Reserve Bank of Australia Annual Report – 2006 Financial Statements Note 1

NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS 30 June 2006
Reserve Bank of Australia and Controlled Entities

Note 1 SUMMARY OF ACCOUNTING POLICIES

The Reserve Bank of Australia (RBA) reports its financial statements in accordance with the Reserve Bank Act 1959 and the Commonwealth Authorities and Companies (CAC) Act 1997. In accordance with the Finance Minister's Orders (FMOs) 2005–2006, which are issued pursuant to the CAC Act 1997, the RBA has prepared its financial statements for the year ended 30 June 2006 under Australian equivalents to International Financial Reporting Standards (AIFRS), other accounting standards and accounting interpretations issued by the Australian Accounting Standards Board. This is the first time the RBA has prepared its financial statements under AIFRS. These financial statements comply fully with International Financial Reporting Standards. As the RBA is a financial institution, these financial statements have been prepared using AASB 130 – Disclosures in the Financial Statements of Banks and Similar Financial Institutions. The RBA has been granted an exemption from the requirements of the FMOs as detailed in Note 1(j). 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.

These financial statements and attached notes are a general purpose financial report prepared in accordance with relevant AIFRS. Elections as to the accounting treatment under AIFRS made by the Bank are noted appropriately. All amounts are expressed in Australian dollars unless another currency is indicated. Under the FMOs, the RBA is classified as a for-profit public-sector entity for purposes of financial disclosure. Fair 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.

(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. 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 was incorporated as a wholly-owned subsidiary of the RBA on 1 July 1998, with an initial capital of $20,000,000. Note Printing Australia Limited's total assets, liabilities and capital as at 30 June 2006 were $63.2 million, $16.8 million and $46.4 million respectively ($57.9 million, $15.7 million and $42.2 million as at 30 June 2005).

The assets, liabilities and results of Note Printing Australia Limited have been consolidated with the parent entity accounts in accordance with AASB 127 – Consolidated and Separate Financial Statements. All internal transactions and balances have been eliminated on consolidation.

The RBA equity accounts for its investment in Securency Pty Ltd in accordance with AASB 131 – Interests in Joint Ventures. The RBA's investment in Securency Pty Ltd is included in Note 7.

(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, bank deposits, interest rate futures, foreign currency swap contracts, gold loans, cash and cash equivalents, notes on issue, deposit liabilities and its shareholding in the Bank for International Settlements. The RBA accounts for its financial instruments in accordance with AASB 139 – Financial Instruments: Recognition and Measurement and reports these instruments under AASB 132 – Financial Instruments: Disclosure and Presentation. The RBA has elected to apply the provisions of AASB 139 in preparing its opening balance sheet and the 2004/05 comparative balances under AIFRS.

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

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. Domestic securities, except those contracted for sale under repurchase agreements, are classified under AASB 139 as “at fair value through profit or loss”, as they are held for purposes 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 immediately taken to profit. Only realised gains are available for distribution in accordance with the Reserve Bank Act 1959 (Note 1(f)). Interest earned on the securities is accrued over the term of the security and included as revenue in the Income Statement.

Commonwealth Treasury Fixed Coupon Bonds are coupon securities; the interest is received biannually at the coupon rate and the principal is received at maturity. 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.

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 highly rated international 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 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 immediately taken to profit, but only realised gains are available for distribution in accordance with the Reserve Bank Act 1959 (Note 1(f)). Interest revenue and revaluation gains and losses on foreign currency assets and interest expense on foreign currency liabilities are converted to Australian dollars using the relevant market bid or offer exchange rate on the date they are accrued or recognised, in accordance with AASB 121.

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; the principal of these securities is received at maturity. 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. Foreign securities, except those contracted for sale under repurchase agreements, are classified under AASB 139 as “at fair value through profit or loss”, as they are held for trading. 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 are available for distribution in accordance with the Reserve Bank Act 1959 (Note 1(f)). Interest earned on securities is accrued over the term of the security as revenue in the Income Statement.

Foreign bank deposits

The RBA invests part of its foreign currency reserves in deposits with highly-rated international banks; it also maintains working accounts in foreign currencies. 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 paid is included in Accrued Interest (Note 16).

Foreign currency swaps

The RBA uses foreign currency swaps to assist daily domestic liquidity management and to manage its balance sheet holdings. 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 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 2006 (including those under swap contracts) have been valued at market exchange rates (Note 16).

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 positions are classified under AASB 139 as “at fair value through profit or loss”. In accordance with this standard, 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 are available for distribution in accordance with the Reserve Bank Act 1959 (Note 1(f)).

