KpmG INtErNatIoNaL: Impact of IFRS: Banking: kpmg.com/ifrs

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1 Impact of ifrs: BANKING 1 KpmG INtErNatIoNaL: Impact of IFRS: Banking: kpmg.com/ifrs

2 2 Impact of ifrs: BANKING Contents: Overview of the International Financial Reporting Standards (IFRS) conversion process 4 Accounting and reporting 5 Financial instruments classification, measurement, recognition and derecognition 6 Financial instruments impairment 8 Hedge accounting 9 Consolidation and special purpose entities (SPEs) 10 Definition of debt versus equity 12 Presentation of financial statements and disclosures of financial instruments 13 Leases 14 Insurance contracts 16 Post-employment benefits 17 IFRS 1 first-time adoption 18 Systems and processes 20 From accounting gaps to information sources 21 How to identify the impact on information systems 22 Banking accounting differences and respective system issues 23 Parallel reporting timing the changeover from local GAAP to IFRS reporting 24 Harmonisation of internal and external reporting 27 People 29 Business 30 Stakeholder analysis and communications 30 Audit Committee considerations 30 Monitoring peer group 30 Other areas of conversion risks to mitigate 31 Benefits of Ifrs 31 KPMG: An Experienced Team, a Global Network 32

3 Impact of ifrs: BANKING 3 Foreword: Given the significance of the financial crisis over the last few years, there is greater political and regulatory will than ever before for a single set of converged, global accounting standards. Transparency and comparability across the banking sector is in the spotlight once again. With many countries having converted to IFRS in 2005, conversion is imminent for other countries such as Canada, South Korea and Mexico in 2011 and 2012; and with the US debating the merits of conversion to IFRS, it s clear that IFRS is high on the accounting agenda across the globe. Since the first major wave of adoption in Europe and Australia there is a mass of information available for individuals to sift through over 699,000 hits for IFRS in banks alone on some internet search engines. This publication is focused on assisting conversions to IFRS in the banking sector. Whether you are starting your project or merely considering the impact, the broad overview of the topics listed below will help you to better understand the implications of an IFRS conversion: Overview of the IFRS conversion process. We look at how the conversion management needs to take a holistic view of the different aspects of the accounting under IFRS and its impact across the entity. Top Ten IFRS banking accounting and reporting issues, giving guidance on the key areas of focus that are likely to be the cornerstone of the project. Many other accounting areas are not specifically banking related and are therefore excluded from our discussions, but will need consideration. Information technology and systems considerations. We discuss how the banks will need to bridge the gap between IFRS reporting and the general ledger and sub-ledger systems so as to deal with parallel reporting (i.e. local generally accepted accounting principles and IFRS reporting at the same time) and internal vs external reporting. People knowledge transfer and change management. Ways to drive training and knowledge management into the teams dealing with the changes required. Business and reporting. The issues around operational performance and measurement that needs to reflect the impact of IFRS and how to communicate this to different groups of stakeholders. While the main audience of this publication are those contemplating IFRS conversion rather than those already converted, we hope there is something stimulating and thought-provoking for all those dealing with IFRS, particularly given the forthcoming changes in standards such as IFRS 9 Financial Instruments, which will have a significant impact on banks. Colin Martin Head of UK Assurance Services, Banking

4 4 Impact of ifrs: BANKING Overview of the International Financial Reporting Standards (IFRS) conversion process: all Ifrs conversionsahave consistent themes and milestones to them. the key is to tailor the conversion specifically to your own issues, your management style, the structure of your working groups, the engagement of your stakeholders and the requirements of your corporate governance. Whilst banks may be similar in many respects there will always be differences in the corporate DNa that makes this tailoring of the project a necessary part of the Ifrs conversion. the Ifrs conversion management overview diagram below presents a holistic approach to planning and implementing an Ifrs conversion by ensuring that all linkages and dependencies are established between accounting and reporting, systems and processes, people and the business. thetconversion needs to effectively address the challenges and opportunities of adopting Ifrs to all aspects of your business. this includes, for example, consideration of the impact of Ifrs transition on the regulatory and tax aspect of your operations, which may vary depending on state, federal, product, reporting or competitive requirements. Accounting and Reporting How to link? Systems and Processes PROGRAM MANAGEMENT How to link? How to link? Business PROGRAM MANAGEMENT Overall Management IFRS CONVERSION How to link? People

5 Impact of ifrs: BANKING 5 Accounting and reporting: The first key area to tackle in the holistic approach outlined above is the accounting and reporting. It will involve a diagnostic and in-depth analysis of the differences between your local Generally Accepted Accounting Principles (GAAP) and IFRS, from which will flow all the project requirements around which any organisational change needs to be managed. Making sure that this upfront assessment of the impact of IFRS and the Gap analysis is accurate and comprehensive is critical to a successful conversion. It is essential that this is undertaken for your specific entity, even if the sector issues are deemed to be similar. Based on our firms experience of IFRS conversions, we outline below the Top Ten accounting issues for banks to consider when converting to IFRS. This list is not meant to be comprehensive; indeed it does not cover many areas that banks need to consider. There are many other important accounting topics such as share-based payments, tax, joint ventures, and other areas of accounting for financial instruments, to name a few, that we have not considered in this publication. In our experience, these Top Ten issues are significant to banks as: they may result in significant accounting policy decisions that impact future results, for example deciding whether to account for certain financial instruments at amortised cost or fair value, or whether to apply hedge accounting; they may require significant time and cost to evaluate and implement, for example review of special purpose entities (SPEs) to decide whether or not they should be consolidated, or review of contracts to determine whether they meet the definition of an insurance contract; issues may have significant impact on information systems and accounting processes and internal controls, for example, calculating effective yield or impairment of financial instruments, or collecting data for the additional disclosures relating to financial instruments. Top Ten issues Financial instruments classification, measurement, recognition and derecognition 1 6 Presentation of financial statements and disclosures of financial instruments Financial instruments impairment 2 7 Leases Hedge accounting 3 8 Insurance contracts Consolidation and special purpose entities (SPEs) 4 9 Post-employment benefits Definition of debt vs equity 5 10 IFRS 1 first-time adoption

