Barclays 2004 Annual Report Download - page 96

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Critical Accounting Estimates
UK accounting standards require that the Group adopt the accounting
policies and estimation techniques that the Directors believe are most
appropriate in the circumstances for the purpose of giving a true and
fair view of the Group’s state of affairs, profit and cash flows. However,
different policies, estimation techniques and assumptions in critical
areas could lead to materially different results. The accounting policies
and estimation techniques to be used in the 2005 consolidated
accounts will be impacted by the conversion to International Financial
Reporting Standards, as discussed on pages 129 and 130.
The following are estimates which are considered to be the most
complex and involve significant amounts of management valuation
judgements, often in areas which are inherently uncertain.
Bad and Doubtful Debts
The estimation of potential credit losses is inherently uncertain and
depends upon many factors, including general economic conditions,
changes in individual customer’s circumstances, structural changes
within industries that alter competitive positions, and other external
factors such as legal and regulatory requirements and other
governmental policy changes.
Specific provisions are raised when the Group considers that the
creditworthiness of a borrower has deteriorated such that the recovery
of the whole or part of an outstanding advance is in serious doubt.
For larger accounts this is usually done on an individual basis and all
relevant considerations that have a bearing on the expected future
cash flows are taken into account, for example, the business prospects
for the customer, the realisable value of collateral, the Group’s position
relative to other claimants, the reliability of customer information and
the likely cost and duration of the work-out process. Subjective
judgements are made in this process that may vary from person to
person and team to team. Furthermore, judgements change with time
as new information becomes available or as workout strategies evolve,
resulting in frequent revisions to the specific provisions as individual
decisions are taken, case by case.
Within the retail and small businesses portfolios which are comprised
of large numbers of small homogeneous assets, statistical techniques
are used to raise specific provisions on a portfolio basis, based on
historical recovery rates. These statistical analyses use as primary
inputs the extent to which accounts in the portfolio are in arrears and
historical information on the eventual losses encountered from such
delinquent portfolios. There are many such models in use, each
tailored to a product, line of business or customer category. The
models are updated from time to time. However, experience suggests
that the models are reliable and stable, stemming from the very large
numbers of accounts from which the model building information is
drawn. These models do not contain judgemental inputs, but
judgement and knowledge is needed in selecting the statistical
methods to use when the models are developed or revised.
General provisions are raised to cover losses which are known from
previous historical experience to be present in loans and advances
at the balance sheet date, but which have not yet been specifically
identified. These provisions are adjusted at least half-yearly by an
appropriate charge or release of general provision based on statistical
analyses, other information about customers and judgements by
management and the Board.
In outline, the statistical analyses are performed on a portfolio basis
as follows: For larger accounts, gradings are used to rate the credit
quality of borrowers. Each grade corresponds to an expected default
frequency and is calculated by using statistical methodologies and
expert judgement. To ensure that the result is as accurate as possible,
several different sources may be used to rate a borrower (e.g. internal
model, external vendor model, ratings by credit rating agencies and
the knowledge and experience of the credit officers). The general
provision also takes into account the expected severity of loss at
default, i.e. the amount outstanding when default occurs that is not
subsequently recovered. Recovery is usually substantial and depends,
for example, on the level of security held in relation to each loan, and
the Bank’s position relative to other claimants. Also taken into account
is the expected exposure at default. Both loss given default and
exposure at default are statistically derived values.
For the large numbers of retail accounts, the approach is in principle
the same as for the corporate and business accounts. However,
individual consideration of accounts is not practicable, and statistical
methodologies are used to assess the loss in portfolios of accounts.
The general provision also includes a specifically identified element
to cover country transfer risk calculated on a basis consistent with the
overall general provision calculation.
In establishing the level of the general provision, management
judgement is applied to the results of the statistical analyses. This is
applied at business level where management takes account of the
quality of the statistical analyses and the relevance of historical data
used in the analyses to individual or groups of customers, current
information, and the general economic and environmental factors
mentioned above.
Further information on credit risk provisioning is set out on page 57.
Fair Value of Financial Instruments
Some of the Bank’s financial instruments are carried at fair value,
including derivatives and debt securities held for trading purposes.
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between
willing parties, other than in a forced or liquidation sale.
Financial instruments entered into as trading transactions, together
with any associated hedging, are measured at fair value and the
resultant profits and losses are included in dealing profits, along
with interest and dividends arising from long and short positions
and funding costs relating to trading activities. Assets and liabilities
resulting from gains and losses on derivative and foreign exchange
contracts are reported gross in other assets or liabilities, reduced by
the effects of qualifying netting agreements with counterparties.
Financial review
Critical accounting estimates