Reserve Bank of Australia Annual Report – 2014 Financial Statements Note 1 – Accounting Policies

Notes to and Forming Part of the Financial Statements – 30 June 2014
Reserve Bank of Australia and Controlled Entity

Note 1

The Reserve Bank of Australia (RBA) reports its consolidated financial statements in accordance with the Reserve Bank Act 1959 and the Commonwealth Authorities and Companies Act 1997 (CAC Act). These financial statements for the year ended 30 June 2014 have been prepared under Australian Accounting Standards (AAS), other accounting standards and accounting interpretations issued by the Australian Accounting Standards Board, in accordance with the Finance Minister's Orders for Financial Reporting (FMOs), which are issued pursuant to the CAC Act. In preparing these financial statements, the RBA has not ‘early adopted’ new accounting standards or amendments to current standards that will apply from 1 July 2014.

These financial statements and accompanying notes are a general purpose financial report prepared in accordance with relevant AAS. Elections of accounting treatment under AAS are noted appropriately. All amounts are expressed in Australian dollars, the functional and presentational currency of the RBA, unless another currency is indicated. The RBA is classified as a for-profit public sector entity for purposes of financial disclosure. Fair values are used to measure the RBA's major assets, including domestic and foreign marketable securities, gold and foreign currency, and property, plant and equipment. Revenue and expenses are brought to account on an accruals basis. All revenues, expenses and profits of the RBA are from ordinary activities.

These financial statements were approved and authorised for issue by a resolution of the Reserve Bank Board on 5 August 2014.

From 1 July 2014, the Public Governance, Performance and Accountability Act 2013 (PGPA Act) replaced the CAC Act. As a result, the RBA's consolidated financial statements will be prepared in accordance with the PGPA Act from the 2014/15 financial reporting period. The requirements of the PGPA Act are not expected to have a material impact on these financial disclosures.

(a) Consolidation and joint venture

The financial statements show information for the economic entity only; this reflects the consolidated results for the parent entity, the Reserve Bank of Australia, and its wholly owned subsidiary, Note Printing Australia Limited (NPA). The results of the parent entity do not differ materially from the economic entity and have therefore not been separately disclosed.

Note Printing Australia Limited

NPA was incorporated as a wholly owned subsidiary of the RBA on 1 July 1998, with an initial capital of $20.0 million. The RBA provided NPA with additional capital of $15.0 million in July 2008 and a further $25.0 million of capital in July 2009. NPA's total assets, liabilities and equity as at 30 June 2014 were $143.4 million, $22.0 million and $121.4 million respectively ($135.7 million, $23.4 million and $112.3 million as at 30 June 2013).

The assets, liabilities and results of NPA have been consolidated with the accounts of the parent entity in accordance with AASB 10 – Consolidated Financial Statements. All internal transactions and balances have been eliminated on consolidation. These transactions include items relating to the purchase of Australian banknotes, lease of premises and the provision of general administrative services.

Innovia Security Pty Ltd (formerly Securency International Pty Ltd)

In February 2013, the RBA completed the sale of its 50 per cent interest in Securency International Pty Ltd (Securency). The sale of the RBA's shares was made to a related entity of Innovia Films, a UK-based film manufacturer, which prior to the sale owned the other half share of Securency.

Under the terms of the sale agreement, additional payments arising from the sale may be made to the RBA in future periods, including if Innovia Security exceeds certain earnings benchmarks. In 2013/14, an amount of $7.3 million was received under these arrangements and recognised in the Statement of Comprehensive Income. The receipt is shown within the Gain on sale of Securency in Note 2. As the possibility of further additional payments is uncertain at the reporting date, they are not recognised in the financial statements.

Legal issues

Charges were laid against NPA and Securency and against former employees of these companies in the period between 2011 and 2013. These charges related to allegations that these employees and the companies had conspired to provide, or offered to provide, benefits to foreign public officials that were not legitimately due. The RBA has accounted for these matters in accordance with the relevant accounting standards. Specific information about these charges and the associated costs has not been disclosed in the notes to the accounts as these legal matters remain before the courts.

