Reserve Bank of Australia Annual Report – 2016 Financial Statements Note 1 – Accounting Policies

For the year ended 30 June 2016
Reserve Bank of Australia and Controlled Entity

The Reserve Bank of Australia (RBA) reports its consolidated financial statements in accordance with the Reserve Bank Act 1959 and the Public Governance, Performance and Accountability Act 2013 (PGPA Act). These financial statements for the year ended 30 June 2016 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 Public Governance, Performance and Accountability (Financial Reporting) Rule 2015 (FRR), which is issued pursuant to the PGPA Act. These financial statements comply with International Financial Reporting Standards. In preparing them, the RBA has not ‘early adopted’ new accounting standards or amendments to current standards that apply from 1 July 2016.

These financial statements and accompanying notes are a general purpose financial report prepared in accordance with relevant AAS. Specific 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 Australian dollar 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 by a resolution of the Reserve Bank Board on 2 August 2016 in accordance with the Reserve Bank Act.

(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 in July 2009.

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 had previously owned the other half 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 exceeded certain earnings benchmarks in the period to 31 December 2015. Under these arrangements, an amount of $6.0 million was recognised in the Statement of Comprehensive Income in 2015/16 ($7.7 million in 2014/15). These amounts are shown in Note 2 as the Gain on sale of Securency. Other potential payments relating to the sale remain uncertain at the reporting date and are, therefore, not recognised in these 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 relate 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 include 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), a shareholding in the BIS, gold loans, cash and cash equivalents, Australian banknotes on issue and deposit liabilities. 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. Deposits and repurchase agreements are brought to account on settlement date.

Financial assets

Australian dollar securities

The RBA holds on an outright basis Australian Government Securities and securities issued by the central borrowing authorities of state and territory governments.

Australian dollar securities, except those held under reverse repurchase agreements, are classified under AASB 139 as ‘at fair value through profit or loss’, as they are held to conduct monetary policy and may be sold or lent, typically for short terms, under repurchase agreements. The securities are valued at market bid prices on balance date; valuation gains or losses are taken to profit. Interest earned is accrued over the term of the security and included as revenue in the Statement of Comprehensive Income.

Repurchase agreements and reverse repurchase agreements

In carrying out operations to manage domestic liquidity and foreign reserves, the RBA enters into repurchase agreements and reverse repurchase agreements in Australian dollar and foreign currency securities. A repurchase agreement involves the sale of securities with an undertaking to repurchase them on an agreed future date at an agreed price. In a reverse repurchase agreement, securities are initially bought and this transaction is reversed at an agreed price in the second leg. As a reverse repurchase agreement provides the RBA's counterparties with cash for the term of the agreement, the RBA treats it as an asset by recording 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. This treatment of repurchase agreements 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, the equivalent of 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 in November 2013 to assist eligible financial institutions manage their liquidity after normal business hours following the introduction of same-day settlement of Direct Entry payments. An RBA open repurchase agreement is an Australian dollar reverse repurchase agreement without an agreed maturity date. The RBA accrues interest daily on open repurchase agreements at the target cash rate.

Foreign government securities

Foreign government securities, except those held under reverse repurchase agreements, are classified under AASB 139 as ‘at fair value through profit or loss’, as they are available to be traded in managing the portfolio of foreign exchange reserves. These securities are valued at market bid prices on balance date and valuation gains or losses are taken to profit. 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, while small working balances are also maintained with a small number of commercial banks. Deposits are classified as ‘loans and receivables’ under AASB 139 and recorded at 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).

Foreign currency swaps

The RBA uses foreign currency swaps with market counterparties both to assist daily domestic liquidity management and in managing foreign reserve assets. A foreign currency swap is the simultaneous purchase and sale of one currency against another currency for a specified maturity. 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 market price and valuation gains and losses are taken to profit.

Asian Bond Fund

The RBA invests in a number of non-Japan Asian debt markets through participation in the EMEAP Asian Bond Fund. The RBA had 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 valued on balance date at the relevant unit price of the fund and valuation gains and losses are taken to profit.

Following agreement among member central banks, EMEAP announced the closure of ABF1 in July 2016. The funds of member central banks, including the RBA, invested in ABF1 were transferred to ABF2.