6 6 Impact of ifrs: BANKING 1 Financial instruments classification, measurement, recognition and derecognition: financialfinstruments make up the majority of most banks assets and liabilities and Ifrs requirements for accounting for financial instruments are prescriptive. this often leads to major implementation challenges. Financial instruments are initially measured at fair value, which most often, but not always, is the transaction price. After initial recognition they are measured at fair value, amortised cost, or cost. Amortised cost is a concept similar to cost, but involves adjusting the balance sheet amount for the effect of calculating the yield on certain financial instruments by spreading fees, transaction costs and discounts/ premiums over the lives of those instruments. The types of financial assets that can be accounted for under amortised cost are mostly limited to debt instruments held to maturity and those not quoted in an active market. Financial assets that do not meet the amortised cost criteria are accounted for at fair value with gains and losses recognised either in profit or loss or in other comprehensive income. Derivatives are generally accounted for at fair value with gains and losses generally recognised in profit or loss. If derivatives are embedded in other contracts (those contracts may or may not be financial instruments) they may have to be separated and accounted for separately from the host contract, at fair value, with gains and losses recognised in profit or loss. Equity investments are generally accounted for at fair value. There is a limited exemption for unlisted equity investments when fair value cannot be reliably measured, which are accounted for at cost less impairment.

7 Impact of ifrs: BANKING 7 In November 2009 and october 2010 the IasB issued the first two parts of a new standard on accounting for financial instruments Ifrs 9 Financial Instruments. they cover classification and measurement for financial assets and financial liabilities and are effective for accounting periods starting on or after 1 January 2013, but can be adopted early. the standard removes the cost accounting category for investments in equity instruments and introduces new classification criteria. Under its requirements, financial assets are eligible for accounting at amortised cost only if they are held within a business model whose objective is to collect contractual cash flows and their contractual terms give rise to cash flows that are solely payments of principal and interest. Financial assets that do not meet the criteria for amortised cost accounting are measured at fair value with gains and losses recognised in profit or loss. For equity investments, an election can be made to recognise gains and losses in other comprehensive income. Accounting for financial liabilities remains similar to that in IAS 39 except that the effect of changes in credit risk on financial liabilities designated as at fair value is generally recognised in other comprehensive income. Requirements relating to derecognition of financial instruments are complex, requiring a comprehensive analysis of the transaction. The requirements are a mixture of risk and rewards and control models.

8 8 Impact of ifrs: BANKING 2 Financial instruments impairment: Impairment of financial assets is an area in which accounting, regulatory and internal risk management requirements meet. It is important that, on conversion to Ifrs, any accounting solution minimises the need for additional systems, process and internal control changes and also ensures that differences between those requirements are well understood and managed. The impairment of financial assets is currently measured on an incurred loss basis. This means that no impairment allowance can be established at initial recognition of a financial asset. Impairment is recognised if objective evidence indicates that an asset is impaired due to events occurring after initial recognition. An impairment loss is measured differently for financial assets accounted for at amortised cost than those accounted for at fair value with gains and losses recognised in other comprehensive income (the latter measurement category is called Available for Sale, or AFS). For financial assets measured at amortised cost, the impairment loss is measured as the difference between an asset s carrying amount and the present value of the estimated future cash flows, discounted at the asset s original rate of return. For AFS assets impairment is measured as the difference between acquisition cost and fair value. The IASB is in the process of revising the accounting for the impairment of financial assets. In November 2009 the IASB issued Exposure Draft Financial Instruments: Amortised cost and Impairment, which proposes to replace the incurred loss approach with an approach based on expected losses (i.e. expected cash flow approach). Under this model the initial estimate of credit losses would be spread over the expected lives of the financial assets as part of the recognition of return from those assets. Any subsequent changes to the initial estimate would be recognised immediately in profit or loss. Extensive additional disclosures are also proposed. The proposals are likely to be very challenging for banks to implement. However, current discussions by the IASB indicate that significant changes may be made to the proposals. Unlike IAS 39, the new IFRS 9 will only require an impairment assessment on assets measured at amortised cost; therefore, the expected cash flow model would become the single impairment model for financial assets.