(b) Financial instruments

A financial instrument is defined as any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. The RBA's financial instruments are its Australian dollar securities, foreign government securities, repurchase agreements, deposits with the Bank for International Settlements (BIS) and other central banks, interest rate futures, foreign currency swap contracts, holdings in the Asian Bond Fund (ABF), gold loans, cash and cash equivalents, notes on issue, deposit liabilities and a shareholding in the BIS. The RBA accounts for its financial instruments in accordance with AASB 139 – Financial Instruments: Recognition and Measurement and reports these instruments under AASB 7 – Financial Instruments: Disclosures and AASB 13 – Fair Value Measurement.

The RBA brings its securities transactions and foreign exchange transactions to account on a trade date basis; that is, it recognises the effects of purchases and sales of securities in the financial statements on the date these transactions are arranged (not when they are settled). Bank deposits and repurchase agreements are brought to account on settlement date.

Financial assets

Australian dollar securities

The RBA holds Commonwealth Government Securities and securities issued by the central borrowing authorities of state and territory governments. These holdings include fixed coupon, inflation indexed and discount securities. It also holds under repurchase agreements: bank bills, certificates of deposit and debt securities of authorised deposit-taking institutions licensed in Australia; Australian dollar-denominated securities issued by foreign governments, foreign government agencies that have an explicit government guarantee (or equivalent support) and by certain highly rated supranational organisations; and eligible Australian dollar domestic residential and commercial mortgage backed securities, asset-backed commercial paper and corporate securities.

Domestic securities, except those held under repurchase agreements, are classified under AASB 139 as ‘at fair value through profit or loss’, as they are held for the purpose of conducting monetary policy and may be sold or lent, typically for short terms, under repurchase agreements. In accordance with this standard, the securities are valued at market bid prices on balance date; realised and unrealised gains or losses are taken to profit. Only realised gains and losses are available for distribution in accordance with the Reserve Bank Act (Note 1(g)). Interest earned on these securities is accrued over the term of the security and included as revenue in the Statement of Comprehensive Income.

Interest on fixed coupon securities is received biannually at the coupon rate and the principal is received at maturity. Inflation indexed bonds are coupon securities with the nominal value of the security indexed in line with movements in the Consumer Price Index each quarter until maturity; interest is paid quarterly. Interest earned on discount securities is the difference between the purchase cost and the face value of the security; this is accrued over the term the securities are held. The face value is received at maturity.

Foreign exchange

Foreign exchange holdings are invested mainly in securities issued by the governments of the United States, Germany, France, the Netherlands, Canada, Japan and China and deposits with the BIS and other central banks. The RBA transacts in interest rate futures and foreign currency swaps.

Foreign exchange translation

Assets and liabilities denominated in foreign currency are converted to Australian dollar equivalents at the relevant market bid or offer exchange rate ruling on balance date in accordance with AASB 121 – The Effects of Changes in Foreign Exchange Rates. Realised and unrealised gains or losses on foreign currency are taken to profit, but only realised gains and losses are available for distribution in accordance with the Reserve Bank Act (Note 1(g)). Interest revenue and expenses and revaluation gains and losses on foreign currency assets and liabilities are converted to Australian dollars using the relevant market exchange rate on the date they are accrued or recognised, in accordance with AASB 121.

Foreign government securities

Foreign government securities include coupon and discount securities. Coupon securities have biannual or annual interest payments depending on the currency and type of security; the principal is received at maturity. Interest earned on discount securities is the difference between the purchase cost and the face value of the security; this is accrued over the term the securities are held. The face value is received at maturity. Foreign securities, except those held under reverse repurchase agreements, are classified under AASB 139 as ‘at fair value through profit or loss’, as they are traded in managing the portfolio of foreign exchange reserves. In accordance with this standard, the securities are valued at market bid prices on balance date. Realised and unrealised gains or losses are taken to profit; only realised gains and losses are available for distribution in accordance with the Reserve Bank Act (Note 1(g)). Interest earned on securities is accrued as revenue in the Statement of Comprehensive Income.

