Reserve Bank of Australia Annual Report – 2005 Financial Statements Note 1

NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS 30 June 2005
Reserve Bank of Australia and Controlled Entities

Note 1 SUMMARY OF ACCOUNTING POLICIES

The financial statements have been prepared in accordance with the Reserve Bank Act 1959 and the Commonwealth Authorities and Companies Act 1997.

The form and content of the financial statements incorporate the requirements of the Finance Minister's Orders (FMOs) 2004–2005. These orders provide that the financial statements of agencies and authorities must comply with accounting standards and accounting interpretations issued by the Australian Accounting Standards Board. As the Reserve Bank of Australia (RBA) is a financial institution, the financial statements have been prepared using AASB1032 – Specific Disclosures by Financial Institutions.

The RBA has been granted an exemption from the requirements of the FMOs as detailed in Note 1(m). This exemption relates to a matter of disclosure and presentation which is of a minor nature and is adequately dealt with elsewhere in these financial statements.

The statements are a general purpose financial report prepared in accordance with Australian Accounting Standards. All amounts are expressed in Australian dollars unless another currency is indicated. Current market values are used for the RBA's major assets, including domestic and foreign marketable securities, gold and foreign currency, as well as for premises, plant and equipment. Revenue and expenses are brought to account on an accrual basis. All revenues, expenses and profits of the RBA are from ordinary activities. Unless otherwise stated, the accounting policies and practices followed in these statements are consistent with those followed in the previous year.

(a) Consolidation and associated company

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. The results of the parent entity do not differ materially from the economic entity and have therefore not been separately disclosed other than in Note 15, Related Party and Other Disclosures. Note Printing Australia Limited was incorporated as a wholly owned subsidiary of the RBA on 1 July 1998, with an initial capital of $20,000,000.

The assets, liabilities and results of Note Printing Australia Limited have been consolidated with the parent entity accounts in accordance with AASB1024 – Consolidated Accounts. All internal transactions and balances have been eliminated on consolidation. Note Printing Australia Limited is subject to income tax; its income tax expense is included in the Statement of Financial Performance as part of Other Expenses.

The RBA accounts for its investment in Securency Pty Ltd in accordance with AASB1016 – Accounting for Investments in Associates. The carrying amount of the RBA's investment in Securency Pty Ltd is reviewed annually to ensure that it is not in excess of its recoverable amount. The RBA's investment in Securency Pty Ltd is included in Note 7.

(b) Gold

Gold holdings (including gold on loan to other institutions) are valued at the Australian dollar equivalent of the 3pm fix in the London gold market on the last business day of June. The RBA lends gold to financial institutions participating in the gold market. Gold loans are secured to 110 per cent of their market value by Australian dollar denominated collateral security. Interest on gold loans is accounted for on a standard accrual basis.

(c) Foreign exchange

Foreign exchange holdings are invested mainly in securities (issued by the governments of the United States, Germany, France and Japan) and bank deposits (with major OECD foreign commercial banks, central banks and international agencies). The RBA engages in interest rate futures and foreign currency swaps.

Assets and liabilities denominated in foreign currency are converted to Australian dollar equivalents at exchange rates ruling on the last business day of June. Realised and unrealised gains or losses on foreign currency are immediately taken to profit, but only realised gains are available for distribution.

Foreign government securities

Foreign government securities comprise coupon and discount securities and repurchase agreements. Coupon securities have biannual or annual interest payments depending on the currency and type of security. Interest earned on discount securities is the difference between the actual purchase cost and the face value of the security. The face value is received at maturity. Interest earned on securities is accrued over the term of the security.

Marketable securities, other than those contracted for sale under repurchase agreements, are reported at market values on the last business day of June; realised and unrealised gains and losses arising from changes in market valuations during the year are taken to profit. Earnings on foreign currency investments are converted to Australian dollars using the exchange rate on the date they are accrued.

Foreign currency swaps

The RBA uses foreign currency swaps to assist daily domestic liquidity management and to manage its balance sheet holdings. A 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 must therefore reflect 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.

Foreign exchange holdings contracted for sale beyond 30 June 2005 (including those under swap contracts) have been valued at market exchange rates (refer Note 18).

Interest rate futures

The RBA uses interest rate futures contracts on overseas exchanges to hedge risks 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 are off-balance sheet items. Interest rate futures positions are marked to market on the last business day of June and valuation gains and losses are taken to profit (refer Note 18). The RBA did not trade in any other derivative instruments during 2004/05.

