amortized cost is the amount at which the financial instrument was recognized at initial recognition less any principal repayments, plus accrued interest, and for financial assets less any write-down for incurred impairment losses. Accrued interest includes amortization 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 amortized discount or premium (including fees deferred at origination, if any), are not presented separately and are included in the carrying values of related balance sheet 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. The effective interest rate discounts cash flows of variable interest instruments to the next interest repricing date except for the premium or discount which reflects 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 amortized over the whole expected life of the instrument. The present value calculation includes all fees paid or received between parties to the contract that are an integral part of the effective interest rate. Initial recognition of financial instruments. Trading securities, derivatives and other financial instruments at fair value through profit or loss are initially recorded at fair value. All other financial instruments 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. 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 asset. All other purchases are recognized when the entity becomes a party to the contractual provisions of the instrument. After the initial recognition financial assets and liabilities are evaluated in the amortized cost based on the effective interest method. Derecognition of financial assets. The Bank derecognizes 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. 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 all interbank placements with original maturities of less than three months. Funds restricted for a period of more than three months on origination are excluded from cash and cash equivalents. Cash and cash equivalents are carried at amortized cost. 8
3 Summary of Significant Accounting Policies (Continued) Mandatory cash balances with the CBAR. Mandatory cash balances in AZN and foreign currency held with the CBAR are carried at amortized cost and represent non-interest bearing mandatory reserve deposits, which are not available to finance the Bank s day-to-day operations, and hence are not considered as part of cash and cash equivalents for the purposes of the consolidated cash flow statement. Trading securities. Trading securities are financial assets which are either acquired for generating a profit from short-term fluctuations in price or trader s margin, or are securities included in a portfolio in which a pattern of short-term trading exists. The Bank classifies securities into trading securities if it has an intention to sell them within a short period after purchase, i.e. within 4 months. Trading securities are not reclassified into another category even if the Bank has changed its plans. Trading securities are carried at fair value. Interest earned on trading securities based on the effective interest method is presented in the consolidated statement of comprehensive income as interest income. Dividends are included in dividend income within other operating income when the Bank s right to receive the dividend payment is established and it is probable that the dividends will be collected. All other elements of the changes in the fair value and gains or losses on derecognition are recorded in profit or loss as gains less losses from trading securities in the period in which they arise. Due from other banks. Amounts due from other 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 other banks are carried at amortized 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 amortized cost. Impairment of financial assets carried at amortized cost. Impairment losses are recognized 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 group 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 whether a financial asset is impaired is its overdue status and realizability of related collateral, if any. The following other principal criteria are also used to determine that there is objective evidence that an impairment loss has occurred: - Any installment is overdue and the late payment cannot be attributed to a delay caused by the settlement systems; - The borrower experiences a significant financial difficulty as evidenced by the borrower s financial information that the Bank obtains; - The borrower considers bankruptcy or a financial reorganization; 9
3 Summary of Significant Accounting Policies (Continued) - There is an adverse change in the payment status of the borrower as a result of changes in the national or local economic conditions that impact the borrower; or - The value of collateral significantly decreases as a result of deteriorating market conditions. For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics. Those characteristics are relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtors ability to pay all amounts due according to the contractual terms of the assets being evaluated. Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of the contractual cash flows of the assets and the experience of management in respect of the extent to which amounts will become overdue as a result of past loss events and the success of recovery of overdue amounts. 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. If the terms of an impaired financial asset held at amortized cost are renegotiated or otherwise modified because of financial difficulties of the borrower or issuer, impairment is measured using the original effective interest rate before the modification of terms. Impairment losses are always recognized through an allowance account to write down the asset s carrying amount to the present value of expected 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 collateralized financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable. 