BANK OF BAKU
AUDITORS REPORT AND FINANCIAL STATEMENTS AT 31 DECEMBER 1998

The financial statements of the Bank are prepared under the historical cost convention and applicable IAS except that certain fixed assets have been revalued using the indices prescribed in the guidelines of the Cabinet of Ministers of the Azerbaijan Republic as set out below.

For the purposes of the accompanying financial statements, parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the party in making financial and operational decisions.

Cash and short-term funds include cash on hand, balances with the NBAR and correspondent accounts, including overnight deposits and short-term placements with other banks.

Loans and advances are stated at the principal amounts outstanding net of provisions for bad and doubtful loans. Provisions for bad and doubtful loans are based on the evaluation by management of the collectability of loans and advances. Specific provisions are made against loans whose recovery has been identified as doubtful. A general provision is made against the latent bad and doubtful loans which are present in the loan portfolio but which at the date of preparing the financial statements have not been specifically identified. The aggregate provisions made during the year are charged against profit for the year.

Estimates of losses require the exercise of judgment and the use of assumptions. The principal factors considered in determining the provisions are the growth, composition and quality of the loan portfolio, the level of overdue loans, current economic conditions and the value and adequacy of collateral.

Loans and advances, which cannot be recovered are written off and charged against the provision for bad and doubtful loans. Such loans are written off after all the necessary legal procedures have been completed and the amount of the loss has been determined. Recoveries of amounts previously provided for are treated as a reduction of the charge for provision of bad and doubtful loans for the year.

Premises and equipment are stated at cost or revalued amounts, less accumulated depreciation. 
Premises and equipment were last revalued on 30 September 1996, and the revaluation has been included in the balance sheet as at 31 December 1998 and 1997. The revaluation is performed on the basis of government indices. The indices applied are provided by the Cabinet of Ministers of the Azerbaijan Republic and are designed to restate the net book value of the asset to a level which more closely reflects market value. The indices vary according to asset type and acquisition date.

Depreciation is applied on a straight-line basis over the estimated useful lives of the assets using the following rates:
Computers and office equipment 25% per annum
Fixture, furniture and others 20% per annum
Motor vehicles 15% per annum

Deferred income tax is provided, using the liability method, for all temporary differences arising between the tax bases of assets and liabilities and their carrying values for financial reporting purposes. Currently enacted tax rates are used to determine deferred income tax.

The principal temporary differences arise from accrued interest income and expenses, accrued other expenses and provision for loan losses (Note 17).

Deferred tax liabilities and assets are recognized when it is probable that the future economic benefit resulting from the reversal of temporary differences will flow to or from the Bank. Deferred tax assets resulting from temporary differences in the recognition of expense for income tax and financial reporting purposes are recognized to the extent that it is probable that future taxable profit will be available against which the deferred tax asset can be utilized.

Income and expenses are recognized on an accrual basis. Fees and commission income from banking services are recorded as income at the time of effecting the transactions to which relate. In the case of overdue loans interest income is recorded on an accrual basis until the loan is assessed as non-performing or the collection of principal or interest becomes doubtful; at that point, recognition of interest is suspended until the interest is received.

Transactions denominated in foreign currency are recorded at the exchange rate prevailing at the transaction date. Exchange differences resulting from the settlement of transactions denominated in foreign currency are included in the statement of income using the exchange rate prevailing on the date of settlement. 
Monetary assets and liabilities denominated in foreign currency are translated into AZM at the official rates of the NBAR at the balance sheet date. Foreign currency gains and losses arising from the translation of the assets and liabilities are reflected in the statement of income for the year in net gains from dealing in foreign currency. At 31 December 1998, the principal rate of exchange used for translating foreign currency balances was US$1 = AZM 3,890 (1997: US$1 = AZM 3,888).

The Bank contributes to the Azerbaijan Republic state social insurance funds for its employees. The Bank's contribution amounts to 37% of employees gross salaries, and is expensed as incurred.

Note 1 Principal Activities
Note 2 Basis of Presentation
Note 3 Significant Accounting Policies
Note 4 Cash and Short-Termshort-term funds
Note 5 Loans and Advances to Banks
Note 6 Loans and Advances to Customers
Note 7 Premises and Equipment
Note 8 Deposits From Banks
Note 9 Customer Accounts
Note 10 Other Liabilities
Note 11 Share Capital
Note 12 Accumulated Deficit / Retained earnings
Note 13 Dividends
Note 14 Fees and Commission Income
Note 15 Fees and Commission Expense
Note 16 General, Administrative and Other Operating Expenses
Note 17 Taxation
Note 18 Asset and Liability Concentration
Note 19 Fair value of Financial Instruments
Note 20 Risk Management
Note 21 Commitments and Contingent Liabilities
Note 22 Reconciliation of Azeri Accounting Rules to International. Accounting Standards
Note 23 Related Party Transactions