Bank for International Settlements

Under AASB 139 the RBA's shareholding in the Bank for International Settlements (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 reflects BIS' net asset value, less a discount of 30 per cent. Dividends are recognised as revenue in the Income Statement when declared.

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 classified under AASB 139 as “at fair value through profit or loss”, as they are held for trading, and reported on the Balance Sheet within the relevant investment portfolio. In accordance with this standard, the securities are valued at market bid prices on balance date and realised and unrealised gains or losses on Australian dollar securities are immediately taken to profit. Only realised gains are available for distribution in accordance with the Reserve Bank Act 1959 (Note 1(f)). 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.

Securities purchased and contracted for sale under repurchase agreements are classified under AASB 139 as “loans and receivables” and valued at amortised cost. The difference between the purchase and sale price is accrued over the term of the agreement and recognised as interest revenue.

Cash invested in securities purchased and contracted for sale under repurchase agreements is secured to 102 per cent of the market value of the securities. The proceeds of securities sold and contracted for purchase under repurchase agreements equates to the market value of these securities.

Deposit liabilities

Deposits include deposits at call and term deposits. Deposits are classified as financial liabilities under AASB 139. 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 2004/05, the RBA periodically adjusted its liability for note series that ceased to be issued, to reflect the likelihood that the remaining notes on issue from these series would not be presented for redemption because they were judged to have been destroyed or were otherwise unavailable for presentation. Under this policy, notes totaling $133 million were written down and the gains included in accounting profits. As these notes were written down prior to 1 January 2005, the RBA has not had to re-recognise the liability for the notes under AIFRS. 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.

(c) 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 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 these loans in accordance with AASB 139 and reports the loans under AASB 132. Gold loans are secured to 110 per cent of their market value by Australian dollar denominated collateral. Interest on gold loans is accounted for on an accrual basis.

(d) 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. In accordance with AASB 116 – Property, Plant and Equipment, properties are valued at market value, which reflects observable prices and are based on the assumption that assets would be exchanged between knowledgeable, willing parties at arm's length. Due to its specialised nature, the value of the Craigieburn property has been determined on the basis of vacant possession. Valuation gains and losses are transferred to the Property Revaluation Reserve. These valuations have been incorporated in the accounts. Annual depreciation is based on market values and assessments of useful remaining life.

Plant and equipment is recognised on a fair value basis; valuation gains and losses are treated in accordance with AASB 116. Plant and equipment is valued by independent valuers on a triennial basis. The most recent independent valuation was on 30 June 2005. Annual depreciation is based on fair values and the RBA's assessments of useful remaining life. Computer software is accounted for in accordance with AASB 138 – Intangible Assets. Software is recognised at cost less accumulated amortisation, which is calculated at rates based on the estimated useful life of the relevant assets. Amortisation expense for computer software is included in Other Expenses in Note 2.

The useful lives used for each class of asset are:

	Years
Buildings	16–50
Fitout and furniture	5–20
Computer equipment
– hardware	4–5
– software	4–7
Office equipment	4–5
Motor vehicles	4–5
Plant	4–20

Details of annual net expenditure, revaluation adjustments and depreciation of buildings, and plant and equipment are included in Note 8; details of computer software are included in Note 7.

(e) Reserves

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(f)).

The balance of asset revaluation reserves in the balance sheet reflect differences between the fair value of a number of the RBA's assets, mainly non-traded assets (gold; property, plant and equipment; and shares in international financial institutions), and their cost. Balances in these reserves represent unrealised gains on assets which are not distributable until the gains are realised through the sale of the relevant asset.

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 Reserve for Unrealised Profits on Investments.

Unrealised gains and losses on the surplus of the staff superannuation funds are also recognised in the Income Statement in accordance with the ‘corridor’ approach under AASB 119 – Employee Benefits. These amounts are reflected in the Reserve for Unrealised Profits on Superannuation.

(f) 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.

(g) Provisions

The RBA maintains provisions for accrued annual leave in accordance with AASB 119 – Employee Benefits, 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 consistent with AASB 119. 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.

(h) Superannuation funds

The RBA includes in its balance sheet an asset representing the surpluses in its defined benefit superannuation funds in accordance with the ‘corridor’ approach under AASB 119 – Employee Benefits ; the counterpart to this asset is the Reserve for Unrealised Profits on Superannuation. Details of the superannuation funds and superannuation expenses are included in Note 14.

