Business combinations, foreign exchange and NFRS 9

Functional and presentation currency

Simple definition. The currency the bank operates in, and the currency it reports in.

Technical definition. Under NAS 21, the functional currency is that of the primary economic environment in which the entity operates; the presentation currency is that in which the financial statements are presented. They may differ, requiring translation.

The report's statement:

Three consequences:

1. 1Functional = presentation = NPR → no translation reserve (Part 3.10 is nil)
2. 2All Group entities share the same functional currency → no foreign operations
3. 3Figures are in thousands — a NPR 405,921,893 balance sheet total means NPR 405.9 billion

Related terms. Part 3.10 · Foreign Exchange Transactions

Rounding off and Comparative Figures

The report's statement:

The comparative-figures point matters. Under NAS 1, comparatives must be restated when presentation changes, with disclosure. A reclassification that is not flagged can make a trend look real when it is only a presentation change.

Related terms. Reclassified / regrouped figures · Part 5.13 Adjustment/Restatement

Reclassified / regrouped figures

Prior-period amounts moved between line items to match the current period's presentation. Not an error correction (that is NAS 8 — Part 5.13) and not a policy change; purely presentational.

The report's note 3 to the unaudited highlights states: "The figures of previous periods have been regrouped/rearranged wherever necessary."

— BUSINESS COMBINATION AND FOREIGN EXCHANGE (9 terms)

Business Combination (NFRS 3)

Objective of the standard. To improve the relevance, reliability and comparability of information about a business combination and its effects.

Scope. Transactions in which an acquirer obtains control of one or more businesses.

Recognition. The acquirer recognises, at the acquisition date, the identifiable assets acquired, liabilities assumed and any non-controlling interest.

Measurement. "The consideration transferred in the acquisition is generally measured at fair value, as are the identifiable net assets acquired" — the report's own words.

Presentation and disclosure. Goodwill or bargain purchase gain; the nature and financial effect of the combination.

The Nepali context in full. Set out in Part 1.14 — NRB's Merger and Acquisition Bylaws 2073, the ICAN carve-outs 3 and 4 issued 2077.07.25, their withdrawal via the Explanatory Note of 2079.04.15, and goodwill recognition in FY 2021/22.

Differences from NRB regulatory treatment:

NFRS 3 (accounting)                NRB (regulatory)
───────────────────                ────────────────
Goodwill recognised as an asset    Goodwill DEDUCTED from CET1 [R]
Bargain purchase gain → profit     Gain BLOCKED from distribution
                                    (Part 7.15)
Fair value of net assets           Merger and Acquisition Bylaws 2073
determined by the acquirer          set the process and approvals [R]

Related terms. Part 1.14 · Part 5.22 · Part 7.14, 7.15 · Acquisition method

Acquisition method

The single method NFRS 3 permits. Four steps:

1. Identify the ACQUIRER
2. Determine the ACQUISITION DATE (when control passes)
3. Recognise and measure the identifiable ASSETS ACQUIRED,
   LIABILITIES ASSUMED and any NCI — at fair value
4. Recognise GOODWILL or a BARGAIN PURCHASE GAIN

The report: "The Group accounts for business combinations using the acquisition method when control is transferred to the Group as per NFRS 3."

Worked example: see Part 1.14.

Identifiable net assets acquired

The fair value of assets acquired less liabilities assumed that meet the recognition criteria at the acquisition date. The residual against consideration is goodwill (or a bargain gain).

Note that acquisition accounting can recognise assets the acquiree never had on its own balance sheet — customer relationships, brand — provided they are identifiable (separable or arising from contractual/legal rights).

Goodwill

Fully covered in Part 1.14 — definition, formula, worked example, non-amortisation, impairment testing, deduction from CET1 [R], and the distributable-profit block (Part 7.14).

(NMB Group: NPR 134,051 thousand within Goodwill and Intangible assets.)

Foreign Exchange Transactions

Simple definition. How the bank converts foreign-currency amounts into rupees.

Technical definition. Under NAS 21, transactions in foreign currency are recorded at the spot rate at transaction date; monetary items are retranslated at the closing rate at each reporting date, with exchange differences recognised in profit or loss.