9 Impact of ifrs: BANKING 9 3 Hedge accounting: IFRS has strict rules on hedge accounting and it is not possible to apply hedge accounting until all documentation is complete. Care should be taken to put such documentation in place by the first day of the first IFRS comparative period presented to ensure that hedge accounting can be applied from that date. Hedge accounting is often used to minimise profit or loss fluctuation arising due to volatility in foreign exchange, interest rates, and other changes in fair values of certain financial instruments and other non-financial items. as under Ifrs generally all derivatives have to be accounted for at fair value, with gains and losses recognised in profit or loss, hedge accounting aims to mitigate profit or loss impact in respect of the portion of the hedge that is effective. there are three types of hedging relationships under Ias 39: fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation. accounting implications of each are as follows: for fair value hedges, the gains and losses relating to both the hedged item and the hedging instrument are recognised in profit or loss. For cash flows hedges and hedges of a net investment in foreign operation, the gains and losses on the hedging item are recognised in other comprehensive income. In addition, IFRS specifically allows some types of portfolio hedges in which many derivatives can be used to hedge many assets/liabilities in a single relationship. This so-called macro-hedging can be very useful in minimising documentation requirements. A hedging relationship only qualifies for hedge accounting if certain criteria are met, including formal designation and documentation of the hedging relationship at inception of the hedge. It should also be demonstrated, both at the outset and throughout the existence that the hedge is expected to be and has been highly effective, that is remaining within percent range. The initial documentation and subsequent effectiveness testing can be time consuming and systems-based solutions may be helpful in monitoring the effectiveness of the hedging relationships. Hedge accounting requirements are detailed and prescriptive. They define the items that can be hedged (including components and risks) and the allowed hedging instruments. Care needs to be taken to ensure that hedge relationships are identified in a manner that meets the requirements of the standard and, in particular, that the effectiveness tests are designed in a way that minimises the risk of future hedge relationships failure. The IASB is currently revising the hedge accounting requirements and issued an exposure draft in December 2010.

10 10 Impact of ifrs: BANKING 4 Consolidation of Special Purpose Entities (SPEs): Banks often use spes, for example to securitise loan receivables, design investment products for customers or effect certain leasing transactions. some banks are party to many hundreds of spes that may not be consolidated under the local accounting rules. the resulting structures can be complex and are likely to require review of each individual transaction in order to determine whether consolidation under Ifrs is appropriate. consolidatedcfinancial statements should include all subsidiaries of the parent company. the definition of a subsidiary focuses on the concept of control, which is defined in Ias 27 Consolidated and Separate Financial Statements as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. Ifrs contains specific guidance on the application of the control concept to spes, as many spes have predetermined objectives and so it is more difficult to determine who controls them. an spe is defined as an entity created to accomplish a narrow and welldefined objective (e.g. securitisation of receivables). In practice, judgement is often needed to conclude whether an entity should be regarded as an spe. sic 12 Consolidation Special Purpose Entities provides guidance on when an spe should be consolidated and gives the following indicators of control: the spe conducts its activities to meet the entity s specific needs; the entity has decision-making powers to obtain the majority of the benefits of the SPE s activities, for example through setting the autopilot mechanism through which its activities are run; the entity has a right to the majority of the SPE s benefits; or the entity has the majority of residual interest in the SPE. Significant judgment is often required to determine whether the criteria for consolidating an SPE are met. The IASB is developing a new consolidation standard to replace IAS 27 and SIC 12. The objective of the project is to develop a single definition of control that can be applied to all investees and to develop enhanced disclosure requirements for entities involved with structured entities. The IASB issued a staff draft of the standard in September 2010 and intends to issue the standard in the first quarter of A consolidation exemption for investment companies has been separated from the main project and will be the subject of an exposure draft scheduled for the second quarter of 2011.

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12 12 Impact of ifrs: BANKING 5 Definition of debt vs equity: the definitiontof an instrument as debt or equity may have an important impact on a bank s results and equity. It may also affect a bank s regulatory capital and ratios. Ias 32 Financial Instruments: Presentation addresses the liability or equity classification of financial instruments. the classification is dependent on the substance of the contractual arrangements rather than its legal form. In general, an instrument is classified as a financial liability if it contains a contractual obligation to transfer cash or another financial asset, or if it may be settled in a variable number of the entity s own equity instruments. an obligation to transfer cash may arise from a requirement to repay principal or to pay interest or dividends. an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. an exception to the rules are puttable instruments, which give the holder the right to put the instruments back to the issuer for cash or another financial asset or instruments imposing an obligation on an entity only in liquidation. If certain criteria are met, then such instruments are classified as equity. Some contracts may contain both equity and liability components, which may have to be accounted for separately. An example is a convertible bond that comprises a debt instrument and an equity conversion option. The equity conversion option would require analysis to determine whether it meets the definition of equity. This is an example of another area that requires contract-by-contract analysis during the IFRS conversion process. The IASB started a project to review its guidance on the definition of debt vs equity, but has decided to postpone deliberations until after June 2011 when it expects to have more time available.