Foreign deposits

Some foreign currency reserves are invested in deposits with the BIS and other central banks. Deposits are classified as ‘loans and receivables’ under AASB 139 and recorded at their face value, which is equivalent to their amortised cost using the effective interest method. Interest is accrued over the term of deposits and is received periodically or at maturity. Interest accrued but not received is included in Accrued interest (Note 15).

Repurchase agreements and reverse repurchase agreements

In carrying out operations to manage domestic liquidity and international reserves, the RBA enters into repurchase agreements and reverse repurchase agreements in domestic and foreign securities. A repurchase agreement involves the sale of securities with an undertaking to repurchase them on an agreed future date at an agreed price. A reverse repurchase agreement initially involves the purchase of securities with this transaction being reversed in the second leg. A reverse repurchase agreement provides the RBA's counterparties with cash for the term of the agreement and is an asset as the RBA records a cash receivable. Repurchase agreements result in cash being paid to the RBA and are treated as a liability reflecting the obligation to repay cash. The accounting treatment of this financial liability is discussed further below.

Securities purchased and contracted for sale under reverse repurchase agreements are classified under AASB 139 as ‘loans and receivables’, and valued at amortised cost, equivalent to fair value. The difference between the purchase and sale price is accrued over the term of the agreement and recognised as interest revenue.

RBA open repurchase agreements were introduced after the introduction of same-day settlement of Direct Entry payments in November 2013 to assist eligible financial institutions manage their liquidity. An RBA open repurchase agreement is an Australian dollar reverse repurchase agreement contracted without an agreed maturity date. The RBA accrues interest revenue daily on open repurchase agreements at the target cash rate.

Foreign currency swaps

The RBA uses foreign currency swaps with market counterparties to assist daily domestic liquidity management. A foreign currency swap is the simultaneous purchase and sale of one currency against another currency for specified maturities. The cash flows are the same as borrowing one currency for a certain period and lending another currency for the same period. The pricing of the swap therefore reflects the interest rates applicable to these money market transactions. Interest rates are implicit in the swap contract but interest itself is not paid or received.

Interest rate futures

The RBA uses interest rate futures contracts on overseas exchanges to manage interest rate risk on its portfolio of foreign securities. An interest rate futures contract is a contract to buy or sell a specific amount of securities for a specific price on a specific future date.

Interest rate futures positions are classified under AASB 139 as ‘at fair value through profit or loss’. Futures positions are marked to market on balance date at the relevant bid or offer price and valuation gains and losses taken to profit. Only realised gains and losses are available for distribution in accordance with the Reserve Bank Act (Note 1(g)).

Asian Bond Fund

The RBA invests in a number of non-Japan Asian debt markets through participation in the EMEAP Asian Bond Fund Initiative. The RBA has modest holdings in the US dollar-denominated fund, ABF1, and the local currency-denominated fund, ABF2. The two funds are classified under AASB 139 as ‘at fair value through profit or loss’. The funds are marked to market on balance date at the relevant unit price of the fund and valuation gains and losses taken to profit. Only realised gains and losses are available for distribution in accordance with the Reserve Bank Act (Note 1(g)).

Bank for International Settlements

Under AASB 139, the RBA's shareholding in the BIS is classified as ‘available for sale’ for accounting purposes. The shareholding is valued at fair value and revaluation gains and losses are transferred directly to the revaluation reserve for Shares in international financial institutions (Note 5). The fair value is estimated on the basis of BIS' net asset value, less a discount of 30 per cent. This discount is consistent with the decision of the Hague Arbitral Tribunal, and has been applied by the BIS to new central bank subscriptions of shares. When declared, dividends are recognised as revenue in the Statement of Comprehensive Income.

