Methodological Recommendations on Accounting for Changes in Accounting Estimates, Changes in Accounting Policies, and Corrections of Fundamental Errors in Financial Statements of Banks Regulated by the National Bank of the Kyrgyz Republic

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Date of creation: 2018-08-23

APPROVED

by the resolution of the Supervisory Committee of the NBKR

No. 22/4 dated 08.09.2004

Methodological Recommendations on Accounting for Changes

in Accounting Estimates, Changes in Accounting Policies

and Corrections of Fundamental Errors in Financial Statements

of Commercial Banks and Financial-Credit Organizations,

Regulated by the National Bank of the Kyrgyz Republic

(Changes and additions were approved by resolutions of the Supervisory Committee

No. 53/2 dated 24.12.2012, No. 22/2 dated 29.06.2017)

I. General Provisions

1.1.

These Methodological Recommendations define the procedure for accounting for changes in accounting estimates, changes in accounting policies, and corrections of fundamental errors in the financial statements of commercial banks, the State Development Bank of the Kyrgyz Republic, and other financial-credit organizations of the Kyrgyz Republic regulated by the National Bank of the Kyrgyz Republic (hereinafter - Banks), and correspond to International Financial Reporting Standards (IFRS).

In developing these recommendations, IAS 8 "Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policy" was used.

II. Definitions

2.1. Financial Statements

– a structured representation of information about the financial position and operations conducted by the bank, useful to a wide range of users in making economic decisions.

2.2. Accounting

– a system for collecting, measuring, registering, processing, and transmitting information about the bank's assets, liabilities, equity, income, and expenses, through financial reports, for making informed decisions.

2.3. Fundamental Errors

– errors identified in the current period of such significance that the financial statements for one or more prior periods can no longer be considered reliable at the time of their issuance.

2.4. Accounting Policy

– the specific principles, methods, procedures, rules, and practices adopted by the bank for the preparation and presentation of financial statements.

2.5. Accounting Estimate

– a professional judgment based on the most current and available information. A reliable accounting estimate ensures compliance with qualitative characteristics in the preparation of financial statements.

2.6. Comparative Information

– accounting data for the previous reporting period presented in the financial statements of the current period to ensure comparability of accounting data.

III. Changes in Accounting Estimates

3.1. An accounting estimate is an approximation that may need revision as additional information becomes available.

3.2. An accounting estimate may be revised if the circumstances on which it was based change (as a result of new information, accumulation of experience, or subsequent events).

3.3. The amount of adjustment resulting from a change in accounting estimate shall be included in net profit/loss:

• in the current period, if the change affects only that period;

• in the current and future periods, if the change affects the current and subsequent reporting periods.

3.4. The amount of adjustment resulting from a change in accounting estimate shall be included in the same line items in the income statement in which the estimate was previously accounted for.

3.5. The nature and amount of changes in accounting estimates that have a significant impact on financial statements in the current period, or whose significant impact is expected in subsequent periods, must be disclosed. If it is practically impossible to quantify the impact, information about this must also be disclosed.

IV. Fundamental Errors

4.1. When correcting a fundamental error, financial statements, including comparative information for the prior period, shall be presented as if the fundamental error had been corrected in the period in which it was committed.

4.2. The amount of correction of a fundamental error, which relates to each of the periods presented in the financial statements (current and prior), is included in net profit/loss for the corresponding period.

4.3. The amount of correction of a fundamental error, which relates to prior periods, shall be presented in the financial statements by adjusting the opening balance of retained earnings of the corresponding period.

4.4. Information for periods prior to those presented in the financial statements is also restated.

4.5. Restating comparative information does not result in the correction of financial statements that were approved by shareholders and accounted for by regulatory authorities.

4.6. When correcting a fundamental error in financial statements, the following information must be disclosed:

• the nature of the fundamental error;

• the amount of correction for the current and previous reporting periods;

• the amount of correction relating to periods prior to those included in the financial statements;

• the fact of restating comparative information or a statement of practical impossibility of such restatement.

V. Changes in Accounting Policy

5.1. In accordance with the principle of consistency, the adopted accounting policy must be applied consistently by the bank from period to period.

Accounting policy should only be changed when required by legislation or financial reporting standards, or when the change will lead to an improved reflection of events and transactions in the bank's financial statements. Improvement in the quality of reflection of events and transactions in financial statements occurs when the application of a new accounting policy leads to the presentation of more relevant and reliable information about the bank's financial position, performance, or cash flows.

5.2. The following actions are not considered changes in accounting policy:

adoption of accounting policy for events and transactions that are substantially different from previously occurring events and transactions;

adoption of a new accounting policy for events and transactions that have not occurred previously or were not material.

5.3. A change in accounting policy is applied retrospectively or prospectively.

The retrospective approach involves applying the new accounting policy to events and transactions as if this policy had always been used. When using this approach, the new accounting policy is applied to events and transactions from the moment such items arose.

