BANK OF BAKU AUDITORS REPORT AND
FINANCIAL STATEMENTS AT
31 DECEMBER 1999
Note 3 - Significant accounting policies
The following significant accounting policies have been
applied in the preparation of the financial statements.
Accounting convention
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.
Related parties
For the purpose 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. Accordingly, shareholders, directors, and
companies and individuals that are directly and/or indirectly related to them
are considered related parties.
Cash and cash equivalents
For the purpose of the cash flow statement, cash and cash
equivalents comprise cash in hand, balances with the NBAR (excluding mandatory
reserves), correspondent accounts including overnight deposits, and short-term
(up to three months) placements with other banks.
Loans and provisions for loan impairment
Loans and advances are stated at the principal amounts
outstanding, net of provisions for loan impairment. Provisions for loan
impairment are based on the evaluation by management of the collectibility of
loans and advances. Specific provisions are made against loans whose recovery
has been identified as doubtful. A general provision is made against potential
doubtful loans that are present in the loan portfolio but have not been
specifically identified at the date of the financial statements. The aggregate
provisions made during the year are charged against income for the year.
Provision estimates require the exercise of judgement and
the use of assumptions. The principal factors considered in determining the
size of provisions are the growth, composition and quality of the loan
portfolio, level of overdue loans, current economic conditions and value and
adequacy of collateral.
Loans and advances that cannot be recovered are written off
and charged against the provision for loan impairment. Such loans are written
off after all 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 in the provision charge for the year.
Premises and equipment
Premises and equipment are stated at cost or revalued
amounts, less accumulated depreciation.
The statutory revaluation of premises and equipment was
last made on 30 September 1996 and the revaluation surplus has been included
in the revaluation reserve. The revaluation is performed on the basis of
indices, which 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, that more closely reflects market value. The indices vary according to
asset type and acquisition date.
Depreciation
Depreciation is applied on a straight-line basis over the
estimated useful lives of the assets using the following rates:
Annual rate
(%)
Computers and office equipment
25
Fixture, furniture and others
20
Motor vehicles
15
Deferred taxation
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.
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 for utilization
of the deferred tax asset. Currently enacted tax rates are used to
determine deferred income tax.
The principal temporary differences arise from provisions
for loan impairment, accrued interest income and expenses and accrued expenses
(Note 18).
Income and expense recognition
Income and expenses are recognized on an accrual basis. Fee
and commission income from banking services is recorded as income at the time
of effecting the transactions to which they 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.
Foreign currency transactions
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 at
the transaction date.
Monetary assets and liabilities denominated in foreign
currency are translated into AZM using the exchange rates of the NBAR
prevailing at the balance sheet date. Foreign currency gains and losses
arising from the translation of monetary assets and liabilities are reflected
in the statement of income under the net gains from dealing in foreign
currency. At 31 December 1999, the principal rate of exchange used for
translating foreign currency balances was US$ 1 = AZM 4,373 (1998: US$ 1 = AZM
3,890).
Computer software development costs
Generally, costs associated with developing computer
software programs are recognized as expense as they are incurred. However,
expenditure that enhances and extends the benefits of computer software
programs beyond their original specifications and lives is recognized as a
capital improvement and added to the original cost of the software. Computer
software development costs recognized as assets are amortized using the
straight-line method over their useful lives, not exceeding a period of 4
years.
Costs associated with the maintenance of existing computer
software programs and the modifications for the Year 2000 are expensed as
incurred.
Financial instruments
Because of the nature of its operations, the Bank is
exposed to a variety of risks, the major risks being foreign exchange risk,
interest rate risk, liquidity risk, and credit risk. Use of various offsetting
positions and continuous monitoring of the risk positions and financial
markets manage these risks. The Bank does not use derivative financial
instruments to manage these risks.
Foreign exchange risk
Foreign exchange denominated assets and liabilities give
rise to foreign exchange exposure. The Bank does not use derivative products
to hedge its foreign exchange exposure. The exposure is managed by using
natural hedges that arise from offsetting foreign currency denominated assets
and liabilities (Note 20).
Interest rate risk
The Bank is exposed to interest rate risk through the
impact of rate changes on interest bearing liabilities and assets. However,
this risk is kept at minimum as the Banks major borrowings are lent to
credit customers at the rates including a margin over the borrowing rate.
These exposures are also managed by using natural hedges that arise from
offsetting interest rate sensitive assets and liabilities (Note
21).
Liquidity risk
The ability to fund the existing and prospective debt
requirements is managed by maintaining sufficient cash and short-term funds, the
availability of funding through an adequate amount of credit lines and the
ability to close out market positions.
Credit risk
Ownership of financial assets involves the risk that
counter-parties may be unable to meet the terms of their agreements. This risk
is monitored by limiting the aggregate risk to any individual counter-party,
group of companies and industry. The credit risk is generally diversified due to
the large number of entities comprising the customer bases and their dispersion
across different industries.
Fair value of financial instruments
Fair value is the amount at which a financial instrument
could be exchanged in a current transaction between willing parties, other than
in a forced sale or liquidation, and is best evidenced by a quoted market price.
The estimated fair values of financial instruments have been
determined by the Bank using available market information and appropriate
valuation methodologies, where they exist. However, judgement is necessarily
required to interpret market data to determine the estimated fair value.
Accordingly, the estimates presented herein are not necessarily indicative of
the amount the Bank could realize in a current market exchange.
Management does not believe that it is practicable to
estimate the fair value of loans and term deposits. These instruments are not
currently traded in the Azeri financial markets and an objective estimate of
fair value is not available. The stability of the interest rate and exchange
rate environment significantly affects the fair value of financial instruments.
NBAR has from time to time significantly changed interest rates in order to
support the Azeri Manat. However, the exchange rate of the Azeri Manat against
fully convertible currencies has been stable since the beginning of 1996.
Management considers the interest rate and exchange rate environment in setting
interest rates on loans and term deposits and reduces the risk of significant
fluctuations in fair value by issuing loans and term deposits with short
maturities.
The following methods and assumptions were used to estimate
the fair value of the Banks other financial instruments:
Financial assets
For monetary assets, excluding loans, fair value approximates
carrying value. Balances denominated in foreign currencies have been translated
at appropriate year-end exchange rates.
The fair values of certain financial assets carried at cost,
including cash and amounts due from banks, accrued interest and other financial
assets, are considered to approximate their respective carrying values due to
their short-term nature and negligible credit losses.
Financial liabilities
For monetary liabilities, excluding term deposits, fair value
approximates carrying value. Balances denominated in foreign currencies have
been translated at appropriate year-end exchange rates. The fair value of
deposit liabilities without a stated maturity is recorded as the carrying
amount.
Comparatives
Where necessary, comparative figures have been adjusted to
conform to changes in presentation in the current year.
