For the year ended 31 December 2010
Standards and interpretations issued but not yet effective continued
The following standards and interpretations which have been issued but not yet effective are not considered relevant to the CFS Group’s operations: • Revised IFRS 1 (First Time Adoption of International Financial Reporting Standards);
• Amended IFRS 5 (Non-Current Assets Held for Sale and Discontinued Operations); and • IFRIC 18 (Transfer of Assets from Customers).
Accounting date
The financial statements are made up for the year to 31 December 2010 and as such are headed 2010. The 2009 figures relate to 51 weeks to 31 December 2009 and as this is virtually coterminous with the calendar year, the 2009 figures are headed 2009.
Significant accounting policies
The accounting policies set out below have been applied consistently to all periods presented in these financial statements.
(a) Financial instruments (excluding derivatives)
The CFS Group classifies its financial assets (excluding derivatives) as either: • loans and receivables;
• available for sale; or
• financial assets at fair value through income statement.
i) Loans and receivables
Loans and receivables to customers and banks (except for specific banking assets designated at fair value through income statement) are measured at amortised cost using the effective interest method less impairment provision for incurred losses.
Impairment provisions are raised when objective evidence exists that an impairment loss has been incurred. The amount of the loss is the difference between:
• asset’s carrying amount; and
• present value of estimated future cash flows (discounted at the asset’s original or variable interest rate).
The amount of the impairment loss is recognised immediately through the income statement and a corresponding reduction in the value of the financial asset is recognised through the use of an allowance account.
The written down value of the impaired loan is compounded back to the new realisable balance over time using the original effective interest rate. This is reported through interest within the consolidated income statement and represents the unwind of the discount.
A write off is made when all or part of a claim is deemed uncollectible or forgiven. Write offs are charged against previously established provisions for impairment or directly to the consolidated income statement.
Provisions are released at the point when it is deemed that following a subsequent event the risk of loss has reduced to the extent that a provision is no longer required.
ii) Available for sale
Available for sale financial assets are debt securities that are not held for trading and are intended to be held for an indefinite period of time. These are measured at fair value with movements in fair value recorded in equity as they occur, except for changes in value arising from impairment and foreign exchange gains and losses which are recognised in the income statement. On disposal, gains and losses recognised previously in equity are transferred to the income statement.
iii) Financial assets at fair value through income statement
These are either:
• acquired or incurred principally for the purpose of selling or repurchasing in the near term;
• part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short term profit taking; or
• upon initial recognition designated at fair value through income statement to eliminate or significantly reduce a measurement and recognition inconsistency, or where management specifically manages an asset or liability on that basis, i.e. capital bonds.
Significant accounting policies continued
(b) Derivative financial instruments
i) Derivatives used for asset and liability management purposes
Derivatives are used to hedge interest and exchange rate exposures related to non-trading positions. Instruments used for hedging purposes include swaps, forward rate agreements, futures, options and combinations of these instruments.
Derivative financial instruments are stated at fair value. The gain or loss on remeasurement to fair value is recognised immediately in the income statement except where derivatives qualify for cashflow hedge accounting.
Embedded derivatives: A derivative may be embedded in another instrument, known as the host contract. Where the economic characteristics and risk of an embedded derivative are not closely related to those of the host contract (and the host contract is not carried at fair value through income statement), the embedded derivative is separated from the host and held on balance sheet at fair value. Movements in fair value are posted to the income statement, whilst the host contract is accounted for according to the policy for that particular asset or liability.
Cashflow hedges: Where derivatives are designated as hedges of the exposure to variability in cash flows of a recognised asset or liability, or a highly probable forecast transaction, the portion of the fair value gain or loss on the derivative that is determined to be an effective hedge is recognised directly in equity. The ineffective part of any gain or loss is recognised in the income statement immediately.
Cumulative amounts recognised through equity are recycled to the income statement in the period in which the underlying hedged item matures and its associated gain or loss affects the income statement. When a hedging relationship is dedesignated or the hedge become ineffective, hedge accounting is discontinued. The cumulative unrealised gain or loss remaining in equity continues to be held in equity, and is transferred to the income statement when the forecast transaction is recognised.
Fair values are based on quoted market prices in active markets, and where these are not available, using valuation techniques such as discounted cashflow models.
ii) Derivatives used for trading purposes
Derivatives entered into for trading purposes include swaps, forward rate agreements, futures, options and combinations of these instruments. Derivatives used for trading purposes are measured at fair value and any gains or losses are included in the income statement. The use of derivatives and their sale to customers as risk management products is an integral part of the Bank’s trading activities.
(c) Investment property
Property held for long term rental yields that is not occupied by the CFS Group or property held for capital appreciation is classified as investment property. Investment property comprises freehold land and buildings. It is carried at fair value. Fair value is based on discounted expected future cash flows and is representative of current prices in an active market for similar properties in the same location and condition. No depreciation is provided on these properties. Any gain or loss arising from a change in fair value is recognised in the income statement.
If the CFS Group takes occupancy of an investment property it is reclassified as property, plant and equipment and its fair value at the date of reclassification becomes its cost for subsequent accounting purposes. Similarly, transfers to the investment property portfolio are made when occupancy by the CFS Group ceases and the property meets the criteria of an investment property under IAS 40. Prior to such a transfer the property is measured at fair value with any gain or loss recognised in the income statement.
(d) Revenue recognition
Interest income is recognised on an effective interest rate (EIR) basis, inclusive of directly attributable incremental transaction costs and fees, discounts, and premiums where appropriate. The EIR basis spreads the interest income over the expected life of the instrument.