13 Impact of ifrs: BANKING 13 6 Presentation of financial statements and disclosures of financial instruments IFRS is not prescriptive as to the format of the statement of comprehensive income, the balance sheet or other primary statements. However, this means that the format has to be carefully developed to appropriately reflect the activities of each entity. Disclosures in many areas, for example for financial instruments, can be extensive. Instead of being prescriptive, IAS 1 Presentation of Financial Statements provides minimum requirements for the presentation of financial statements, including its content and guidelines for their structure. As a result, variations on presentation and disclosure may exist across the banking sector. A first-time adopter of IFRS is required to present the opening balance sheet at the start of its earliest comparative period. Subsequent to the adoption of IFRS, this third balance sheet is presented only in certain circumstances. Probably the most sensitive of the financial statements is the statement of comprehensive income. Here, IFRS stipulates very few line items, but call for management to select the method of presentation that is most reliable and relevant. The standard provides entities the option to present an analysis of expenditures either on the basis of nature or based on function. Ifrs 7 Financial Instruments: Disclosures requires extensive qualitative and quantitative information explaining the significance of financial instruments to an entity s financial statements, its exposure to risk and how this exposure is managed. the financial crisis has had a significant impact on the banking sector, and there is considerable demand from financial statement users to improve the quality of the disclosures, including explanation of significant management judgement and sensitivity analysis, a move away from so-called Boiler plate compliance with the standard. some of the information required by Ifrs 7 may not be readily available and new systems, processes and internal controls may need to be put in place to collect it. the IasB is working on a financial statement presentation project which may introduce changes to the existing requirements, for example separate presentation of items measured using different bases. However, this project is currently postponed and IasB expects to resume its deliberations after June 2011.

14 14 Impact of ifrs: BANKING 7 Leases: Banks commonly engage in leasing activities, particularly in financing transactions that can take many legal forms. the application of Ifrs may potentially result in many more leased assets being recognised on-balance sheet. Accounting for leases under IFRS currently depends on whether a lease is a finance or an operating lease. Finance leases are accounted for by the lessor as financing transactions. Operating leases require the lessor to continue to recognise the leased assets on its balance sheet. Classification of a lease does not depend on which party has legal ownership of the leased asset, but rather on which party has substantially all of the risks and rewards of ownership. Lease accounting under IFRS may affect those banks that under local GAAP keep assets off-balance sheet as operating leases, when the substance of the arrangement is that the bank obtains substantially all of the risks and rewards incidental to ownership of the asset. As a result, many more leases could be recognised on the balance sheet upon conversion to IFRS. Determining whether an arrangement constitutes an operating or a finance lease may require judgement. In addition, an entity may enter into an arrangement comprising a transaction or a series of transactions that do not take the legal form of a lease but convey the right to use an asset. Such arrangements would have to be reviewed on conversion to IFRS to determine whether they contain a lease and therefore whether lease accounting is appropriate. The IASB is reviewing the accounting for leases. The aim of the project is to develop a new approach to lease accounting for lessees and lessors. The IASB published an exposure draft in August 2010 and the revised standard is expected in the second quarter of 2011.

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16 16 Impact of ifrs: BANKING 8 Insurance contracts: many banking groups undertake insurance business and some that do not may still find that they have contracts that meet the definition of an insurance contract under Ifrs. on conversion to Ifrs, one of the significant work streams for an insurance business is to determine which of its contracts meet the definition of an insurance contract and which meet the definition of a financial instrument. Ifrs has minimal guidance on accounting for insurance contracts. Ifrs 4 Insurance Contracts only provides minimum accounting criteria, which in most cases allow companies to continue using existing Gaap and require some specific disclosures. However, Ifrs 4 does define an insurance contract and some contracts entered into by an insurance business may not meet the definition of an insurance contract and instead may have to be accounted for as a financial instrument under Ias 39. an insurance contract is defined as one under which one party accepts significant insurance risk from another party (policyholder) by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder. for example, insurers often offer what are substantially investment products in which mortality or other insurance risk is minimal or non-existent. such instruments are required to be accounted for as financial instruments. the IasB issued an exposure draft in July 2010, which proposes a comprehensive measurement model for all types of insurance contracts issued by entities. the measurement model is based on a principle that insurance contracts create a bundle of rights and obligations that work together to create a package of cash inflows (premiums) and outflows (benefits, claims and costs). a revised standard is expected in the second quarter of 2011.

17 Impact of ifrs: BANKING 17 9 Post-employment benefits: Banks that operate defined benefit pension plans may be significantly impacted on conversion to Ifrs, especially if they have large unfunded pension obligations. this in turn may affect regulatory capital and ratios. Many banks have in place defined benefit pension plans and/or retirement healthcare schemes for their employees. Defined benefit plans are plans other than those in which an employer pays a fixed contribution and has no other obligations. Under IAS 19 Employee Benefits, the accounting for a defined benefit plan involves applying actuarial techniques to estimate the employer s obligations. Actuarial gains and losses may arise as a result of estimation differences from period to period. These may be recognised immediately in other comprehensive income or profit or loss, or recognised in profit or loss over time, using the so-called corridor method. The IASB is working on a project to amend IAS 19 and issued an exposure draft in April One of the main proposed changes is to eliminate the corridor method, which allows companies to defer recognition of a portion of the actuarial gains and losses. This will result in the full actuarial gain/ loss being recognised immediately in other comprehensive income rather than being unrecognised until it is amortised into profit or loss. A final standard is scheduled for the first quarter of The IASB is also considering undertaking a more comprehensive review of accounting in this area.