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 recognized (such as an improvement in the debtor s credit rating), the previously recognized impairment loss is reversed by adjusting the allowance account through profit or loss. Uncollectible assets are written off against the related impairment loss provision after all the necessary procedures to recover the asset have been completed and the amount of the loss has been determined. Amounts previously written off and then recovered are recognized as impairment losses in profit or loss during the year. Credit related commitments. The Bank enters into credit related commitments, including letters of credit and financial guarantees. Financial guarantees represent irrevocable assurances to make payments in the event that a customer cannot meet its obligations to third parties and carry the same credit risk as loans. Financial guarantees and commitments to provide a loan are initially recognized at their fair value, which is normally evidenced by the amount of fees received. This amount is amortized on a straight line basis over the life of the commitment, except for commitments to originate loans if it is probable that the Bank will enter into a specific lending arrangement and does not expect to sell the resulting loan shortly after origination; such loan commitment fees are deferred and included in the carrying value of the loan on initial recognition. At each balance sheet date, the commitments are measured at the higher of (i) the remaining unamortized balance of the amount at initial recognition and (ii) the best estimate of expenditure required to settle the commitment at the balance sheet date. 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. 10
3 Summary of Significant Accounting Policies (Continued) Investment securities available for sale are carried at fair value. Interest income on available for sale debt securities is calculated using the effective interest method and recognized in profit or loss. Dividends on available-for-sale equity instruments are recognized in profit or loss when the Bank s right to receive payment is established and it is probable that the dividends will be collected. All other elements of changes in the fair value are deferred in other comprehensive income until the investment is derecognized or impaired, at which time the cumulative gain or loss is removed from other comprehensive income to profit or loss. Impairment losses are recognized 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 recognized in profit or loss is removed from other comprehensive income and recognized 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 recognized in profit or loss, the impairment loss is reversed through current period s profit or loss. Investment properties. Investment property is property held by the Bank to earn rental income or for capital appreciation and which is not occupied by the Bank. Goodwill. Goodwill represents the part of purchase value over the fair value of purchaser s share in the identifiable assets, liabilities and contingent liabilities of the affiliated/associated enterprise purchased at the purchase date. Goodwill from the purchase of affiliated enterprises is represented separately in the consolidated statement of financial position. Goodwill from the purchase of associated enterprises is represented as investment in associates. Goodwill is noted at purchase value less impairment losses (if exist). The Bank evaluates the impairment of goodwill at least every year or in cases of existence of possible impairment signs. Goodwill is assigned to cash making business unit groups or cash making business unit groups related to increasing of activity effectiveness of joint enterprises. Such units or unit groups represent the main level at which the Bank accounts goodwill and don t exceed the operating segment. When an asset is derecognized from generation units group to which goodwill relates, appropriate gains or losses from derecognition represent the carrying value of goodwill related to derecognized assets. The carrying value of goodwill is determined proportionally to derecognized assets within cash making business units. Premises and equipment. Premises are stated at revalued amounts, as described below, less accumulated depreciation and provision for impairment, where required. Premises are subject to revaluation with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period. Increases in the carrying amount arising on revaluation are credited to revaluation reserve in other comprehensive income. Decreases that offset previous increases of the same asset are charged against revaluation reserve directly in other comprehensive income; all other decreases are charged to the statement of comprehensive income. The revaluation reserve for premises and equipment included in other comprehensive income is transferred directly to retained earnings when the surplus is realized on the retirement or disposal of the asset. 11
