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Notes to the Financial Statements

1. REPORTING ENTITY

Bank of Ceylon (the “Bank”) is a Government corporation domiciled in Sri Lanka, duly incorporated on 1st August 1939 under the Bank of Ceylon Ordinance No.53 of 1938. It is a licensed commercial bank under the Banking Act No.30 of 1988 and amendments thereto. The registered office of the Bank is situated at Bank of Ceylon, “BOC Square”, No.01, Bank of Ceylon Mawatha, Colombo 01, Sri Lanka. The debentures issued by the Bank are listed on the Colombo Stock Exchange and the senior notes amount USD 500 million are listed on the Singapore Stock Exchange.

The staff strength of the Bank as at 31st December 2012 was 7,790 (2011 - 8,115).

Consolidated Financial Statements

The Consolidated Financial Statements prepared as at and for the year ended 31st December 2012 comprise the Bank (“Parent”), its Subsidiaries (together referred to as the “Group”) and the Group’s interests in its Associate companies.

The Bank does not have an identifiable parent of its own.

Approval of Financial Statements by the Board of Directors

The Financial Statements for the year ended 31st December 2012 were authorised for issue on 21st March 2013.

1.1 Principal Activities

Bank

The principal activities of the Bank during the year were commercial banking, personal banking, development financing, mortgage financing, lease financing, investment banking, Islamic banking, Bancassurance, corporate financing, dealing in government securities, pawning, credit card facilities, off-shore banking, foreign currency operations, tele- banking facilities, internet banking and other financial services.

Subsidiaries

The principal activities of the Subsidiaries of the Bank are as follows :

Associates

The principal activities of the Associates of the Bank are as follows.

There were no significant changes in the nature of principal activities of the Bank, Subsidiaries and Associates during the year under review.

Subsequent to the year end 2012, two subsidiaries, Ceylease Limited and MCSL Financial Services Limited have entered into merger agreement, which is due to complete in due course. MCSL Financial Services Limited is continued to be the post amalgamated entity.

Further, two subsidiaries Merchant Bank of Sri Lanka PLC and MBSL Savings Bank Limited have agreed to merge and Merchant Bank of Sri Lanka PLC is continued to be the post amalgamated entity. Merchant Bank of Sri Lanka PLC is awaiting for a license to convert it to a Licensed Specialised Bank along with the merger. Upon receipt of approval of the Central Bank of Sri Lanka, Merchant Bank of Sri Lanka PLC will operate as a Licensed Specialised Bank.

Arrangements have been made to liquidate Southern Development Financial Company Limited during 2013.

2. DIRECTORS’ RESPONSIBILITY FOR FINANCIAL STATEMENTS

The Board of Directors is responsible for the preparation and presentation of the Financial Statements of the Bank and its subsidiaries and associates in compliance with the requirements of the Bank of Ceylon Ordinance and its amendments read with the Banking Act No. 30 of 1988 and its amendments thereto and Sri Lanka Accounting Standards.

3. BASIS OF PREPARATION

3.1 Statement of Compliance

The Consolidated Financial Statements of the Group and the separate Financial Statements of the Bank have been prepared in accordance with Sri Lanka Accounting Standards comprising of Sri Lanka Financial Reporting Standards and Sri Lanka Accounting Standards laid down by The Institute of Chartered Accountants of Sri Lanka. (together referred to as SLFRS in these Financial Statements) The preparation and presentation of these Financial Statements are in compliance with the requirements of the Bank of Ceylon Ordinance and the Companies Act No.07 of 2007. The presentation of the Financial Statements is also in compliance with the requirements of the Banking Act No.30 of 1988.

These Financial Statements, for the year ended 31st December 2012, are the first the Group has prepared in accordance with SLFRS. For periods up to and including the year ended 31st December 2011, the Group prepared its Financial Statements in accordance with the Sri Lanka Accounting Standards (SLAS) which were applicable up to that date. Accordingly, the Group has prepared Financial Statements which comply with SLFRS applicable for the year ending on or after 31st December 2012, together with the comparative year data as at and for the year ended 31st December 2011, as described in the accounting policies. In preparing these Financial Statements, the Group’s opening Statement of Financial Position was prepared as at 1st January 2011, the Group’s date of transition to SLFRS. Note 57 explains the principal adjustments made by the Bank and the Group in restating its Statement of Financial Position as at 1st January 2011 and its previously published Financial Statements as at and for the year ended 31st December 2011.

