Barclays 2008 Annual Report Download - page 43

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Business review
Barclays PLC Annual Report 2008 41
Financial review
Additional financial disclosure
Critical accounting estimates
The Group’s accounting policies are set out on pages 193 to 203. Certain of
these policies, as well as estimates made by management, are considered
to be important to an understanding of the Group’s financial condition
since they require management to make difficult, complex or subjective
judgements and estimates, some of which may relate to matters that are
inherently uncertain. The following accounting policies include estimates
which are particularly sensitive in terms of judgements and the extent to
which estimates are used. Other accounting policies involve significant
amounts of judgements and estimates, but the total amounts involved
are not significant to the financial statements. Management has
discussed the accounting policies and critical accounting estimates with
the Board Audit Committee.
Fair value of financial instruments
Some of the Group’s financial instruments are carried at fair value through
profit or loss such as those held for trading, designated by management
under the fair value option and non-cash flow hedging derivatives.
Other non-derivative financial assets may be designated as available
for sale. Available for sale financial investments are initially recognised at
fair value and are subsequently held at fair value. Gains and losses arising
from changes in fair value of such assets are included as a separate
component of equity. 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 net trading
income, 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 financial instruments held
for trading are reported gross in trading portfolio assets and liabilities
or derivative financial instruments, reduced by the effects of netting
agreements where there is an intention to settle net with counterparties.
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. Where a valuation model
is used to determine fair value, it makes maximum use of market inputs.
Financial instruments with a fair value based on observable inputs include
valuations determined by unadjusted quoted prices in an active market
and market standard pricing models that use observable inputs.
Financial instruments whose fair value is determined, at least in part,
using unobservable inputs are further categorised into Vanilla and Exotic
products as follows:
– Vanilla products are valued using simple models such as discounted
cash flow or Black Scholes models however, some of the inputs are
not observable.
– Exotic products are over-the-counter products that are relatively
bespoke, not commonly traded in the markets, and their valuation
comes from sophisticated mathematical models where some of the
inputs are not observable.
An analysis of financial instruments carried at fair value by valuation
technique, including the extent of valuations based on unobservable
inputs, together with a sensitivity analysis of valuations using
unobservable inputs is included in Note 50.
Allowances for loan impairment and other credit risk provisions
Allowances for loan impairment represent management’s estimate of the
losses incurred in the loan portfolios as at the balance sheet date. Changes
to the allowances for loan impairment and changes to the provisions for
undrawn contractually committed facilities and guarantees provided are
reported in the consolidated income statement as part of the impairment
charge. Provision is made for undrawn loan commitments and similar
facilities if it is probable that the facility will be drawn and result in
recognition of an asset at an amount less than the amount advanced.
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 £2,333m (2007: £1,605m) and amounts to 51% (2007: 70%) of the
total impairment charge on loans and advances in 2008.
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