3 Summary of Significant Accounting Policies (Continued) Construction in progress is carried at cost less provision for impairment where required. Cost includes borrowing costs incurred on specific or general funds borrowed to finance construction of qualifying assets. Upon completion, assets are transferred to premises and equipment at their carrying amount. Construction in progress is not depreciated until the asset is available for use. All other items of premises and equipment are stated at cost less accumulated depreciation and impairment losses, if any. The costs of minor repairs and maintenance are expensed when incurred. The cost of replacing major parts or components of premises and equipment items are capitalized and the replaced part is retired. If impaired, premises and equipment 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 in equity. An impairment loss recognized for an asset in prior years is reversed if there has been a change in the estimates used to determine the asset s value in use or fair value less costs of sell. Gains and losses on disposals determined by comparing proceeds with carrying amount are recognized as profit or loss from disposal of fixed assets. Depreciation. Land is not depreciated. Depreciation on other items of premises and equipment is calculated using the straight-line method to allocate their cost or revalued amounts to their residual values over their estimated useful lives as follows: Premises Computer and communication equipment Furniture, fixtures and other Vehicles 20 years; 4-5 years; 4-5 years; and 4-5 years; The residual value of an asset is the estimated amount that the Bank would currently obtain from disposal of the asset less the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The residual value of an asset is nil if the Bank expects to use the asset until the end of its physical life. The assets residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. Intangible assets. The Bank s intangible assets, except goodwill have definite useful life and primarily include capitalized computer software. Acquired computer software licenses are capitalized based on the costs incurred to acquire and bring to use the specific software. Development costs that are directly associated with identifiable and unique software controlled by the Bank are recorded as intangible assets if the inflow of incremental economic benefits exceeding costs is probable. Capitalized costs include staff costs of the software development team and an appropriate portion of relevant overheads. All other costs associated with computer software, e.g. its maintenance, are expensed when incurred. Capitalized computer software is amortized on a straight line basis over expected useful lives of 5 to 10 years. Operating leases. Where the Bank is a lessee in a lease which does not transfer substantially all the risks and rewards incidental to ownership from the lessor to the Bank, the total lease payments are charged to profit or loss on a straight-line basis over the period of the lease. 12
3 Summary of Significant Accounting Policies (Continued) Financial leases. Where the Bank is a lessee in a lease which does not transfer substantially all the risks and rewards incidental to ownership from the lessor to the Bank, the lease assets are shown as accounts receivable and presented at discounted value of future lease payments. Financial lease receivables are noted at the date of leasing relations accrual based on discount rate determined at the date (the date of signing of lease contract is a date when the lease contract is signed or the main conditions of lease are approved by lease relations participants) of signing of the lease contract. Difference between the amounts of receivables and discounted value of future lease payments represents unearned financial income. This income is noted during the lease period using net investment method (before tax) which represents permanent profitability ratio. The additional expenses directly related to the organisation of leasing relations are included in the initial cost of financial lease receivables and decreases the amount of the income during the lease period. The financial income from lease is charged to profit or loss for the year as other operating income. The impairment losses are represented in profit or loss for the year when accrued as a result of one or more accidents ( loss accidents ). The Bank uses the same main criteria for loans at amortised cost in purpose of determining objective signs related to impairment loss. Impairment losses are noted making provision at the amount of the difference between net carrying value of financial lease receivables and current value of future cash flows (except future losses which are not incurred yet) discounted based on the profitability ratio considered in the lease contract. The estimated future cash flow represents possible cash flow from purchase and sale of assets according to the contract. Due to other banks. Amounts due to other banks are recorded when money or other assets are advanced to the Bank by counterparty banks. The non-derivative liability is carried at amortized cost. If the other Banks purchases its own debt, it is removed from the balance sheet and the difference between the carrying amount of the liability and the consideration paid is included in gains or losses arising from retirement of debt. Customer accounts. Customer accounts are non-derivative liabilities to individuals, state or corporate customers and are carried at amortized cost. Debt securities in issue. Debt securities in issue include promissory notes and debentures issued by the Bank. Debt securities are stated at amortized cost. If the Bank purchases its own debt securities in issue, they are removed from the balance sheet and the difference between the carrying amount of the liability and the consideration paid is included in gains arising from retirement of debt. Other borrowed funds. Other borrowed funds include loans from resident and non-resident financial institutions with fixed maturities and fixed or floating interest rates. Term borrowings are carried at amortized cost. Income taxes. Income taxes have been provided for in these consolidated financial statements in accordance with Azerbaijani legislation enacted or substantively enacted by the end of the reporting period. The income tax charge comprises current tax and deferred tax and is recognised in the statement of comprehensive income except if it is recognised directly in the statement of other comprehensive income because it relates to transactions that are also recognised, in the same or a different period. 13