3.2 Basis of Measurement

The Consolidated Financial Statements have been prepared on the basis of historical cost convention except for the following:

No adjustments have been made for inflationary factors affecting the Financial Statements.

3.3 Functional and Presentation currency

Items included in the Consolidated Financial Statements are measured in Sri Lankan Rupees (‘LKR’) which is the currency of the primary economic environment in which the Bank operates. The Consolidated Financial Statements are presented in Sri Lankan Rupees, which is the Group’s functional and presentation currency. Except as otherwise indicated, financial information presented in Sri Lankan Rupees has been rounded to the nearest thousand.

3.4 Presentation of Financial Statements

The Bank and the Group present its Statement of Financial Position broadly in order of their relative liquidity.

Financial Assets and Financial Liabilities are offset and the net amount is reported in the Consolidated Statement of Financial Position only when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the assets and settle the liability simultaneously. Income and expenses are not offset in the Consolidated Income Statement unless required or permitted by any accounting standard or interpretation, and as specifically disclosed in the accounting policies of the Bank.

3.5 Use of Significant Accounting Judgments, Estimates and Assumptions

The preparation of the Consolidated Financial Statements requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates.

The judgment, estimates and assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances and reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimates are revised and/or in future periods if the revision affects future periods too.

In the process of applying the Group’s accounting policies, management has made the following estimates, assumptions and judgments, which have the most significant effect on the amounts recognised in the Consolidated Financial Statements.

Going Concern

The management has made an assessment on the Bank’s ability to continue as a going concern and is satisfied that it has the resources to continue in business for the foreseeable future. Furthermore, management is not aware of any material uncertainties that may cast significant doubt upon the Bank’s ability to continue as a going concern. Therefore, the Financial Statements continue to be prepared on the going concern basis.

Fair Value of Financial Instruments

When the fair value of financial assets and financial liabilities recorded in the Statement of Financial Position cannot be derived from active markets, they are determined using variety of valuation techniques that include the use of mathematical models. The inputs to these models are taken from observable markets where possible, however if such data are not available, a degree of judgment is exercised in establishing fair values.

Impairment of Available for Sale Investments

The Group reviews its debt securities classified as Available for Sale Investments at each reporting date to assess whether they are impaired. This requires similar judgment as applied to the individual assessment of loans and advances. The Group also records impairment charges on available for sale equity investments when there has been a significant or prolonged decline in the fair value below their cost. The determination of what is ‘significant or prolonged’ requires judgment. In making this judgment, the Group evaluates, among other factors, historical share price movements and duration and extent to which the fair value of an investment is less than its carrying value.

Impairment Losses on Loans and Advances

The Group reviews its individually significant loans and advances at each reporting date to assess whether an impairment loss should be recorded in the Income Statement. In particular, management’s judgment is required in the estimation of the amount and timing of future cash flows when determining the impairment loss. These estimates are based on assumptions about a number of factors and actual results may differ, resulting in future changes to the allowance.

Loans and advances that have been assessed individually and found to be not impaired and all individually insignificant loans and advances are assessed collectively, in groups of assets with similar risk characteristics, to determine whether provision should be made based on incurred loss events for which there is objective evidence, but the effects of which are not yet evident. The collective assessment takes account of data from the loan portfolio (such as loan type, levels of arrears etc.), and judgments on the effect of concentrations of risks and economic data (including levels of unemployment, real estate prices indices, country risk and the performance of different individual groups).

Defined Benefit Obligation

The cost of the defined benefit pension plans and other post employment benefit plans are determined using an actuarial valuation. An actuarial valuation involves making various assumptions determining the discount rates, expected rates of return on assets, future salary increases, mortality rates and future pension increases. Due to the long term nature of these plans, such estimates are subject to significant uncertainty. All assumptions are reviewed at each reporting date.

Fair Value of Property Plant and Equipment

The freehold land and buildings and the buildings on leasehold land of the Group are reflected at fair value. The group engaged independent valuation specialists to determine fair value of such properties. When current market prices of similar assets are available, such evidences are considered in estimating fair value of these assets.

Taxation

The Group is subject to income tax and other taxes including Value Added Tax (VAT) on financial services. Significant judgment was required to determine the total provision for current, differed and other taxes pending the issues of tax guidelines on the treatment of the adoption of SLFRS in the Financial Statements and the taxable profit for the purpose of imposition of taxes. Uncertainties exist with respect to the interpretation of the applicability of tax laws, at time of the preparation of these Financial Statements.