18 18 Impact of ifrs: BANKING 10 IFRS 1 first-time adoption of IFRS: an early understanding of the numerous mandatory and optional exemptions from the retrospective application of Ifrs that are available to first-time adopters of Ifrs is paramount for a successful and cost-effective implementation of Ifrs. selecting accounting policies at the time of preparing the opening balance sheet under Ifrs not only affects the first Ifrs financial statements but also the financial statements for subsequent periods, including reported profits. Ifrs 1 First-time adoption of IFRS allows an entity converting to Ifrs a number of reliefs from the requirements that otherwise would apply if Ifrs was adopted as if the entity had always applied Ifrs. Without any relief, an entity would be required to retrospectively implement Ifrs from the start of its corporate history. the standard aims to ensure that an entity s first Ifrs financial statements contain high-quality information that is transparent for users and comparable over periods presented while also balancing the cost of first-time adoption.

19 Impact of ifrs: BANKING 19 Ifrs 1 is not industry-specific. Banks will need to go through each of the available options in Ifrs 1 and decide which are the most appropriate for them based on the corporate profile they have. We note below a couple of issues to consider. one of the most commonly used Ifrs 1 exemption by banks is the option not to restate pre-ifrs business combinations. Here, acquisitive banks may not wish to revisit previous acquisition accounting under prior Gaap. there is also an optional exemption in Ifrs 1 that allows a first-time adopter to designate at the date of transition any financial asset (or where applicable, liability) as at fair value through profit or loss or available for sale provided that the relevant criteria to qualify for classification are met at that date. this is regardless of the classification under previous Gaap. for a full understanding of the relief available upon the adoption of Ifrs, we recommend that you refer to KpmG s publication IFRS Handbook: First-time Adoption of IFRS.

20 20 Impact of ifrs: BANKING Systems and processes: a major effect of converting to Ifrs will be the increased effort required throughout the banking entity to capture, analyse and report new data to comply with Ifrs requirements. making strategic and tactical decisions relating to information systems and supporting processes early in the project helps limit unnecessary costs and risks arising from possible duplication of effort or changes in approach at a later stage. the more new processes are automated, the less they will disrupt day-to-day operations. temporary work-arounds introduced at the time of conversion to Ifrs can be labour-intensive and often remain in existence years after the conversion project is finished. much depends on factors such as: whether the bank utilises enterprise resource planning (Erp) systems all major Erp systems are able to handle parallel accounting the volume and mixture of in-house developed and vendor systems for financial reporting processes the level of customisation the more customised the system, the more effort and planning the conversion process will take the number of systems required for financial reporting a greater number of systems will require significant updating for consolidation and reconciliation purposes. some entities take the opportunity of an Ifrs conversion project to streamline the existing systems and processes. most banking operations have a number of processes to deal with both geographic and product reporting. many of these processes will need to be analysed and potentially redesigned under Ifrs. the extent of differing information systems within an

21 Impact of ifrs: BANKING 21 organisation and differing local reporting requirements will complicate matters further, especially if internal control reporting is necessary. The silver lining is that there may be an opportunity to simplify and streamline processes and controls and ultimately reduce the longterm costs of reporting. From accounting gaps to information sources The foundation of the project, as described earlier, is to understand the IFRS to local GAAP accounting differences. That initial analysis needs to be followed by determining the effect of those accounting gaps on internal processes, information systems and internal controls. What banks need to determine is which systems and processes will need to change and translate accounting differences into technical system specifications. One of the difficulties banks face in creating technical specifications is to understand the detailed end-to-end flow of information from the source systems to the general ledger and further to the consolidation and reporting systems. Embedded accounting rules in frontoffice transactional systems need to be identified, catalogued and modified based on the revised accounting policy. Subledgers that reside on the back end of transactional systems may contain posting rules that will change on the basis of IFRS. Significant data cleansing and sourcing exercises may be required to enhance data quality and data sets designed to support local GAAP reporting, as this may not contain key data fields to comply with IFRS. Some of this data may well reside in end-user computing applications that do not always have the same level of rigour and robustness over production, completeness and accuracy as the mainstream systems. Data warehouses will need to support consolidated financial information from multiple financial systems and ledgers, and may require expansion and modification to accept the greater level of detail required. The simplified diagram below outlines a process that organisations can adopt to identify the impact of IFRS conversion on information systems. Process for identifying the information systems of IFRS Accounting and Disclosure Gaps General ledger Data warehouse Source systems Front-end applications

22 22 Impact of ifrs: BANKING How to identify the impact on information systems There are many ways information systems may be affected, from the initiation of transactions through to the generation of financial reports. The following table shows some areas in which information systems change might be required under IFRS depending upon facts and circumstances. Change New data requirements New accounting disclosure and recognition requirements may result in more detailed information; new types of data; new fields; and information may need to be calculated on a different basis. Changes to the chart of accounts There almost always will be a change to the chart of accounts due to reclassifications and additional reporting criteria. Reconfiguration of existing systems Existing systems may have built-in capabilities for specific IFRS changes, particularly the larger enterprise resource planning (ERP) systems and high-end general ledger packages. Modifications to existing systems New reports and calculations are required to accommodate IFRS. Spreadsheets and models used by management as an integral part of the financial reporting process should be included when considering the required systems modifications. New systems interface and mapping changes When previous financial reporting standards did not require the use of a system, or the existing system is inadequate for IFRS reporting, it may be necessary to implement new software. When introducing new source systems and decommissioning old systems, interfaces may need to be changed or developed and there may be changes to existing mapping tables to the financial system. When separate reporting tools are used to generate the financial statements, mapping these tools will require updates to reflect changes in the chart of accounts. Action Modify the general ledger system and reporting system to capture new or changed data. Modify the work procedure documents. Create new accounts and delete accounts that are no longer required. Reconfigure existing software to enable accounting under IFRS (and parallel local GAAP, if required). Make amendments such as: new or changed calculations new or changed reports new models. Implement software in the form of a new software development project or select a package solution. Interfaces may be affected by: modifications made to existing systems the need to collect new data the timing and frequency of data transfer requirements.