3 Summary of Significant Accounting Policies (Continued) Current tax is the amount expected to be paid to or recovered from the taxation authorities in respect of taxable profits for the current and prior periods. Taxable profits are based on estimates if financial statements are authorized prior to filing relevant tax returns. Taxes, other than on income, are recorded within administrative and other operating expenses. Deferred income tax is provided using the balance sheet liability method for tax loss carry forwards and temporary differences arising between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. In accordance with the initial recognition exemption, deferred taxes are not recorded for temporary differences on initial recognition of an asset or a liability in a transaction other than a business combination if the transaction, when initially recorded, affects neither accounting nor taxable profit. Deferred tax balances are measured at tax rates enacted or substantively enacted at the balance sheet date which are expected to apply to the period when the temporary differences will reverse or the tax loss carry forwards will be utilized. Deferred tax assets for deductible temporary differences and tax loss carry forwards are recorded only to the extent that it is probable that future taxable profit will be available, against which the deductions can be utilized. Dividends. Dividends are recorded in equity in the period in which they are declared. Dividends declared after the balance sheet date and before the financial statements are authorized for issue are disclosed in the subsequent events note. The statutory accounting reports of the Bank are the basis for profit distribution and other appropriations. Azerbaijani legislation identifies the basis of distribution as the current year net profit. Income and expense recognition. Interest income and expense are recorded on an accrual basis using the effective interest method. This method defers, as part of interest income or expense, all fees paid or received between the parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts. Fees integral to the effective interest rate include origination fees received or paid by the entity relating to the creation or acquisition of a financial asset or issuance of a financial liability, for example fees for evaluating creditworthiness, evaluating and recording guarantees or collateral, negotiating the terms of the instrument and for processing transaction documents. Commitment fees received by the Bank to originate loans at market interest rates are integral to the effective interest rate if it is probable that the Bank will enter into a specific lending arrangement and does not expect to sell the resulting loan shortly after origination. The Bank does not designate loan commitments as financial liabilities at fair value through profit or loss. When loans and other debt instruments become doubtful of collection, they are written down to the present value of expected cash inflows and interest income is thereafter recorded for the unwinding of the present value discount based on the asset s effective interest rate which was used to measure the impairment loss. All other fees, commissions and other income and expense items are generally recorded on an accrual basis by reference to completion of the specific transaction assessed on the basis of the actual service provided as a proportion of the total services to be provided. Loan syndication fees are recognized as income when the syndication has been completed and the Bank retains no part of the loan package for itself or retains a part at the same effective interest rate as for the other participants. Commissions and fees arising from negotiating, or participating in the negotiation of a transaction for a third party, such as the acquisition of loans, shares or other securities or the purchase or sale of businesses, and which are earned on execution of the underlying transaction, are recorded on its completion. Portfolio and other management advisory and service fees are recognized based on the applicable service contracts, usually on a time-proportion basis. Asset management fees related to investment funds are recorded rateably over the period the service is provided. The same principle is applied for wealth management, financial planning and custody services that are continually provided over an extended period of time. Foreign currency translation. The functional currency of the Bank s consolidated entities is the currency of the main economic environment in which they operate. The functional currency of the Bank s entities and the Bank s presentation currency is the national currency of the Republic of Azerbaijan, Azerbaijani Manat ( AZN ). 14