The prospective approach means that the new accounting policy is applied to events and transactions occurring after the date of change. No adjustments are made for prior periods, and current account balances are not restated. When using this approach, the new accounting policy is applied to existing balances from the date of its implementation.

5.4. A change in accounting policy shall be applied retrospectively if the amount of any cumulative adjustment relating to prior periods can be sufficiently determined.

Financial statements, including comparative information for the prior period, shall be presented as if the new accounting policy had always been used.

5.5. The amount of adjustment resulting from a change in accounting policy, which relates to each of the periods presented in the financial statements (current and prior), is included in net profit/loss for the corresponding period.

5.6. The amount of adjustment resulting from a change in accounting policy, which relates to prior periods, shall be presented in the financial statements by adjusting the opening balance of retained earnings of the corresponding period.

5.7. Information for periods prior to those presented in the financial statements is also restated.

5.8. Restating comparative information does not result in the correction of financial statements that were approved by shareholders and accounted for by regulatory authorities.

5.9. A change in accounting policy shall be applied prospectively if the amount of adjustment to the opening balance of retained earnings for the period, relating to prior periods, cannot be reasonably determined. The application of this method must be justified and documented.

5.10. When a change in accounting policy has a significant impact on the current or any prior period, or may have a significant impact on subsequent periods, the following information must be disclosed in the financial statements:

• the reason for the change in accounting policy;

• the approach used to reflect changes in accounting policy in financial statements;

• the amount of adjustment for the current and previous reporting periods;

• the amount of adjustment relating to periods prior to those included in the financial statements;

• information that comparative information was restated, or that it was practically impossible to do so.

Appendix

to the Methodological Recommendations on reflecting changes

in accounting estimates, changes in accounting policies

and corrections of fundamental errors in financial

statements of commercial banks and FCOs licensed by the National Bank

I. Changes in Accounting Estimates

Examples of changes in accounting estimates may include:

• change in the estimate of the amount of bad debts;

• change in the useful life of assets;

• change in the expected pattern of economic benefits from depreciable assets, etc.

The result of a change in accounting estimate may be included in income/expenses of the current period or of the current and future periods.

For example, a change in the estimate of the amount of bad debts (amount of Provision for Possible Losses on Loans - PPLLL) affects only the current period and is recognized immediately. A change in the useful life or expected pattern of economic benefits (amortization method) of a depreciable asset affects amortization expenses in the current period and in each subsequent period of the remaining useful life of the asset.

Example 1: The Bank acquired a fixed asset costing 100,000 som. At the time of acquisition, the useful life of the asset was estimated at 10 years, and the residual value at the end of the useful life was 0 som. After 4 years, the useful life of the fixed asset was revised and a new remaining useful life of 3 years was determined. For depreciation, the bank used the straight-line method and by the time of the revision had accrued depreciation in the amount of 40,000 som. Thus, the new amount of annual depreciation charges became (100,000 – 40,000)/3 = 20,000 som.

In accordance with the requirements of the policy, revision of an accounting estimate does not result in the correction of previously recognized accounting data in the financial statements. A change in accounting estimate affects only the current and future periods. Therefore, from the date of revision of the useful life of the asset, for the next 3 years, the bank will annually accrue depreciation in the amount of 20,000 som.

II. Fundamental Errors

An example of a fundamental error may be

the inclusion in the financial report of the previous period of a significant amount of receivables under falsified contracts, which significantly distorts reported profit.

At the same time, for example, a loss recognized as a result of

extraordinary

circumstances that could not be reliably estimated earlier is not a correction of a fundamental error. This adjustment is the result of a change in accounting estimate, which, unlike a fundamental error, is an approximation and needs revision upon receipt of additional information.

Example 2: During 2003, Bank A discovered that in 2002, interest income on securities, due to the use of an incorrect formula for calculating discount amortization, was overstated by 7 million som. As a result, net profit was overstated by 16.3%. The significance of the error committed allowed it to be classified as fundamental.

The accounting books of Bank A for 2003 contained the following data (million som):

Interest Income

415

Interest Expenses

(323)

Other Income

130

Other Expenses

(152)

Income Statement of Bank A for 2002 (million som):

Interest Income

353

Interest Expenses

(290)

Other Income

132

Other Expenses

(145)

Profit before income tax

50

Income tax (rate 30%)

15

Net Profit

35

Retained earnings in 2002 amounted to 70 million som at the beginning of the period and 105 million som at the end of the period.

Income tax is equal to 30% (assume that this adjustment will be taken into account by tax authorities when calculating the tax payable in 2003).