Financial liabilities

Deposit liabilities

Deposits are classified as financial liabilities under AASB 139. Deposits include deposits at call and term deposits. Deposit balances are shown at their amortised cost, which is equivalent to their face value. Interest is accrued over the term of deposits and is paid periodically or at maturity. Interest accrued but not paid is included in Other Liabilities (Note 10). Details of deposits are included in Note 9.

Australian notes on issue

Notes on issue are recorded at face value. Prior to 2005/06, the RBA periodically reduced its liability for note series that had ceased to be issued – to reflect the likelihood that the remaining notes on issue from these series would not be presented for redemption – and the gains were included in accounting profits. If the written down notes are subsequently presented, the RBA charges an expense against profits. In 2013/14, notes with a face value of $214,034 which had previously been written down were presented to the RBA and expensed ($208,491 in 2012/13).

The RBA pays interest on working balances of banknotes held by banks under cash distribution arrangements. Details of the interest expense are included in Note 4.

Costs related to the production of banknotes are included in General administrative expenses in Note 2.

Repurchase agreements

Securities sold and contracted for repurchase under repurchase agreements are classified under AASB 139 as ‘at fair value through profit or loss’, as these securities are held for trading, and reported on the balance sheet within the relevant investment portfolio. The counterpart obligation to repurchase the securities is reported in Other Liabilities (Note 10) at amortised cost; the difference between the sale and purchase price is accrued over the term of the agreement and recognised as interest expense.

(c) Gold

Gold holdings (including gold on loan to other institutions) are valued at the Australian dollar equivalent of the 3 pm fix in the London gold market on balance date. Revaluation gains and losses on gold are transferred to the gold revaluation reserve. The RBA lends gold to financial institutions participating in the gold market. As outlined in Note 1(b), gold loans are a financial instrument and the RBA accounts for them in accordance with AASB 139 and reports them under AASB 7.

(d) Property, plant and equipment

The RBA accounts for its property, plant and equipment at fair value in accordance with AASB 116 – Property, Plant and Equipment and AASB 13. Valuation gains (losses) are generally transferred to (from) the relevant revaluation reserve. Valuation losses which exceed the balance in the relevant asset revaluation reserve are expensed. Subsequent valuation gains are included in income if they offset prior losses that were treated as an expense.

Property

Formal valuations of all the RBA's Australian properties are conducted annually; overseas properties are formally valued on a triennial basis. Australian properties are valued by an independent valuer; overseas properties are valued by local independent valuers. The most recent independent valuation of overseas properties was at 30 June 2013. The RBA's properties are recognised in accordance with AASB 116 at fair value, which reflects the price that would be received from an orderly sale between market participants at the reporting date, having regard also to the highest and best use of an asset as required by AASB 13. Reflecting its specialised nature, the RBA's Business Resumption Site is valued at depreciated replacement cost. Annual depreciation is based on fair values and assessments of the remaining useful life of the relevant asset, as determined by the independent valuer.

Plant and equipment

Plant and equipment is valued by independent valuers on a triennial basis. The most recent independent valuation was at 30 June 2014. Between revaluations, plant and equipment is carried at the most recent valuation less any subsequent depreciation. Annual depreciation is based on fair values and the RBA's assessment of the remaining useful life of individual assets.

Depreciation rates for each class of depreciable assets are based on the following range of useful lives:

	Years
Buildings	20–50
Fit-out and furniture	5–13
Computer hardware	3–5
Office equipment	4–5
Motor vehicles	5
Plant	4–20

The RBA's assets are assessed for impairment at the end of each financial year. Where indications of impairment exist, the asset's recoverable amount is estimated and an impairment adjustment is made if the asset's recoverable amount is less than its carrying amount.