(i) Rounding

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

(j) Exemptions

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

(k) Transition to Australian equivalents to International Financial Reporting Standards

Authorities of the Australian Government reporting under the CAC Act 1997 have adopted AIFRS for reporting periods beginning on or after 1 January 2005. AIFRS has affected a number of areas in the RBA's financial statements. The new standards have had little impact on balance sheet footings, but involved a range of changes to disclosure in the notes to the RBA's financial statements. The main effects of the new standards on the opening balance sheet and the financial statements for 2004/05 are discussed below.

Superannuation

Under AIFRS, the RBA recognises in its balance sheet an asset representing the surpluses in the RBA's defined benefit superannuation schemes, the Officers' Superannuation Fund and the UK Pension Scheme; the counterpart to this asset is a new accounting reserve, the Reserve for Unrealised Profits on Superannuation. The RBA recognised all previous cumulative actuarial gains and losses in the opening fair value of the superannuation asset. The value of this asset in the opening balance sheet is $57 million ($55 million as at 30 June 2005); this amount is included in Loans, advances and other assets. Subsequently, the RBA has valued the superannuation asset in accordance with the ‘corridor’ approach under AASB 119 – Employee Benefits. Prior to AIFRS, surpluses from the defined benefit schemes were not recorded on the balance sheet, but disclosed in the notes to the RBA's financial statements.

Under the new approach, superannuation expense charged to the Income Statement includes the RBA's contributions, service costs, interest costs, less the actuarially assumed return on fund assets and any amortisation of actuarial gains and losses which exceed the corridor (10 per cent of the superannuation funds' assets or liabilities, whichever is greater). Under previous standards, superannuation expense comprised only the RBA's contributions to these superannuation schemes. Accordingly, the RBA's superannuation expense in 2004/05 under AIFRS was $2 million higher than in the financial statements published for 2004/05.

Financial instruments

The RBA brings its foreign and domestic securities transactions and foreign exchange transactions to account under AIFRS on a trade date basis – that is, it recognises 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. Under previous arrangements, these transactions were recognised on the balance sheet at settlement date. Bank deposits and repurchase agreements continue to be brought to account on settlement date. In addition, all securities are valued at bid prices, while all foreign currency assets and liabilities and futures contracts are valued at relevant bid or offer rates. Domestic securities, futures contracts and foreign currency assets and liabilities were previously valued using mid rates.

As a result of these changes:

• foreign currency assets and liabilities in the opening balance sheet under AIFRS were $106 million and $127 million higher compared with previous standards (and $259 million and $267 million higher at 30 June 2005);
• accounting profits in 2004/05 were $13 million higher than under previous standards; and
• the Reserve for Unrealised Profits on Investments in the opening balance sheet was $21 million lower ($8 million lower as at 30 June 2005).

Interest receivable of $39 million on repurchase agreements and foreign bank deposits was reported as a separate asset under AIFRS in the RBA's opening balance sheet, rather than included in the asset value as was the treatment under previous standards. The amount of interest receivable reclassified in the balance sheet as at 30 June 2005 was $99 million. This has had a small compositional effect on the RBA's balance sheet.

Gold

The RBA values gold at the bid price under AIFRS, whereas it previously valued this asset using the mid price. This has had the effect of reducing the value of gold in the opening balance sheet by $0.2 million and by $0.9 million as at 30 June 2005. The counterpart adjustments are reflected in lower balances in the gold revaluation reserve at these dates under the new standards.

Property, plant and equipment

In accordance with AIFRS, the RBA has established individual asset revaluation reserves for each property and item of plant and equipment. Under previous accounting standards, the RBA revalued individual properties as a single class of assets and all plant and equipment assets as a separate aggregate class of assets. Consequently, the balance of asset revaluation reserves in the opening balance sheet and at 30 June 2005 was $3 million lower than under previous standards. There was no material impact on profits for 2004/05. These adjustments have their counterparts in the Reserve Bank Reserve Fund, the equivalent of the RBA's ‘equity’.

Securency

The value of the RBA's investment in Securency in the opening balance was determined from the share of Securency's equity as at 1 July 2004, as measured under AIFRS, owned by the RBA.

Profits

Accounting profits for 2004/05 determined in accordance with AIFRS were $10 million higher than in the financial statements published for 2004/05. The adoption of AIFRS has had no impact on measured earnings available for distribution to the Australian Government in 2004/05.

Cash flows

The adjustments did not materially affect the RBA Cash Flow Statement.

The effects of the adjustments outlined above on the RBA's opening balance sheet, its balance sheet as at 30 June 2005 and the Income Statement for 2004/05 are summarised in the following tables. These effects are the same as the estimates the RBA disclosed in the notes to its published accounts for 2004/05 as part of the transition to the new arrangements; that is, the RBA has not had to revise its earlier estimates.