On initial recognition financial assets are classified in one of the following categories according to the type of instrument and the purpose of the investment:
x financial assets held for trading and derivatives carried at fair value with changes in value recognised in profit or loss x financial instruments designated as at fair value with changes
in value recognised in profit or loss
x financial derivatives designated as hedging instruments x loans and receivables, carried at amortised cost x held-to-maturity investments, carried at amortised cost On initial recognition financial liabilities are classified in one of the following categories:
x financial liabilities held for trading and derivatives carried at fair value with changes in value recognised in profit or loss x financial liabilities designated as at fair value with changes
in value recognised in profit or loss
x financial derivatives designated as hedging instruments x other financial liabilities carried at amortised cost x issued financial guarantees
Guidelines for classification in the various portfolios of the DnB NOR Group are given below.
Financial assets and liabilities in the trading portfolio
Financial instruments in the trading portfolio are recorded at fair value excluding transaction costs. Fair value will normally be the transaction price, unless a different value can be justified based on observable market transactions. See the paragraph below on determining fair value at subsequent valuation.
Changes in value of the financial instruments are included under "Net gains on financial instruments at fair value" in the income statement. Interest income and expenses on fixed-income securities are included under "Net interest income" using the effective interest method.
Changes in value of financial instruments within life insurance are included under "Net gains on assets in Vital".
Financial derivatives are presented as an asset if the market value is positive and as a liability if there is a negative market
value.
The trading portfolio mainly includes financial assets in DnB NOR Markets and financial derivatives excluding derivatives used for hedging. In addition, the portfolio includes securities issued and deposits where instruments are used actively in interest rate and liquidity management and have a short remaining maturity.
Financial assets and liabilities designated as at fair value with changes in value recognised in profit or loss
Financial instruments in the portfolio are recorded at fair value excluding transaction costs. Fair value will normally be the transaction price, unless a different value can be justified based on observable market transactions. See the paragraph below on determining fair value at subsequent valuation. Financial instruments are classified in this category if one of the following criteria is fulfilled:
x The classification eliminates or significantly reduces
measurement inconsistency that would otherwise have arisen from measuring financial assets or liabilities or recognising the gain and losses on them on different bases
x The financial instruments are part of a portfolio that is managed and evaluated on a fair value basis, in accordance with a documented risk management or investment strategy. Changes in value of the financial instruments are included under "Net gains on financial instruments at fair value" in the income statement. Interest income and expenses relating to loans designated as at fair value and other fixed-income securities are included under "Net interest income".
Changes in value of financial instruments within life insurance are included under "Net gains on assets in Vital".
These portfolios include commercial paper and bonds, equities, fixed-rate loans in Norwegian kroner, financial assets – customers bearing the risk, current financial assets within life insurance, fixed-rate securities issued in Norwegian kroner, such as index- linked bonds and equity-linked bank deposits and other fixed-rate deposits in Norwegian kroner.
Financial derivatives designated as hedging instruments
See item 8 Hedge accounting.
Loans and receivables carried at amortised cost
Loans and receivables carried at amortised cost are recorded at the transaction price plus direct transaction costs. Recording and subsequent measurement follow the effective interest method. The effective interest method is described under item 6 Recognition in the income statement.
Upon subsequent measurement, amortised cost is set at the net present value of contractual cash flows based on the expected life of the financial instrument, discounted by the effective interest rate.
Interest income on financial instruments classified as lending is included under "Net interest income" using the effective interest method.
A decrease in value on the balance sheet date based on objective indications of impairment for loans valued at amortised cost and in the portfolios of fixed-rate loans measured at fair value, are reflected in "Write-downs on loans and guarantees".
Other changes in value of the portfolios of fixed-rate loans measured at fair value, and changes in value of loans included in the trading portfolio are included under "Net gains on financial instruments at fair value".
Held-to-maturity investments carried at amortised cost
Held-to-maturity investments are carried at amortised cost and recorded at the transaction price plus direct transaction costs. Recording and subsequent measurement follow the effective interest method. The effective interest method is described under item 6 Recognition in the income statement.
Upon subsequent measurement, amortised cost is set at the net present value of contractual cash flows based on the expected life of the financial instrument, discounted by the effective interest rate.