(d) Australian dollar securities

The RBA holds Commonwealth Treasury Fixed Coupon Bonds, Treasury Notes and Treasury Capital Indexed Bonds, and securities issued by the central borrowing authorities of State and Territory Governments. It also holds under repurchase agreements bank bills and certificates of deposit issued by banks licensed in Australia and Australian dollar denominated securities issued by foreign governments, foreign government agencies that have an explicit government guarantee and by certain highly rated supranational organisations. Realised and unrealised gains or losses on Australian dollar securities are immediately taken to profit, but only realised gains are available for distribution.

Commonwealth Treasury Fixed Coupon Bonds are coupon securities; the interest is payable biannually at the coupon rate. Commonwealth Treasury Notes are discount securities; the interest earned is the difference between the purchase price and the face value on redemption. Treasury Capital 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.

Securities are valued at market prices on the last business day of June except when contracted for sale under repurchase agreements.

(e) Repurchase agreements

In the course of its financial market operations, the RBA engages in repurchase agreements involving foreign and Australian dollar marketable securities.

Securities sold and contracted for purchase under repurchase agreements are reported on the Statement of Financial Position within the relevant investment portfolio and are valued at market prices; the counterpart obligation to repurchase is included in Other Liabilities. The difference between the sale and purchase price is recognised as interest expense over the term of the agreement.

Securities purchased and contracted for sale under repurchase agreements are reported within the relevant investment portfolio at contract amount. The difference between the purchase and sale price is recognised as interest income over the term of the agreement.

(f) Property, plant and equipment

Formal valuations of all the RBA's Australian properties are conducted annually; RBA properties overseas are formally valued on a triennial basis. Australian properties are valued by officers of the Australian Valuation Office and overseas properties are valued by local independent valuers. The most recent valuation of overseas properties was at 30 June 2004. These valuations have been incorporated in the accounts. Annual depreciation is based on market values and assessments of useful remaining life.

Plant and Equipment has been recognised on a fair value basis in accordance with the FMOs. The fair value of plant and equipment at the beginning and end of the reporting period was determined by an independent valuer, with valuation losses taken to accounting profits. Annual depreciation is based on fair values and the RBA's assessments of useful remaining life. In accordance with the FMOs, the RBA continues to recognise computer software at cost less depreciation.

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

(g) Deposits

Deposits include deposits at call and term deposits. Deposit balances are shown at 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. Details of deposits are included in Note 9.

(h) Reserves

Reserves are maintained to cover the broad range of risks to which the RBA is exposed. The Reserve Bank Reserve Fund (RBRF) is a general reserve which provides for events which are contingent and non-foreseeable, mainly those which arise from movements in market values of the RBA's holdings of Australian dollar and foreign securities; the RBRF also provides for potential losses from fraud and other non-insured losses. Amounts set aside for this reserve are determined by the Treasurer after consultation with the Board (refer Note 1(i)).

Asset revaluation reserves reflect the impact of changes in the market values of a number of the RBA's assets, mainly non-traded assets (gold; property, plant and equipment; and shares in international financial institutions).

Unrealised gains and losses on foreign exchange and Australian dollar securities are recognised in profit from ordinary activities. Until such gains or losses are realised, they are not available for distribution to the Australian Government; in the interim, the amounts are reflected in the Unrealised Profits Reserve.

(i) Profits

Profits of the RBA are dealt with in terms of Section 30 of the Reserve Bank Act 1959 as follows:

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

   1. such amount as the Treasurer, after consultation with the Reserve Bank Board, determines is to be set aside for contingencies; and
   2. 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
   3. 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.

(j) Provisions

The RBA maintains provisions for accrued annual leave, calculated on salaries expected to prevail when leave is anticipated to be taken and including associated payroll tax. The RBA also maintains provisions for long service leave and post-employment benefits, in the form of health insurance and housing assistance, and associated fringe benefits tax; these provisions are made on a present value basis in accordance with AASB1028 – Employee Benefits. In addition, the RBA makes provision for future workers' compensation claims in respect of incidents which have occurred before balance date, based on an independent actuarial assessment.

(k) Australian notes on issue

After a note series ceases to be issued, the RBA periodically adjusts its liability for that series, to reflect the likelihood that the remaining notes on issue will not be presented for redemption because they are judged to have been destroyed or are otherwise unavailable for presentation. No amount was written off Australian notes on issue in 2004/05 ($45 million was written off in 2003/04). If the written down notes are subsequently presented, the RBA will reinstate the liability for these notes and charge an expense against profits.

In 2001/02, the RBA began to pay interest on working balances of currency notes held by banks under revised cash distribution arrangements. Interest is paid on balances up to a certain limit.