Details of annual net expenditure, revaluation adjustments and depreciation of buildings and plant and equipment are included in Note 8.

(e) Computer software

Computer software that is internally developed or purchased is accounted for in accordance with AASB 138 – Intangible Assets. Intangibles are recognised at cost less accumulated amortisation and impairment adjustments (if any), details of which are included in Note 7.

Amortisation of computer software is calculated on the basis of the estimated useful life of the relevant asset, which is usually for a period between three and five years. The useful life of core banking software may be up to 15 years reflecting the period over which future economic benefits are expected to be realised. Amortisation of computer software is disclosed in Note 2.

(f) Capital and Reserves

The capital of the Reserve Bank is established by the Reserve Bank Act.

The Reserve Bank Reserve Fund (RBRF) is also established by the Reserve Bank Act and is regarded essentially as capital. The RBRF is a permanent reserve maintained by the RBA to provide for events which are contingent and not foreseeable, including to cover losses from exceptionally large falls in the market value of the RBA's holdings of domestic and foreign securities that cannot be absorbed by its other resources. The RBRF also provides for other risks such as fraud and operational risk. In terms of the Reserve Bank Act, this reserve can be funded only by transfers from earnings available for distribution.

The Reserve Bank Board assesses the adequacy of the balance of the RBRF each year. In line with section 30 of the Reserve Bank Act, the Treasurer, after consultation with the Board, determines any amounts to be placed to the credit of the RBRF from earnings available for distribution (refer Note 1(g)). The Treasurer, after consulting the Board, has determined that in 2013/14 a sum of $8,800 million is to be transferred from net profit to the RBRF. The balance of the RBRF has now been restored to a level that the Board regards as appropriate given the risk the Bank holds on its balance sheet.

The RBA also holds a number of other reserves which form part of its equity.

Unrealised gains and losses on foreign exchange, foreign securities and Australian dollar securities are recognised in profit from ordinary activities. Such gains or losses are not available for distribution and are transferred to the Unrealised profits reserve where they remain available to absorb future unrealised losses or become available for distribution if gains are realised when assets are sold.

The balance of the Superannuation reserve represents accumulated re-measurement gains and losses on the RBA's defined benefit superannuation obligations (refer Note 1 (i)). These unrealised gains and losses are included in Other Comprehensive Income in accordance with AASB 119 – Employee Benefits.

Balances of asset revaluation reserves reflect differences between the fair value of relevant assets, mainly non-traded assets, and their cost. These assets are: gold; property, plant and equipment; and shares in international and other institutions. These unrealised gains are transferred directly to the relevant reserves and are included in Other Comprehensive Income. The unrealised gains on these assets are not distributable unless they are realised if an asset is sold. The RBA sold a residential property in 2013/14 and recognised a gain of $4.0 million, of which $2.6 million represented gains from earlier periods held in the Asset revaluation reserve; the balance of this gain, a sum of $1.4 million, was recognised in net profit in 2013/14.

(g) Profits

Profits of the RBA are dealt with in the following terms by section 30 of the Reserve Bank Act:

1. Subject to subsection (2), the net profits of the Bank in each year shall be dealt with as follows:

   27. such amount as the Treasurer, after consultation with the Reserve Bank Board, determines is to be set aside for contingencies; and
   1. such amount as the Treasurer, after consultation with the Reserve Bank Board, determines shall be placed to the credit of the Reserve Bank Reserve Fund; and
   2. the remainder shall be paid to the Commonwealth.
2. If the net profit of the Bank for a year is calculated on a basis that requires the inclusion of unrealised gains on assets during the year, the amount to which subsection (1) applies is to be worked out as follows:
   1. deduct from the net profit an amount equal to the total of all amounts of unrealised gains included in the net profit; and
   2. if an asset in respect of which unrealised gains were included in the net profit for a previous year or years is realised during the year – add to the amount remaining after applying paragraph (a) the total amount of those unrealised gains.