The Group recognises assets and liabilities as current, differed and other taxes based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters is different from the amounts that were initially recorded, such differences will impact the income and differed tax amounts in the period in which the determination is made.

Useful Life Time of the Property Plant and Equipment

The Group reviews the residual values, useful lives and methods of depreciation of assets at each reporting date. Judgment of the management is exercised in the estimation of these values, rates methods and hence they are subject to uncertainty.

4. SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies applied by the Bank and the Group in preparation of its Financial Statements are included below. The accounting policies set out below have been consistently applied to all periods presented in these Financial Statements and in preparing the opening SLFRS Statement of Financial Position as at 1st January 2011 for the purpose of transition to SLFRS, unless otherwise indicated.

4.1 Basis of Consolidation

4.1.1 Subsidiaries

Subsidiaries are entities controlled by the Bank. The Financial Statements of subsidiaries are included in the Consolidated Financial Statements from the date that control commences until the date that control ceases. The Financial Statements have been prepared using uniform accounting policies for like transactions and other events in similar circumstances.

The Consolidated Financial Statements are prepared to common financial year end of 31st December.

There are no significant restrictions on the ability of Subsidiaries to transfer funds to the parent in the form of cash dividends or to repay loans and advances. All subsidiaries of the Bank have been incorporated in Sri Lanka except for Bank of Ceylon (UK) Limited, which is incorporated in the United Kingdom.

A listing of the Bank’s Subsidiaries is given in Note 1.1 to the Financial Statements.

4.1.2 Associates

Associates are those entities in which the Bank has significant influence, but not control, over the financial and operating policies. Significant influence is presumed to exist when the Group holds between 20 and 50 percent of the voting power of another entity. Investments in associate entities are accounted for using the equity method (equityaccounted investees) and are recognized initially at cost. The cost of the investment includes transaction costs. Even though the Bank holds between 20 and 50 percent of share holdings, if the Bank does not have significant influence, such entities are not considered as associates.

The Consolidated Financial Statements include the Bank’s share of the profit or loss and other comprehensive income, after adjustments to align the accounting policies with those of the Group, from the date that significant influence commences until the date that significant influence ceases.

When the Bank’s share of losses exceeds its interest in an equityaccounted investee, the carrying amount of that interest, including any long-term investments, is reported at nil, and the recognition of further losses is discontinued except to the extent that the Group has an obligation or has made payments on behalf of the investee. If the associate subsequently reports profits, the Bank’s resumes recognising it share of those profits only after its share of the profits equals the share of losses not recognised.

A list of the Bank’s Associates is shown in Note 1.1 to the Financial Statements.

4.1.3 Business Combination

Group measures goodwill as the fair value of the consideration transferred including the recognised amount of any non-controlling interest in the acquires , less the net recognised amount (generally fair value) of the identifiable assets acquired and liabilities assumed, all measured as of the acquisition date less any impairment losses. Also goodwill to be reviewed for impairment periodically. However, as per the requirements of the Section 22 of the Banking Act No 30 of 1988, goodwill is written off in full in the year of acquisition.

When the excess is negative, a bargain purchase gain is recognised immediately in profit or loss. The Group elects on a transaction-bytransaction basis whether to measure non-controlling interest at its fair value, or at its proportionate share of the recognised amount of the identifiable net assets, at the acquisition date.

Transaction costs, other than those associated with the issue of debt or equity securities, that the Group incurs in connection with a business combination are expensed as incurred.

4.1.4 Acquisitions of Non-Controlling Interests

Acquisitions of non-controlling interests are accounted for as transactions with equity holders in their capacity as equity holders. Therefore, no goodwill is recognised as a result of such transactions.

4.1.5 Loss of Control

Upon the loss of control, the Group derecognises the assets and liabilities of the subsidiary, any non-controlling interests and the other components of equity related to the Subsidiary. Any surplus or deficit arising on the loss of control is recognised in the Income Statement. If the Group retains any interest in the previous subsidiary, then such interest is measured at fair value at the date that control is lost. Subsequently, it is accounted for as an equity-accounted investee or in accordance with the Group’s accounting policy for financial instruments .