3 Summary of Significant Accounting Policies (Continued) Monetary assets and liabilities are translated into entity s functional currency at the official exchange rate of the CBAR at the respective balance sheet dates. Foreign exchange gains and losses resulting from the settlement of transactions and from the translation of monetary assets and liabilities into Bank s functional currency at yearend official exchange rates of the CBA are recognized in profit or loss. Translation at year-end rates does not apply to non-monetary items, including equity investments. Effects of exchange rate changes on the fair value of equity securities are recorded as part of the fair value gain or loss. At 31 December 2012, the principal rate of exchange used for translating foreign currency balances was USD 1 = AZN 0.7850 and EUR 1 = AZN 1.0377 (31 December 2011: USD 1 = AZN 0.7865 and EUR 1 = AZN 1.0178). Offsetting. Financial assets and liabilities are offset and the net amount reported in the statement of financial position only when there is a legally enforceable right to offset the recognized amounts, and there is an intention to either settle on a net basis, or to realize the asset and settle the liability simultaneously. Staff costs and related contributions. Wages, salaries, contributions to the Azerbaijan Republic state pension and social insurance funds, paid annual leave and sick leave, bonuses, and non-monetary benefits are accrued in the year in which the associated services are rendered by the employees of the Bank. Segment reporting. Segment is an identifiable component of the Bank related to presentation of goods and rendering services (business segment) or presentation of goods and rendering services in specific economic circumstances with risks and benefits different from other segments. Segments whose revenue, result or assets are ten percent or more of all the segments are reported separately. 4 Critical Accounting Estimates and Judgments in Applying Accounting Policies The Bank makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements are continually evaluated and are based on management s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Management also makes certain judgements, apart from those involving estimations, in the process of applying the accounting policies. Judgements that have the most significant effect on the amounts recognised in the financial statements and estimates that can cause a significant adjustment to the carrying amount of assets and liabilities within the next financial year include: Impairment losses on loans and advances. The Bank regularly reviews its loan portfolios to assess impairment. In determining whether an impairment loss should be recorded in the statement of comprehensive income the Bank makes judgments as to whether there is any observable data indicating that there is a measurable decrease in the estimated future cash flows from a portfolio of loans before the decrease can be identified with an individual loan in that portfolio. This evidence may include observable data indicating that there has been an adverse change in the payment status of borrowers in a group, or national or local economic conditions that correlate with defaults on assets in the group. Management uses estimates based on historical loss experience for assets with credit risk characteristics and objective evidence of impairment similar to those in the portfolio when scheduling its future cash flows. The methodology and assumptions used for estimating both the amount and timing of future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. 15
4 Critical Accounting Estimates, and Judgements in Applying Accounting Policies (Continued) Initial recognition of related party transactions. In the normal course of business the Bank enters into transactions with its related parties. IAS 39 requires initial recognition of financial instruments based on their fair values. Judgement is applied in determining if transactions are priced at market or non-market interest rates, where there is no active market for such transactions. The basis for judgement is pricing for similar types of transactions with unrelated parties and effective interest rate analysis. Terms and conditions of related party balances are disclosed in Note 31. Loans and advances to customers. The Bank has acquired long term financing from the National Fund for Support of Entrepreneurship of the Republic of Azerbaijan and Mortgage Fund of the Republic of Azerbaijan at interest rates below those, at which the Bank could source the funds from other local lenders. As a result of such financing, the Bank was able to issue funds to specific customers at favorable rates. The Bank's policy of IAS 39, Financial Instruments: is to recognize financial instruments at their fair value in accordance with the Recognition and Measurement standard. Management has considered whether gains or losses should arise on initial recognition of such instruments. As the transactions are with unrelated parties, management s judgement is that these funds and the related lending are at the market rates and no initial recognition gains or losses should arise. Tax legislation. Azerbaijani tax, currency and customs legislation is subject to varying interpretations. Refer to Note 24. Going concern. Management prepared these consolidated financial statements on a going concern basis. In making this judgement management considered the Bank s current intentions, profitability of operations and access to financial resources. While recent global events have had a significant impact on the ability to obtain new or extended term borrowings from international financial institutions, and where available, the cost of funding has typically increased, management are actively managing this position and as a result of the following actions believe that the Bank will have access to sufficient resources in order to continue to meet all of its liabilities as they fall due: i. The management of the Bank is continuing negotiations with local and foreign partners, also international financial institutions to obtain new debts. ii. iii. The CBAR declared about its willingness to prolongate the existing loan for the purpose of economic aid to the Bank, if necessary. The Azerbaijani Government is carrying out several monetary policy measures against any impact of the global financial crisis on the economy and financial system of the country. As a part of these steps the CBAR decreased the mandatory reserve rate from 12% to 0.5% and refinancing rate from 15% to 2% during the years ended at 31 December 2008 and 2009. 16