(h) Provisions

The RBA maintains provisions for accrued annual leave and long service leave, including associated payroll tax, and post-employment benefits in the form of health insurance and housing assistance, and the associated fringe benefits tax; these provisions are made on a present value basis consistent with AASB 119. The RBA also makes provision for future workers compensation claims for incidents which have occurred before balance date.

(i) Superannuation funds

The RBA includes in its Statement of Financial Position an asset or liability representing the position of its defined benefit superannuation funds measured in accordance with AASB 119. Movements in the superannuation asset or liability are reflected in the Statement of Comprehensive Income. Re-measurement gains and losses are transferred to the Superannuation Reserve. Details of the superannuation funds and superannuation expenses are included in Note 14.

(j) Commonwealth grant

On 23 October 2013, the Australian Government announced it would make a grant of $8,800 million to strengthen the financial position of the RBA, and enhance its capacity to conduct its monetary policy and foreign exchange operations. The grant was paid to the RBA on 7 May 2014.

The grant has been recognised as revenue in the Statement of Comprehensive Income.

(k) Rounding

Amounts in the financial statements are rounded to the nearest million dollars unless otherwise stated.

(l) Application of new or revised Australian accounting standards

A number of new and revised Australian accounting standards apply to the RBA's financial statements. The RBA's assessment of the main effects of these standards on its financial statements is set out below.

AASB 13 – Fair Value Measurement

AASB 13 has been applied in the RBA's financial statements for the year ending 30 June 2014. AASB 13 provides a framework for measuring fair value. The standard has not had a material effect on the RBA's financial statements but has required additional disclosures to be made around fair value measurements, contained in Note 16.

AASB 10 – Consolidated Financial Statements

AASB 10 introduces a broader concept of control for the preparation of consolidated financial statements. Control is established, and consolidated financial statements are to be prepared, based on whether an entity is exposed, or has the rights, to the variable returns from its involvement with an investee and has the ability to affect those returns through its power over the investee. This standard replaces AASB 127 – Consolidated and Separate Financial Statements and has been applied in preparing the RBA's consolidated financial statements for the year ended 30 June 2014. The application of AASB 10 has not had a material effect on the RBA's financial statements.

AASB 9 – Financial Instruments

AASB 9 contains new requirements for the classification, measurement and de-recognition of financial assets and liabilities. It will replace the corresponding requirements in AASB 139. The RBA is assessing the impact of the new standard, which will now be applicable for annual reporting periods beginning on or after 1 January 2018.

AASB 119 – Employee Benefits

The revised accounting standard AASB 119 – Employee Benefits affects retrospectively the RBA's accounting policy on employee benefits, in particular post-employment benefits. Under the revised standard, actuarial gains and losses on defined benefit superannuation obligations are now fully recognised on the balance sheet, and included in Other Comprehensive Income, in the reporting period in which they occur. Current service and net interest costs are now recognised in net profit. Net interest is now calculated by applying the discount rate to the net defined benefit liability; previously the return on the assets of a superannuation scheme was incorporated in this calculation.

These amendments result in the RBA showing a Superannuation liability of $321 million being retrospectively recognised at 30 June 2013 ($614 million at 30 June 2012), with corresponding adjustments to the historical figures for the RBA's reported Total Comprehensive Income. The impact of these amendments in 2012/13 is shown in the restated financial statements set out in the following tables. Additional narrative disclosures are provided in Note 14.

The historical revision to the RBA's profit and loss from the revised AASB 119 has resulted in a cumulative reduction of $142 million in the balance of the RBRF as at 30 June 2013 from previous disclosures.

In addition, the revised standard amends disclosures for short-term and other long-term employee benefits, in particular annual leave. This does not materially affect the RBA's financial disclosures.

The effect of these changes on the consolidated financial statements if the revised accounting standard had been applied retrospectively, is outlined in the following tables.