Barclays 2007 Annual Report Download - page 66

Financial review
Critical accounting estimates
64 Barclays PLC Annual Report 2007
Within the retail and small businesses portfolios, which comprise large
numbers of small homogeneous assets with similar risk characteristics
where credit scoring techniques are generally used, statistical techniques
are used to calculate impairment allowances on a portfolio basis, based
on historical recovery rates and assumed emergence periods. 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. Judgement and knowledge is needed in selecting the statistical
methods to use when the models are developed or revised. The impairment
allowance reflected in the financial statements for these portfolios is
therefore considered to be reasonable and supportable. The impairment
charge reflected in the income statement for these portfolios is £1,605m
(2006: £1,809m) and amounts to 70% (2006: 87%) of the total
impairment charge on loans and advances in 2007.
For larger accounts, impairment allowances are calculated 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. The level of the
impairment allowance is the difference between the value of the
discounted expected future cash flows (discounted at the loan’s original
effective interest rate), and its carrying amount. Subjective judgements
are made in the calculation of future cash flows. Furthermore, judgements
change with time as new information becomes available or as work-out
strategies evolve, resulting in frequent revisions to the impairment
allowance as individual decisions are taken. Changes in these estimates
would result in a change in the allowances and have a direct impact on
the impairment charge. The impairment charge reflected in the financial
statements in relation to larger accounts is £701m (2006: £265m) or
30% (2006: 13%) of the total impairment charge on loans and advances
in 2007. Further information on impairment allowances is set out on
pages 100 to 101.
Goodwill
Management have to consider at least annually whether the current
carrying value of goodwill is impaired. The first step of the impairment
review process requires the identification of independent cash generating
units, by dividing the Group business into as many largely independent
income streams as is reasonably practicable. The goodwill is then allocated
to these independent units. The first element of this allocation is based on
the areas of the business expected to benefit from the synergies derived
from the acquisition. The second element reflects the allocation of the net
assets acquired and the difference between the consideration paid for
those net assets and their fair value. This allocation is reviewed following
business reorganisation. The carrying value of the unit, including the
allocated goodwill, is compared to its fair value to determine whether any
impairment exists. If the fair value of a unit is less than its carrying value,
goodwill will be impaired. Detailed calculations may need to be carried
out taking into consideration changes in the market in which a business
operates (e.g. competitive activity, regulatory change). In the absence
of readily available market price data this calculation is based upon
discounting expected pre-tax cash flows at a risk adjusted interest rate
appropriate to the operating unit, the determination of both of which
requires the exercise of judgement. The estimation of pre-tax cash flows
is sensitive to the periods for which detailed forecasts are available and
to assumptions regarding the long term sustainable cash flows. While
forecasts are compared with actual performance and external economic
data, expected cash flows naturally reflect management’s view of future
performance. The most significant amounts of goodwill relate to the Absa
and Woolwich acquisitions. The goodwill impairment testing performed
in 2007 indicated that none of the goodwill was impaired. Management
believes that reasonable changes in key assumptions used to determine
the recoverable amounts of Absa and Woolwich goodwill would not result
in impairment.
Intangible assets
Intangible assets that derive their value from contractual customer
relationships or that can be separated and sold and have a finite useful life
are amortised over their estimated useful life. Determining the estimated
useful life of these finite life intangible assets requires an analysis of
circumstances, and judgement by the Bank’s management. At each
balance sheet date, or more frequently when events or changes in
circumstances dictate, intangible assets are assessed for indications of
impairment. If indications are present, these assets are subject to an
impairment review. The impairment review comprises a comparison of the
carrying amount of the asset with its recoverable amount: the higher of
the assets’ or the cash-generating unit’s net selling price and its value in
use. Net selling price is calculated by reference to the amount at which the
asset could be disposed of in a binding sale agreement in an arms-length
transaction evidenced by an active market or recent transactions for
similar assets. Value in use is calculated by discounting the expected
future cash flows obtainable as a result of the asset’s continued use,
including those resulting from its ultimate disposal, at a market-based
discount rate on a pre-tax basis. The most significant amounts of
intangible assets relate to the Absa acquisition.
Retirement benefit obligations
The Group provides pension plans for employees in most parts of the
world. Arrangements for staff retirement benefits vary from country to
country and are made in accordance with local regulations and customs.
For defined contribution schemes, the pension cost recognised in the
profit and loss account represents the contributions payable to the
scheme. For defined benefit schemes, actuarial valuation of each of the
scheme’s obligations using the projected unit credit method and the fair
valuation of each of the scheme’s assets are performed annually in
accordance with the requirements of IAS 19.
The actuarial valuation is dependent upon a series of assumptions, the
key ones being interest rates, mortality, investment returns and inflation.
Mortality estimates are based on standard industry and national mortality
tables, adjusted where appropriate to reflect the Group’s own experience.
The returns on fixed interest investments are set to market yields at the
valuation date (less an allowance for risk) to ensure consistency with the
asset valuation. The returns on UK and overseas equities are based on the
long-term outlook for global equities at the calculation date having regard
to current market yields and dividend growth expectations. The inflation
assumption reflects long-term expectations of both earnings and retail
price inflation.
The difference between the fair value of the plan assets and the present
value of the defined benefit obligation at the balance sheet date, adjusted
for any historic unrecognised actuarial gains or losses and past service
cost, is recognised as a liability in the balance sheet. An asset arising, for
example, as a result of past over-funding or the performance of the plan
investments, is recognised to the extent that it does not exceed the
present value of future contribution holidays or refunds of contributions.
To the extent that any unrecognised gains or losses at the start of the
measurement year in relation to any individual defined benefit scheme
exceed 10% of the greater of the fair value of the scheme assets and the
defined benefit obligation for that scheme, a proportion of the excess is
recognised in the income statement.
The Group’s IAS 19 pension surplus across all pension and post-retirement
schemes as at 31st December 2007 was a surplus of £393m (2006:
£817m deficit). This comprises net recognised liabilities of £1,501m
(2006: £1,719m) and unrecognised actuarial gains of £1,894m (2006:
£902m). The net recognised liabilities comprises retirement benefit
liabilities of £1,537m (2006: £1,807m) relating to schemes that are in
deficit, and assets of £36m (2006: £88m) relating to schemes that are in
surplus. The Group’s IAS 19 pension surplus in respect of the main UK
scheme as at 31st December 2007 was £668m (2006: £495m deficit).
The estimated actuarial funding position of the main UK pension scheme
as at 31st December 2007, estimated from the triennial valuation in 2004,
was a surplus of £1,200m (2006: £1,300m). Cash contributions to the
main UK scheme were £355m (2006: £351m).
Further information on retirement benefit obligations, including
assumptions is set out in Note 30 to the accounts.