(l) Rounding

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

(m) Exemptions

The RBA has been granted an exemption from the following requirement of the FMOs:

(n) Australian equivalents to International Financial Reporting Standards (AIFRS)

Commonwealth authorities reporting under the Commonwealth Authorities and Companies Act 1997 are required to adopt AIFRS for reporting periods beginning on or after 1 January 2005. The RBA will publish its financial statements under AIFRS for the first time for the year ending 30 June 2006. The RBA has reviewed AIFRS and identified the standards which will affect its accounting policies and measurement of items in its financial statements and has put in place arrangements which will enable it to comply with these standards. Staff have been trained in AIFRS and systems and internal controls have been changed so that the required information can be collected. AIFRS will affect the RBA's financial statements in a number of areas. Adjustments for changes in accounting policies have been incorporated in the opening AIFRS balance sheet as at 1 July 2004. While the new standards have little impact on the balance sheet footings, they involve a number of changes to disclosure. The main effects on the financial statements for 2004/05 if prepared in accordance with AIFRS are discussed below.

Superannuation

Under AIFRS, the RBA will recognise in its balance sheet as at 30 June 2005 an asset, estimated at $53 million, representing the surpluses in the RBA's Officers Superannuation Fund and UK Pension Scheme; the counterpart to this asset is a new accounting reserve. The RBA proposes to adopt the ‘corridor’ approach (under AASB119 – Employee Benefits ) for the recognition of the surpluses on these defined benefit superannuation funds. The RBA will recognise all previous cumulative actuarial gains and losses in the opening fair value of the surpluses. The corridor approach is used, subject to this approach being consistent with the FMOs or receiving an exemption from them if necessary. Under this approach, superannuation expense charged to the Income Statement includes the RBA's contributions, the service cost and the interest cost less the expected return on fund assets. At present, surpluses from the defined benefit schemes are not recorded on the balance sheet, but are disclosed in the notes to the RBA's financial statements (Note 16), and superannuation expense comprises only the RBA's contributions to these superannuation schemes. Accordingly, the RBA estimates that its superannuation expense in 2004/05 under AIFRS would be $4 million higher than in the financial statements published for 2004/05.

Financial instruments

The RBA expects to bring its foreign and domestic securities transactions and foreign exchange transactions to account under AIFRS on a trade date basis – that is, it will recognise the effects of these transactions, both in the Income Statement and the Balance Sheet, on the date on which these transactions are arranged, not when the transactions are settled. Bank deposits and repurchase agreements will continue to be brought to account on settlement date. All securities will be valued at bid prices, while all foreign currency assets and liabilities will be valued at bid and offer rates respectively. This approach is used subject to it being consistent with the FMOs or receiving an exemption from them if necessary. As a result of these changes: foreign currency assets and liabilities as at 30 June 2005 are estimated to be $259 and $267 million higher under AIFRS compared with current standards; accounting profits are estimated to be $13 million higher than under current standards; and the Reserve for Unrealised Profits on Investments is estimated to be $8 million lower.

Interest receivable of $137 million on repurchase agreements and foreign bank deposits as at 30 June 2005 will be reported as a separate asset under AIFRS, rather than included in the asset value, the treatment under existing standards. This will have a small compositional effect on the RBA's balance sheet.

Asset revaluation reserves

Under current Australian Accounting Standards, for revaluation purposes the RBA values individual properties as a single class of asset and all plant and equipment assets as a separate aggregate class of asset. In accordance with the reporting requirements for for-profit entities under AIFRS, individual asset revaluation reserves for each property and item of plant and equipment will be maintained. As a result, the balance of asset revaluation reserves is estimated to be $3 million lower than under current standards, although there is no material impact on profits. These adjustments have their counterparts in the RBA's equity. Accordingly, the Reserve Bank Reserve Fund is expected to increase by $1 million, compared with the 2004/05 published accounts.

The estimated effects of the adjustments outlined above on the RBA's balance sheet as at 30 June 2005 are summarised overleaf.

Accounting profits for 2004/05 determined in accordance with AIFRS are estimated to be $8 million higher than in the financial statements published for 2004/05. The adoption of AIFRS would have no impact on measured earnings available for distribution to the Australian Government in 2004/05. No material impacts are expected on the Statement of Cash Flows.

These estimates have been prepared on the basis of the accounting standards (and interpretations) expected to prevail as at 30 June 2006. If the FMOs, accounting standards or interpretations of these evolve, or the RBA does not receive the exemptions from the FMOs that may be required, the estimates might be revised when the first full set of financial statements under AIFRS is published for 2005/06.