Correction of the fundamental error:

1. Accounting entries:

Dr "Retained Earnings" 7,000,000

Cr "Premium/Discount on Securities" 7,000,000

for the amount of adjustment to retained earnings

Dr "Prepaid Taxes" 2,100,000

Cr "Retained Earnings" 2,100,000

for the amount of deferred income tax (7*0.3)

2. Extracts from financial statements for 2003:

Income Statement for 2003

Table 1 (million som)

Items

2003

2002 Restated

Interest Income

415

346=(353-7)

Interest Expenses

(323)

(290)

Other Income

130

132

Other Expenses

(152)

(145)

Profit before income tax

70

43

Income tax (rate 30%)

21

12.9

Net Profit

49

30.1

Statement of Retained Earnings for 2003

Table 2 (million som)

Items

2003

2002 Restated

Retained earnings balance at the beginning of the reporting period

105

70

Correction of fundamental error net of income tax (7*0.7=4.9)

(4.9)

Restated retained earnings balance at the beginning of the period

100.1

70

Net profit for the reporting period (Table 1)

49

30.1

Retained earnings balance at the end of the reporting period

149.1

100.1

Disclosures to the financial statements of the bank for 2003

A fundamental error was identified in the reporting period, as a result of which interest income on securities in 2002, due to the use of an incorrect formula for calculating discount amortization, was overstated by 7 million som. As a result, net profit in the 2002 report was overstated by 16.3%.

Financial statements for 2003 were adjusted for the amount of the fundamental error, and the correct amount of net profit for 2002 under the restated version was recognized as 30.1 million som. The opening balance of retained earnings in the financial statements for 2003 was reduced by 4.9 million som and stated at 100.1 million som.

Thus, the retained earnings balance at the end of 2003 in the amount of 149.1 million som is shown with an adjustment for the amount of the recognized fundamental error.

III. Changes in Accounting Policy

Example 3: In 2003, Bank B changed its accounting policy regarding the reflection of revaluation results of securities available for sale, choosing the preferred method, in accordance with which revaluation results are reflected not on equity accounts, but as revaluation profits/losses.

Calculations showed that this change led to an increase in expenses in periods prior to 2002 by 25 million som, in 2002 by 12 million som, and in 2003 by 4 million som.

The accounting books of Bank B for 2003 contained the following data (million som):

Interest Income

286

Interest Expenses

(263)

Other Income

109

Other Expenses

(112)

Income Statement of Bank B for 2002 (million som):

Interest Income

278

Interest Expenses

(253)

Other Income

126

Other Expenses

(109)

Profit before income tax

42

Income tax (rate 30%)

12.6

Net Profit

29.4

Retained earnings in 2002 amounted to 44 million som at the beginning of the period and 73.4 million som at the end of the period.

Income tax is equal to 30% (assume that this adjustment will be taken into account by tax authorities when calculating the tax payable in 2003).

Adjustment of financial statements in connection with the change in accounting policy:

1. Accounting entries:

Dr "Retained Earnings" 37,000,000

Cr "Reserve for Revaluation of Securities Available for Sale" 37,000,000

for the amount of adjustment to retained earnings (25+12)

Dr "Prepaid Taxes" 11,100,000

Cr "Retained Earnings" 11,100,000

for the amount of deferred income tax (37*0.3)

2. Extracts from financial statements for 2003:

Income Statement for 2003

Table 3 (million som)

2003

2002 Restated

Interest Income

286

278

Interest Expenses

(263)

(253)

Other Income

109

126

Other Expenses

(112)

(121)=109+12

Profit before income tax

20

30

Income tax (rate 30%)

6

9

Net Profit

14

21

Statement of Retained Earnings for 2003

Table 4 (million som)

2003

2002 Restated

Retained earnings balance at the beginning of the reporting period

73.4

44

Change in accounting policy regarding recognition of revaluation results on securities net of income tax (25+12)0.7=25.9 million som for 2002 and 250.7=17.5 million som for 2001

(25.9)

(17.5)

Restated retained earnings balance at the beginning of the period

47.5

26.5

Net profit for the reporting period (Table 3)

14

21

Retained earnings balance at the end of the reporting period

61.5

47.5

Disclosures to the financial statements of the bank for 2003

During 2003, the bank changed its accounting policy regarding the reflection of revaluation results of securities available for sale, choosing the preferred method, in accordance with the requirements of which, revaluation results are reflected directly as revaluation profits/losses, and not in the reserve on equity accounts.

This change is accounted for retrospectively. Comparative reports for 2002 were restated to bring them into compliance with the changed policy. The change in accounting policy led to an increase in revaluation losses on securities by 4 million som in 2003 and by 12 million som in 2002. Retained earnings at the beginning of 2002 decreased by 17.5 million som (taking into account the tax amount), which is the amount of adjustment relating to periods preceding 2002.

IV.

Adjustment of Financial Statements in Connection with Changes in the Amount of PPLLL

Changes in the size of PPLLL on the loan portfolio and assets carrying credit risk are generally a change in accounting estimate.

However, a change in accounting estimate in this case implies that the required level of PPLLL could not be reliably estimated earlier. This adjustment is the result of a change in accounting estimate, which, unlike a fundamental error, is an approximation and needs revision upon receipt of additional information.

In cases where it is obvious that at an early reporting date the size of PPLLL, according to information available to the bank, was determined incorrectly, the adjustment of the PPLLL size can be considered a fundamental error.

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