The report's policy, in three parts:

The two-bucket rule — the most-missed Nepali presentation point

┌────────────────────────────────────────────────────────────────┐
│  BUCKET 1 — REVALUATION                                        │
│  Retranslating FX assets/liabilities at period end             │
│  at the NRB mid-point rate                                     │
│  → an ACCOUNTING remeasurement, no transaction occurred        │
│                        ↓                                       │
│              OTHER OPERATING INCOME  (Part 2.9)                │
├────────────────────────────────────────────────────────────────┤
│  BUCKET 2 — TRADING                                            │
│  The margin between the rate the bank BUYS at and the rate     │
│  it SELLS at, on actual customer transactions                  │
│  → genuine realised income from dealing                        │
│                        ↓                                       │
│              NET TRADING INCOME  (Part 2.8)                    │
└────────────────────────────────────────────────────────────────┘

And a third destination. The FX effect on cash balances is stripped out of the cash flow statement entirely and shown as a separate reconciling line (Part 4.36) — because it is a remeasurement, not a cash flow.

And a fourth. A prescribed share of the revaluation gain is appropriated to the Exchange Fluctuation Fund and blocked from distribution [R] (Part 7.4).

ONE ECONOMIC PHENOMENON — FOUR DIFFERENT PLACES:

FX revaluation gain
     ├─→ Other operating income        (P&L)          Part 2.9
     ├─→ Exchange equalisation reserve (SoCE/Part 7)  Part 5.4, 7.4
     ├─→ Effect of exchange rate on cash (CF)         Part 4.36
     └─→ (if there were foreign ops) OCI              Part 3.10 — nil

Nepali context. Nepali banks have large FX exposure from remittances (a major share of GDP), import LCs, DFI borrowings and nostro balances. The NPR is pegged to the Indian rupee, which means NPR/INR is stable but NPR/USD moves with INR/USD — a structural exposure Nepali banks manage with the forwards and swaps in Part 1.4.

Related terms. Part 2.8, 2.9 · Part 3.10 · Part 4.36 · Part 5.4 · Part 7.4 · Part 1.4

Mid-point exchange rate

The average of NRB's published buying and selling rates, used to translate FX assets and liabilities at the reporting date.

Mid-point rate = (Buying rate + Selling rate) ÷ 2

Using a mid-point rather than buying or selling avoids systematically over- or under-stating either assets or liabilities.

Effective trading rate

An adjustment to the mid-point rate reflecting the rate at which the bank could actually transact in volume, referenced in the report's phrase "after adjustment for effective trading rate."

Revaluation gain/loss

The net difference on retranslating FX assets and liabilities, recognised in Other operating income (Part 2.9). Distinct from PPE revaluation surplus (Part 3.5), which goes to OCI.

Trading gains

Realised income from the buy/sell spread on foreign-exchange transactions, presented in Net Trading Income (Part 2.8).

(NMB, Bank YTD: net trading income NPR 681,415 thousand, up 89% — driven by FX volume.)

— FINANCIAL INSTRUMENTS (20 terms)

Financial Instruments (NFRS 9)

Objective of the standard. To establish principles for the financial reporting of financial assets and financial liabilities that present relevant and useful information for assessing amounts, timing and uncertainty of future cash flows.

Scope. Almost the entire balance sheet of a bank.

The three pillars.

┌──────────────────────────────────────────────────────────────┐
│  1. CLASSIFICATION AND MEASUREMENT                           │
│     Business model + contractual cash flow characteristics   │
│     → Amortised cost / FVOCI / FVTPL                         │
├──────────────────────────────────────────────────────────────┤
│  2. IMPAIRMENT                                               │
│     Expected Credit Loss model, three stages                 │
│     → §8.D                                                   │
├──────────────────────────────────────────────────────────────┤
│  3. HEDGE ACCOUNTING                                         │
│     Optional; NMB does not apply it (Part 3.9)               │
└──────────────────────────────────────────────────────────────┘