23 Impact of ifrs: BANKING 23 Change Consolidation of entities Under IFRS, there potentially will be changes to the number and type of entities that need to be included in the group consolidated financial statements. For example, the application of the concept of control may be different under IFRS. Reporting packages Reporting packages may need to be modified to: (1) gather additional disclosures in the information from branches or subsidiaries operating on a standard general ledger package; or (2) collect information from subsidiaries that use different financial accounting packages. Financial reporting tools Reporting tools can be used to: (1) perform the consolidation and the financial statements based on data transferred from the general ledger; or (2) prepare only the financial statements based on receipt of consolidated information from the general ledger. Action Update consolidation systems / models to account for changes in consolidated entities. Modify reporting packages and the accounting systems used by subsidiaries and branches to provide financial information Modify: reporting tools used by subsidiaries and branches to provide financial information mappings and interfaces from the general ledger the consolidation systems used to report consolidated financial statements based on additional reporting requirements such as segment reporting. Banking accounting differences and respective system issues Each standard under IFRS will require different information system changes. An example of a standard that can have a major impact on information systems is IAS 39. The following table outlines some of the requirements of IAS 39 and the possible information systems impacts arising from these changes.

24 24 Impact of ifrs: BANKING IFRS accounting treatment Calculation of amortised cost/ effective yield from the loan book Hedge accounting Impairment of financial assets Classification of financial assets as held to maturity Potential information systems impacts For retail portfolios systems will need to be designed to incorporate prepayment information, transaction costs, fees, steps in interest etc to arrive at an effective yield from the portfolio. The systems will need to handle the re-estimation of cash flows. Hedge accounting systems may be required to perform hedge effectiveness calculations at regular intervals. Systems and/or process changes may be required to incorporate the data required (timing of expected cash flows) and discount those cash flows using the instruments effective interest rates. A system/process will need to be developed to flag any disposals before maturity. Parallel reporting timing the changeover from local GAAP to IFRS reporting Conversion from local GAAP to IFRS will require parallel accounting for a certain period of time. At a minimum, this will happen for one period as local GAAP continues to be reported, but IFRS comparatives are prepared prior to the go-live date of IFRS. However, in many cases this will be an on-going requirement as data under local GAAP may be required for, say, tax purposes. The parallel reporting may be based on real-time collection of information through the accounting source systems to the general ledger or on top-side adjustments posted as an overlay to the local GAAP reporting system. The manner and timing of processing information for the comparative periods in real-time or through top-side adjustments has to be selected. In deciding the preferred method, the following should be considered:

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26 26 Impact of ifrs: BANKING Parallel accounting option in comparative year Parallel accounting through top-side adjustments: Real-time parallel accounting Effect No real-time adjustments to systems and processes will be required for comparative period. Local GAAP reporting will flow through subsystems to the general ledger (i.e. business as usual). Comparative period will need to be recast in accordance with IFRS, but can be achieved off-line. Migration of local GAAP to IFRS happens on first day of the year in which IFRS reporting commences. Consideration needed for leading ledger in comparative year being local GAAP or IFRS (i.e. which GAAP will management use to run the business). If leading ledger is IFRS in comparative year, conversion back to local standards is necessary for the usual reporting timetable. Changes to systems and information may continue to be needed in the comparative year if the IFRS accounting options have not been fully established. Migration to IFRS ledgers needed prior to first day of the year in which IFRS reporting commences. Considerations Less risky for ongoing reporting requirements in comparative year. Available for all but more typical when there are less volume of transactions to consider. More applicable to small/less complex organisations or when few changes are required. Real-time reporting of two GAAPs in comparative year puts more stress on the finance group. Tracking two sets of numbers for large volume of transactions will make systemisation of comparative year essential. More applicable for large/complex organisations with many changes. Strict control on system changes will need to be maintained over this phased changeover process. All major ERP systems (e.g. SAP, Oracle, Peoplesoft) are able to handle parallel accounting. The two most implemented solutions are the Account Solution or the Ledger Solution. Depending on the release of the respective ERP systems one or both options are available. Account Solution Ledger Solution General Ledger Only IFRS Only Local IFRS Common Accounts Local GAAP Features Features

