TD Bank 2014 Annual Report Download - page 134

TD BANK GROUP ANNUAL REPORT 2014 FINANCIAL RESULTS132
Compound instruments are comprised of both liability and equity
components in accordance with the substance of the contractual
arrangement. At inception, the fair value of the liability component is
initially measured with any residual amount assigned to the equity
component. Transaction costs are allocated proportionately to the
liability and equity components.
Common or preferred shares held by the Bank are classified as
treasury shares in equity, and the cost of these shares is recorded as
a reduction in equity. Upon the sale of treasury shares, the difference
between the sale proceeds and the cost of the shares is recorded in
or against contributed surplus.
DERIVATIVES
Derivatives are instruments that derive their value from changes in
underlying interest rates, foreign exchange rates, credit spreads,
commodity prices, equities, or other financial or non-financial
measures. Such instruments include interest rate, foreign exchange,
equity, commodity, and credit derivative contracts. The Bank uses
these instruments for trading and non-trading purposes to manage the
risks associated with its funding and investment strategies. Derivatives
are carried at their fair value on the Consolidated Balance Sheet.
The notional amounts of derivatives are not recorded as assets or
liabilities as they represent the face amount of the contract to which a
rate or price is applied to determine the amount of cash flows to be
exchanged in accordance with the contract. Notional amounts do not
represent the potential gain or loss associated with the market risk nor
indicative of the credit risk associated with derivatives.
Derivatives Held for Trading Purposes
The Bank enters into trading derivative contracts to meet the needs
of its customers, to enter into trading positions primarily to provide
liquidity and market-making related activities, and in certain cases,
to manage risks related to its trading portfolio. The realized and
unrealized gains or losses on trading derivatives are recognized
immediately in trading income (losses).
Derivatives Held for Non-trading Purposes
Non-trading derivatives are primarily used to manage the market,
interest rate, and foreign exchange risks of the Bank’s traditional
banking activities. When derivatives are held for non-trading purposes
and when the transactions meet the hedge accounting requirements
of
IAS 39, Financial Instruments: Recognition and Measurement (IAS 39),
they are classified by the Bank as non-trading derivatives and receive
hedge accounting treatment, as appropriate. Certain derivative
instruments that are held for economic hedging purposes, and do
not meet the hedge accounting requirements of IAS 39, are also
classified as non-trading derivatives with the change in fair value of
these derivatives recognized in non-interest income.
Hedging Relationships
Hedge Accounting
At the inception of a hedging relationship, the Bank documents the
relationship between the hedging instrument and the hedged item, its
risk management objective, and its strategy for undertaking the hedge.
The Bank also requires a documented assessment, both at hedge
inception and on an ongoing basis, of whether or not the derivatives
that are used in hedging relationships are highly effective in offsetting
the changes attributable to the hedged risks in the fair values or cash
flows of the hedged items. In order to be considered effective, the
hedging instrument and the hedged item must be highly and inversely
correlated such that the changes in the fair value of the hedging
instrument will substantially offset the effects of the hedged exposure
to the Bank throughout the term of the hedging relationship. If a
hedging relationship becomes ineffective, it no longer qualifies for
hedge accounting and any subsequent change in the fair value of the
hedging instrument is recognized in Non-interest income on the
Consolidated Statement of Income.
Customers’ Liability under Acceptances
Acceptances represent a form of negotiable short-term debt issued by
customers, which the Bank guarantees for a fee. Revenue is recognized
on an accrual basis. The potential obligation of the Bank is reported as
a liability under Acceptances on the Consolidated Balance Sheet. The
Bank’s recourse against the customer in the event of a call on any of
these commitments is reported as an asset of the same amount.
Financial Liabilities Carried at Amortized Cost
Deposits
Deposits, other than deposits included in a trading portfolio, are
accounted for at amortized cost. Accrued interest on deposits,
calculated using the EIRM, is included in Other liabilities on the
Consolidated Balance Sheet.
Subordinated Notes and Debentures
Subordinated notes and debentures are initially recognized at fair value
and subsequently accounted for at amortized cost. Interest expense,
including capitalized transaction costs, is recognized on an accrual
basis using the EIRM.
Guarantees
The Bank issues guarantee contracts that require payments to be made
to guaranteed parties based on: (1) changes in the underlying economic
characteristics relating to an asset or liability of the guaranteed party;
(2) failure of another party to perform under an obligating agreement;
or (3) failure of another third party to pay its indebtedness when due.
Financial standby letters of credit are financial guarantees that repre-
sent irrevocable assurances that the Bank will make payments in the
event that a customer cannot meet its obligations to third parties and
they carry the same credit risk, recourse, and collateral security require-
ments as loans extended to customers. Performance standby letters of
credit are considered non-financial guarantees as payment does not
depend on the occurrence of a credit event and is generally related to
a non-financial trigger event. Guarantees, including financial and
performance standby letters of credit, are initially measured and
recorded at their fair value. The fair value of a guarantee liability at
initial recognition is normally equal to the present value of the guaran-
tee fees received over the life of contract. The Bank’s release from risk
is recognized over the term of the guarantee using a systematic and
rational amortization method.
If a guarantee meets the definition of a derivative, it is carried at fair
value on the Consolidated Balance Sheet and reported as a derivative
asset or derivative liability at fair value. Guarantees that are considered
derivatives are a type of credit derivative which are over-the-counter
(OTC) contracts designed to transfer the credit risk in an underlying
financial instrument from one counterparty to another.
SHARE CAPITAL
The Bank classifies financial instruments that it issues as either financial
liabilities, equity instruments, or compound instruments.
Issued instruments that are mandatorily redeemable or convertible
into a variable number of the Bank’s common shares at the holder’s
option are classified as liabilities on the Consolidated Balance Sheet.
Dividend or interest payments on these instruments are recognized in
interest expense in the Consolidated Statement of Income.
Issued instruments are classified as equity when there is no contrac-
tual obligation to transfer cash or other financial assets. Further, issued
instruments that are not mandatorily redeemable or that are not
convertible into a variable number of the Bank’s common shares at the
holder’s option, are classified as equity and presented in share capital.
Incremental costs directly attributable to the issue of equity instruments
are included in equity as a deduction from the proceeds, net of tax.
Dividend payments on these instruments are recognized as a reduction
in equity.