The classification decision tree — reproduced from Part 1.8 because it is the single most important diagram in NFRS 9:

                     FINANCIAL ASSET (debt instrument)
                                  │
                 ┌────────────────┴────────────────┐
                 │   Does it pass the SPPI test?   │
                 └────────────────┬────────────────┘
                     NO ──────────┴────────── YES
                     │                          │
                     ▼                          ▼
               ┌──────────┐        ┌────────────────────────────┐
               │  FVTPL   │        │   BUSINESS MODEL?          │
               └──────────┘        └─────────────┬──────────────┘
                                                 │
           ┌─────────────────────┬───────────────┴──────────────┐
           ▼                     ▼                              ▼
    Hold to COLLECT       Hold to COLLECT AND SELL        Other/trading
           ↓                     ↓                              ↓
    AMORTISED COST            FVOCI                          FVTPL
    ECL applies            ECL applies                     No ECL

EQUITY instruments: FVTPL by default, or an IRREVOCABLE
election at initial recognition to FVOCI (no recycling ever).

The report's application: "The Bank classifies its financial assets into the following categories: those measured at amortised cost, and those measured at fair value. This classification depends on both the contractual characteristics of the assets and the business model adopted for their management."

Related terms. All of §8.C and §8.D · Part 1.7, 1.8 · Part 15

Financial assets / Financial liabilities

The report's definitions:

In a Nepali bank:

The NAS 32 debt-vs-equity boundary. Whether an instrument is a financial liability or equity turns on whether there is a contractual obligation to deliver cash — which is exactly why NMB's PNCPS is equity (Part 1.30, 8.H.13).

Related terms. 8.C.1 · NAS 32 · Part 1.30

Amortised cost

Simple definition. Carrying an instrument at what is still owed on it, adjusted for fees spread over its life, less any impairment.

Technical definition.

Amortised cost  =  Amount at initial recognition
                −  Principal repayments
                +/− Cumulative amortisation of any difference between
                    the initial amount and the maturity amount, using
                    the effective interest method
                −  Loss allowance (for financial assets)

When it applies. Both conditions must hold:

1. 1Business model — held to collect contractual cash flows
2. 2SPPI — cash flows are solely payments of principal and interest

The report: "An investment is classified at 'amortised cost' only if it is not designated as a FVTPL and both of the following criteria are met: the objective of the Bank's business model is to hold the assets in order to collect the contractual cash flows, and the contractual terms of the financial assets must give rise on specified dates to cash flows that are only payments of principal and interest on the principal amount outstanding. If either of the two criteria above is not met, the asset cannot be classified in the amortised cost category and must be classified at fair value."

What is measured this way in a Nepali bank. Loans and advances, placements, cash, NRB balances, held-to-collect debt securities, deposits, borrowings, debentures.

Related terms. EIR · SPPI · Part 1.7

Fair value

Simple definition. What the instrument would sell for today in an orderly transaction between market participants.

Technical definition. The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The report's determination policy:

And the honest caveat the report includes:

Related terms. Determination of fair value · Fair value hierarchy

FVTPL (fair value through profit or loss)

Simple definition. Carrying an instrument at market value with every change going straight to profit.

When it applies:

• Held for trading (mandatory)
• Fails SPPI (mandatory)
• Equity instruments without the FVOCI election (default)
• Derivatives (always)
• Designated at initial recognition to eliminate an accounting mismatch (the "fair value option")

Two distinguishing features:

1. TRANSACTION COSTS ARE EXPENSED IMMEDIATELY
   — everywhere else they are capitalised into the carrying amount

2. NO ECL APPLIES
   — because fair value already reflects credit risk

Where it appears in NMB: derivative assets and liabilities (Part 1.4), other trading assets (nil, Part 1.5), and equity investments not designated FVOCI.

Related terms. Part 1.4, 1.5, 1.8 · Part 3.4 (the FVOCI alternative)

Contractual cash flows

The payments an instrument's contract obliges the counterparty to make — principal and interest on a loan, coupon and redemption on a bond. The business model test asks whether the entity intends to collect them; the SPPI test asks whether they have the right character.