27 Impact of ifrs: BANKING 27 Harmonisation of internal and external reporting Banks should consider carefully the impact of IFRS changes on data warehouses and relevant aspects of internal and external reporting. In many entities, internal reporting is performed on a basis similar to external reporting, using the same data and systems, which will therefore need to change to align with IFRS. With potential multiple changes to the same information systems being required, careful co-ordination and rigorous change management and testing are key to success. The following diagram represents the possible internal reporting areas that may be affected by changing systems to accommodate the new IFRS reporting requirements. External reporting IFRS US GAAP Stand-alone financial reporting per local GAAP Tax reporting Regulatory reporting (i.e. Basel, solvency) Management reporting Business key performance indicators Business unit reporting Product/service reporting Cost accounting Compliance Performance improvement Shareholder value reporting Economic Value Added (EVA) Cash value-added Management incentives Stock compensation plans Planning and budgeting Annual budget Rolling forecast Operational forecast Strategic plans Closing preview forecast The process of aligning internal and external reporting will involve the following: When mappings have changed from the source systems to the general ledger, mappings to the management reporting systems and the data warehouses also should be changed. When data has been extracted from the source systems and manipulated by models to create IFRS adjustments that are processed manually through the general ledger, the impact of these adjustments on internal reporting should be carefully considered. Alterations to calculations and the addition of new data in source systems as well as new timing of data feeds could have an effect on key ratios and percentages in internal reports, which may need to be redeveloped to accommodate them.

28 28 Impact of ifrs: BANKING

29 Impact of ifrs: BANKING 29 People: When your Bank reports for the first time under Ifrs, the preparation of those financial statements will require Ifrs knowledge to have been successfully transferred to the financial reporting team. timely and effective knowledge transfer is an essential part of a successful and efficient Ifrs conversion project. People issues range from an accounts payable clerk coding invoices differently under IFRS to an Audit Committee approval of the internal controls over IFRS reporting. There is a broad spectrum of people and process related issues, all of which require an estimation of the changes that are needed when reporting under the IFRS. The success of the project will depend on the people involved. There needs to be an emphasis on communications, engagement, training, support, and senior sponsorship, all of which are part of change management. Training should not be underestimated and entities often don t fully appreciate the levels of investment and resource involved in training. Although most conversions are driven by a central team, you ultimately need to ensure the conversion project is not dependent on key individuals and that the business-asusual operations can be performed when the project ends. Distinguishing between different audiences and the nature of the content is the key for successful training. Some useful knowledge transfer pointers are as follows: Training tends to be more successful when tailored to the specific needs of the entity. Few entities claim significant benefit from external nontailored training courses. Geographically disparate companies are considering web-based training as a cost and time-efficient method of disseminating knowledge. More complex areas such as financial instrument classification and measurement, hedge accounting etc are best conveyed through workshop training approaches in which entity-specific issues can be tackled. Many entities manage their training through a series of site visits typically partnerships of one member of the core central team along with a second technical expert, often an external advisor. Some entities use training as an opportunity to share their data collection process at the same time. Even with the best planning and training possible, it is critical that an appropriate support structure is in place so that the business units implement the desired conversion plans properly. IFRS knowledge only really becomes embedded in the business when the stakeholders have the opportunity to actually prepare and work with real data on an IFRS basis. We recommend building dry runs into the conversion process at key milestones to test the level of understanding among finance staff.

30 30 Impact of ifrs: BANKING Business One of the challenges of IFRS adoption stems from the number of stakeholders that have a vested interest in the financial performance of the organisation. Your project will have to deal with a large number of internal and external stakeholders so as to manage one fundamental issue the operational performance stays the same but the scoreboard of the financial statements gives a different result under IFRS. Measurement of operational performance cuts across all parts of an organisation and effects the internal business drivers and external perceptions of the entity. The assessment of who those affected groups are, and when is the appropriate time for communications, is a key component of an IFRS conversion project. Stakeholder analysis and communications A thorough review of the internal and external stakeholders is an essential first step. Certain less obvious internal stakeholder groups may be engaged only in the conversion process at a late stage but the awareness of when to engage those groups is necessary. For example, banks have front office, middle office and back office functions that will need to be involved in certain system/reporting changes. However, not all of these groups will need to participate in detailed accounting discussions earlier on in the conversion process. In a similar context, external stakeholders should be properly identified and communicated with throughout the IFRS conversion. Examples include groups such as the tax authorities, regulators, industry analysts and the financial media. Every identified group should be factored into the timing of when and how to present changes in operational performance because of IFRS. Furthermore, project related deliverables should be incorporated into key stakeholder objectives to ensure their successful achievement. Banks should actively consider the communications strategy through which they will ensure that all key stakeholder groups are fully informed of the project s progress. at a minimum this includes the quarterly and annual disclosures in the financial reports, but may need a much broader ranging communications strategy. the format of communications needs to be personalised to the nature of the bank, but a clear and consistent message should be given to those directly but also those not directly involved in the project. Audit Committee considerations audit committees and Board of Directors (Board) need to be actively and appropriately engaged in the conversion process. the project structure needs to ensure that they receive relevant and timely information while not becoming a bottleneck for decisions. the most successful conversion projects are sponsored by a member of the Board who is closely involved in the project. all Ifrs conversions should ensure that Board and audit committee meetings are acknowledged on the project plan as these meetings will drive key deliverables and provide incentive for timely delivery. these senior management groups need to have tailored and periodic training to suit their knowledge requirements so as to not overwhelm them with accounting theory on Ifrs. Monitoring peer group The banking community tends to be close-knit and often uses sector benchmarks and peer group comparisons. As such, most banks in a given geography will want to know what their peers are doing as it relates to IFRS and what choices and options are being taken by those groups. Investors and analysts will also want to be able to look across banks and be aware of the differences, so as to factor those differences into their various buy/sell/hold recommendations. Management will need to assess its peer group, but the manner in which this is achieved may vary depending on the working relationship with other banks.