Unless included in the effective interest calculation, fees and commissions are recognised on an accruals basis when the service has been provided. Fees and commissions payable to introducers in respect of obtaining lending business, where these are direct and incremental costs related to the issue of a financial instrument, are included in interest income as part of the effective interest rate.
Dividend income is recognised in the income statement when the right to receive payment is established. Rental income from investment properties is recognised in the income statement as it accrues.
General insurance gross written premiums comprise premiums receivable on those contracts which incepted during the financial year, irrespective of whether they relate in whole or in part to a later accounting period, together with any necessary adjustments to amounts reported in prior periods.
Gross written premiums are stated gross of commission and excludes any taxes or levies based on premiums including an estimate of the premiums receivable on those contracts which incepted prior to the year end but which has not been notified by the balance sheet date (‘pipeline premium’). When calculating pipeline premiums it is assumed, where appropriate, that options to renew contracts automatically will be exercised.
Long term business written premium is earned evenly over the period of the contract (usually 12 months). The treatment of outward reassurance premiums is analogous to gross written premiums.
For long term business, premiums are accounted for on a due basis. Should the amount due not be known, estimates are used. For unit linked business the due date for payment is taken as the date the related liability was established.
Significant accounting policies continued
(e) Contract classification
Contracts under which the CFS Group accepts significant insurance risk from another party (‘the policyholder’) by agreeing to compensate the policyholder or other beneficiary if a specified uncertain future event (the insured event) adversely affects the policyholder or other beneficiary are classified as insurance contracts. Contracts under which the transfer of insurance risk to the CFS Group from the policyholder is not significant are classified as investment contracts.
A contract that qualifies as an insurance contract remains as an insurance contract until all the risks and obligations are extinguished or expire.
However, an investment contract, classified as such on inception, could be reclassified as an insurance contract if it subsequently meets the definition provided above.
(f) Insurance contract provisions
General insurance claims outstanding comprise provisions representing the estimated ultimate cost of settling: • estimates on claims reported by the balance sheet date (‘claims reported’); and
• expected additional cost in excess of ‘claims reported’ for all claims occurring by the balance sheet date (‘claims incurred but not reported’). Provisions include attributable claims handling expenses.
Aggregate claims provisions are set at a level such that no adverse run off deviations are envisaged.
Adverse run off deviations, which are material in the context of the business as a whole, are separately disclosed.
Anticipated reinsurance recoveries, and estimates of salvage and subrogation recoveries, are disclosed separately within assets.
The long term business provision is calculated on an annual basis with regard to the principles laid down in Chapter 1.2 of the Prudential Sourcebook for Insurers (INSPRU). It principally comprises the realistic valuation of the Society’s liabilities under non-linked contracts by determining asset shares and the cost of options and guarantees and smoothing of investment returns for the major classes of with profit business. Major classes of non-profit business are valued using a net premium valuation method. Such provisioning methodology meets the liability adequacy test minimum requirements.
Although the directors consider the gross long term business provision and the related reinsurance is fairly stated on the basis of the information currently available, the eventual liability may vary as a result of subsequent information and events.
The provision, estimation techniques and assumptions are periodically reviewed with any changes in estimates reflected in the long term business technical account as they occur.
(g) Pension costs
Defined contribution basis
Subsequent to 5 April 2006, the CFS Group has accounted for pension costs on a defined contribution basis. Obligations for contributions are recognised as an expense in the income statement as incurred. With effect from 6 April 2006, the Company, along with other businesses within The Co-operative Group, has participated in The Co-operative Group Pension (Average Career Earnings) Scheme (the PACE scheme). This scheme is a defined benefit scheme, the assets of which are held in a separate fund administered by trustees. As a Groupwide pension scheme, the PACE scheme exposes the participating businesses to actuarial risks associated with the current and former employees of other group companies, with the result that there is no consistent and reliable basis for allocating liabilities, assets and costs to individual companies participating in the scheme. Therefore pension costs in respect of the scheme are accounted for on a defined contribution basis and recognised as an expense in the income statement as incurred.
Defined Benefit Scheme
The Britannia Pension Scheme was transferred to CFS Management Services Limited during August 2009. The heritage Britannia Pension Scheme is a hybrid scheme consisting of a closed defined benefit section and a defined contribution section. The funded element of the defined benefit section pays out pensions at retirement based on service and final pay for colleagues of Britannia Building Society (and for certain colleagues of subsidiary undertakings) who commenced employment prior to 1 September 2001. The unfunded element is a no charge supplementary arrangement for certain executive directors of Britannia Building Society. A full actuarial valuation was carried out at 5 April 2008 and updated to 31 December 2010 by a qualified independent actuary. Scheme assets are stated at their bid value at 31 December 2010. The service cost for the defined benefit section has been calculated using the projected unit method. As a result of the defined benefit section being closed to new entrants, its service cost as a percentage of members’ salaries will increase as the members approach retirement (but applied to a pensionable payroll which is expected to decrease over time).
(h) Significant items
Items which are material both by size and nature (i.e. outside of the normal operating activities of the CFS Group) are treated as significant items and disclosed separately on the face of the income statement.
(i) Profit based payments to members of The Co-operative Group
Members of The Co-operative Group receive a dividend based on their transactions with the Group and its subsidiaries. The profit based payments to members of The Co-operative Group represents a recharge of the proportion of the dividend payable to the ultimate parent company, The Co-operative Group Limited, where the underlying transaction is a CFS product. The recharge is recognised when the profit based payments are approved by The Co-operative Group Limited.