Bank for International Settlements

The RBA holds shares in the BIS. The purpose of this membership is to maintain and develop strong relationships with other central banks. Shares in the BIS are owned exclusively by the central banks and monetary authorities that are its members. Under AASB 139, the RBA's shareholding in the BIS is classified as ‘available for sale’. The shareholding is valued at fair value and revaluation gains and losses are transferred directly to the revaluation reserve for shares in international and other institutions (Note 5). 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 both 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 banknotes on issue

Banknotes on issue are recorded at face value.

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 Other 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) Foreign exchange translation

Assets and liabilities denominated in foreign currency are converted to Australian dollar equivalents at the relevant market exchange rate ruling on balance date in accordance with AASB 121 – The Effects of Changes in Foreign Exchange Rates. Valuation gains or losses on foreign currency are taken to profit. 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.

(d) 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 asset revaluation reserve for gold. The RBA lends gold to institutions that participate 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.

(e) 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 asset revaluation reserve. Any part of a valuation loss that exceeds the balance in the relevant asset revaluation reserve is expensed. Subsequent valuation gains that offset losses that were previously treated as an expense are recognised as revenue in the Statement of Comprehensive Income.

Property

The RBA's Australian properties are formally valued annually by an independent valuer; overseas properties are independently valued on a triennial basis. The most recent independent valuation of overseas properties was at 30 June 2016. Reflecting its specialised nature, the RBA's Business Resumption Site is valued at depreciated replacement cost. Annual depreciation is calculated on a straight line basis using assessments of the remaining useful life of the relevant asset.

Plant and equipment

Plant and equipment is valued by an independent valuer every three years. 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 calculated on a straight line basis using the RBA's assessments 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:

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

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

(f) Computer software

Computer software is treated in accordance with AASB 138 – Intangible Assets. Computer software is recognised at cost less accumulated amortisation and impairment adjustments, if any (refer to Note 7).

Amortisation of computer software is disclosed in Note 2 and is calculated on a straight line basis over the estimated useful life of the relevant asset, usually for a period of 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 from this asset.

(g) 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 to provide for events which are contingent and not foreseeable, including to cover losses from falls in the market value of the RBA's holdings of Australian dollar and foreign currency securities that cannot be absorbed by its other resources. The RBRF also provides for other risks such as fraud and operational risk. In accordance with the Reserve Bank Act, this reserve is funded only by transfers from net profits.

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 consulting the Board, determines any amounts to be placed to the credit of the RBRF from net profit (refer Note 1(h)). Accordingly, the Treasurer, after consulting the Board, has determined that a sum of $1,390 million be transferred from the 2015/16 net profit to the RBRF. The balance of the RBRF currently stands at a level that the Board regards as appropriate for the risks the Bank holds on its balance sheet.

The RBA also holds as equity a number of other reserves.

Unrealised gains and losses on foreign exchange, foreign securities and Australian dollar securities are recognised in net profit. 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 or mature.

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 non-traded assets and their cost. These assets are: gold; property, plant and equipment; and shares in international and other institutions. Valuation gains are transferred directly to the relevant reserves and are included in Other Comprehensive Income; gains on these assets are not distributable unless an asset is sold and these gains are realised.

(h) 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.

(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) Committed Liquidity Facility

From 1 January 2015, the RBA has provided a Committed Liquidity Facility (CLF) to eligible authorised deposit-taking institutions. Fees received from providing the CLF are recognised as fee income in the Statement of Comprehensive Income. Additional information on the CLF is provided in Note 11.

(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 will apply to the RBA's financial statements in future reporting periods, as set out below. Application of these standards is not expected to have a material effect on the RBA's financial statements.

AASB 9 – Financial Instruments

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

AASB 15 – Revenue from Contracts with Customers

AASB 15, which will be applicable for annual reporting periods beginning on or after 1 January 2018, contains requirements for the recognition, measurement, classification and disclosure of revenue arising from contracts with customers. It will replace corresponding requirements currently contained in AASB 118 – Revenue and AASB 111 – Construction Contracts.

AASB 16 – Leases

AASB 16 contains requirements for the recognition, measurement, classification and disclosure of leases for both lessee and lessors. The new standard, which will be applicable for annual reporting periods beginning on or after 1 January 2019, will replace corresponding requirements currently contained in AASB 117 – Leases.