31 Impact of ifrs: BANKING 31 past practice has seen sector groups form that informally share updates on the choices being reviewed and the stage of completion of Ifrs conversion projects. Other areas of conversion risk to mitigate a quality Ifrs conversion should successfully manage the risks of change management. It is essential that a bank does not miss deadlines, or issue reports including errors. as such, the risks are high when it comes to all Ifrs conversions and banks are no different in this regard. there are a number of areas to consider but two main ones are around the use of the external auditor and the internal control certification requirements. the involvement of the bank s auditors should be an integral part of the Ifrs governance process of the project. there needs to be explicit acknowledgement on the part of the entity for frequent auditor involvement. clear expectations should be set around all key deliverables, including timely Ifrs technical partner involvement. the audit committee also needs to ensure the external audit teams have reviewed changes to accounting policies prior to approval by the audit committee. proper planning for new and enhanced internal controls and certification process as part of your Ifrs conversion should be considered. assessment of internal control design for accounting policy management as well as financial close processes are integral and companies need to be cognisant of the impact of any manual work-arounds used. Documentation of new policies, procedures and the underlying internal controls will all need to be reflected as part of the Ifrs process. Benefits of IFRS While the majority of this paper has focused on the micro-based risks and issues associated with Ifrs and Ifrs conversions, senior management should not lose sight of the wider benefits of Ifrs conversion. Ifrs may offer more global transparency and ease access to foreign capital markets and investments, and that may help facilitate cross-border acquisitions, ventures and spin-offs. It is important that these benefits be kept in mind throughout the project to provide clear direction and obtainable goals for all concerned.

32 32 Impact of ifrs: BANKING KPMG: An Experienced Team, a Global Network: KPMG s Banking practice KPMG s Banking practice is dedicated to supporting Retail and Investment banks globally in understanding industry trends and business issues. Our firms professionals offer skills, insights and knowledge based on substantial experience working with the banking sector to understand the issues and deliver the services needed to help banks succeed wherever they compete in the world. We offer customised, industry-tailored audit, tax and advisory services that can lead to value-added assistance for your most pressing business requirements. KPMG, through its global network of highly qualified professionals in the Americas, Europe, the Middle East, Africa and Asia Pacific, can help you reduce costs, mitigate risk, improve controls of a complex value chain, protect intellectual property, and meet the myriad challenges of the digital economy. For more information, visit kpmg.com/global/en/whatwedo/ Industries/Financial-Services/Pages/ default.aspx. Your conversion to IFRS As a global network of member firms with experience in more than 1,500 IFRS convergence projects around the world, we can help ensure that the issues are identified early, and can share leading practices to help avoid the many pitfalls of such projects. KPMG firms have extensive experience and the capabilities needed to support you through your IFRS assessment and conversion process. Our global network of specialists can advise you on your IFRS conversion process, including training company personnel and transitioning financial reporting processes. We are committed to providing a structured approach with the aim of delivering consistent, high-quality services for our clients across geographies. Our approach comprises four key work-streams: Accounting and reporting Business impact Systems, processes, and controls People.

33 Impact Impact of ifrs: of ifrs: Automotive BANKING 33

34 34 Impact of ifrs: BANKING contact us: Global FS practice Global FS contacts Global fs, chairman Jeremy Anderson tel: Brazil Ricardo Anhesini fs Line of Business Head tel: Germany Klaus Becker fs Line of Business Head tel: canada Mark D. Smith fs Line of Business Head tel: India Abizer Diwanji fs Line of Business Head tel: +91 (22) china Simon Gleave fs Line of Business Head tel: Netherlands Jeroen Van Nek fs Line of Business Head tel: france Fabrice Odent fs Line of Business Head tel: [email protected] Usa Scott Marcello fs Line of Business Head tel: [email protected]

35 Impact of ifrs: BANKING 35 Acknowledgements We would like to acknowledge the authors of this publication, including: Ewa Bialkowska Colin Martin KpmG International standards Group (part of KpmG IfrG Limited) KpmG in the UK Other KPMG publications We have a range of Ifrs publications that can assist you further, including: Insights into Ifrs Ifrs: an overview Ifrs compared to Us Gaap Ifrs Handbook: first-time adoption of Ifrs New on the Horizon publications that discuss exposure drafts. the following may be of particular relevance to the banking sector: New on the Horizon: ED/2009/12 financial Instruments: amortised cost and Impairment; New on the Horizon: Hedge accounting; New on the Horizon: Leases; New on the Horizon: Insurance contracts. first Impressions publications that discuss new pronouncements. the following may be of particular relevance to the banking sector: first Impressions: Ifrs 9 financial Instruments; first Impressions: additions to Ifrs 9 Ifrs practice Issues publication which discusses current issues, for example fair value disclosures Illustrative financial statements for banks Disclosure checklist. regular Briefing sheets summarising current developments 2011 KpmG International cooperative ( KpmG International ). KpmG International provides no client services and is a swiss entity with which the independent member firms of the KpmG network are affiliated.

36 kpmg.com/ifrs Global FS practice Jeremy Anderson Global FS, Chairman T: E: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG International Cooperative ( KPMG International ), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Designed by Evalueserve. Publication name: Impact of IFRS: Banking Publication number: Publication date: February 2011