Interest income relating to the instruments is included under "Net interest income".
In 2008, the Group reclassified the liquidity portfolio in DnB NOR Markets from a trading portfolio to the held–to-maturity category.
Other financial liabilities carried at amortised cost
Financial liabilities carried at amortised cost are recorded at the transaction price less direct transaction costs.
Interest expenses on such instruments are included under "Net interest income" using the effective interest method.
This category includes deposits from customers and credit institutions, commercial paper issued, bonds, subordinated loan capital and perpetual subordinated loan capital securities.
Issued financial guarantees
Contracts resulting in the Group having to reimburse the holder for a loss incurred because a specific debtor fails to make payment when due, are classified as issued financial guarantees.
On initial recognition, issued financial guarantees are recorded at the consideration received for the guarantee.
Issued financial guarantees are subsequently measured at the higher of the consideration received for the guarantee excluding any amortised amounts recorded in the income statement and the best estimate of the consideration due if the guarantee is honoured.
When issuing financial guarantees, the consideration for the guarantee is recorded under "Provisions" in the balance sheet. Except for individually identified impaired commitments, any changes in the carrying amount of financial guarantee contracts issued are recorded as "Net gains on financial instruments at fair value". Changes in the value of such guarantee contracts are recorded under "Net write-downs on loans and guarantees".
Reclassification
Non-derivative financial assets may be reclassified from the held- for-trading category to the held-to-maturity or available-for-sale categories according to specific rules if the financial asset is no longer held for sale or repurchase in the near term.
Equity instruments and fixed-income securities that have quoted prices in an active market can be reclassified only in rare and extraordinary circumstances.
Fixed-income securities that do not have quoted prices in an active market, may be reclassified from the held-for-trading category to the loans and receivables category if the Group has the intention and ability to hold the financial assets for the foreseeable future or until maturity. If, after the reclassification, the Group increases its estimates for future cash receipts as a result of increased recoverability of those cash receipts, the effect of the increase will be recognised as an adjustment to the effective interest rate from the date the estimate was changed.
The Group will consider reclassifications based on the individual financial instruments. The earliest reclassification date will be the date when the asset is reclassified out of the trading category. The fair value of the financial asset on the reclassification date will be
Accounting principles (continued)
the new acquisition cost or amortised cost.
In 2008 the Group reclassified the liquidity portfolio in DnB NOR Markets from fair value through profit or loss to the held– to-maturity category. No reclassifications were made in 2010.
Determination of fair value
Fair value is the amount for which an asset could be traded, or a liability settled, in a transaction between independent parties. Financial assets and liabilities are measured at bid or asking prices respectively. Derivatives which are carried net, are recorded at mid-market prices on the balance sheet date.
Instruments traded in an active market
With respect to instruments traded in an active market, quoted prices are used, obtained from a stock exchange, a broker or a price-setting agency.
A market is considered active if it is possible to obtain external, observable prices, exchange rates or interest rates and these prices represent actual and frequent market transactions.
Most of the DnB NOR Group's financial derivatives, e.g. forward currency contracts, forward rate agreements (FRAs), interest rate options, currency options, interest rate swaps and interest rate futures, are traded in an active market. In addition, some investments in equities and commercial paper and bonds are traded in active markets. If no prices are quoted for the instrument in its entirety, but for the components, it is decomposed and valued on the basis of quoted prices on the individual components. Transactions with customers which are not directly observable in the market, are measured based on trades in other comparable markets and may be adjusted by adding a margin or changing the credit risk.
Instruments not traded in an active market
Financial instruments not traded in an active market are valued according to different valuation techniques and are divided into two categories:
Valuation based on observable market data:
x recently observed transactions in the relevant instrument between informed, willing and independent parties
x instruments traded in an active market which are substantially similar to the instrument that is valued
x other valuation techniques where key parameters are based on observable market data.
Valuation based on other factors than observable market data: x estimated cash flows
x valuation of assets and liabilities in companies
x models where key parameters are not based on observable market data
x possible industry standards.
When using valuation techniques, values are adjusted for credit and liquidity risk. Valuations are based on pricing of risk for similar instruments.