4.1.6 Transactions Eliminated on Consolidation

All intra-group transactions, balances, income and expenses (except for foreign currency transaction gains or losses) are eliminated on consolidation. Unrealised gains and losses resulting from transactions between the Group and its Associates are also eliminated on consolidation to the extent of the Group’s interests in the Associates. Unrealised losses are eliminated in the same way as unrealised gains, but only to the extent that there is no evidence of impairment.

4.2 Foreign Currency

4.2.1 Foreign Currency Transactions

Transactions in foreign currencies are translated into the respective functional currency of the operation at the spot exchange rate at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the reporting date are retranslated into the functional currency at the spot exchange rate at that date and all differences arising on non trading activities are taken to ‘Other Operating Income’ in the Income Statement.

Non-monetary assets and liabilities denominated in foreign currencies that are measured at fair value are retranslated into the functional currency at the spot exchange rate at the date of the initial transaction. Foreign currency differences arising on retranslation are recognised in the Income Statement.

Non-monetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction.

Forward exchange contracts are valued at the forward market rates ruling on the reporting date resulting net unrealised gains or losses are dealt with the Income Statement.

4.2.2 Foreign Operations

The results and financial position of foreign operations, whose functional currencies are not Sri Lankan Rupees are translated into Sri Lankan Rupees as follows.

The assets and liabilities of foreign operations are translated into Sri Lankan Rupees at spot exchange rates at the reporting date. The income and expenses of foreign operations are translated at monthly average rate.

Foreign currency differences on the translation of foreign operations are recognised in Other Comprehensive Income.

When a foreign operation is disposed off, the relevant amount in the translation is transferred to the Income Statement as part of the profit or loss on disposal.

4.3 Cash and Cash Equivalents

Cash and cash equivalents include local and foreign currency notes and coins on hand, unrestricted balances held with central banks, balances with other banks and highly liquid financial assets with original maturities of less than three months, which are subject to insignificant risk of changes in their fair value, and are used by the Group in the management of its short-term commitments.

4.3.1 Cash Flow Statement

Consolidated Cash Flow Statement has been prepared by using of ‘Indirect Method’ in accordance with the Sri Lanka Accounting Standards - LKAS 07, whereby the profit is adjusted to derive the cash flow from operating activities. Cash and cash equivalents comprise cash, amounts due from / due to other banks other short-term highly liquid investment with maturity less than three months from date of acquisition.

4.4 Financial Assets and Financial Liabilities

4.4.1 Date of Recognition

All financial assets and liabilities are initially recognised on the settlement date, i.e., the date that the Group becomes a party to the contractual provisions of the instrument. This includes ‘regular way trades’: purchases or sales of financial assets that require delivery of assets within the time frame generally established by regulation or convention in the market place.

4.4.2 Initial Measurement of Financial Instruments

The classification of financial instruments at initial recognition depends on their purpose and characteristics and the management’s intention in acquiring them.

Financial assets and liabilities are initially measured at their fair value plus transaction cost, except in the case of financial assets and liabilities recorded at fair value through profit or loss.

For the purpose of measuring financial assets and liabilities following classification is made:

Fair value through profit or loss
Held-to-maturity investments
Loans and receivable
Available-for-sale financial assets

4.4.3 Financial Assets and Liabilities at Fair Value Through Profit or Loss

Financial assets and liabilities are classified as fair value through profit or loss (FVTPL) if they are held for trading or are designated at fair value through profit or loss. Upon initial recognition, transaction cost are directly attributable to the acquisition are recognized in profit or loss as incurred.

• Derivatives Recorded at Fair Value Through Profit or Loss

The Group uses derivatives such as cross-currency swaps, forward foreign exchange contracts. Derivatives are recorded at fair value and carried as assets when their fair value is positive and as liabilities when their fair value is negative. Changes in the fair value of derivatives are included in ‘Net trading income’.

• Financial Assets and Liabilities Held for Trading

Financial assets and liabilities held for trading are recorded in the Statement of Financial Position at fair value. Changes in the fair value of financial assets and liabilities held for trading is recorded in ‘Net Trading Income’. Included in this classification are debt securities that have been acquired principally for the purpose of selling or repurchasing in the near term.

4.4.4 Held-to-Maturity Financial Assets

Held-to-maturity financial investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group has the positive intent and ability to hold to maturity.

After initial measurement, held-to-maturity financial assets are subsequently measured at amortised cost using the Effective Interest Rate (EIR) less impairment. Amortised cost is calculated by taking into account any discount or premium on acquisition and fees that are an integral part of the EIR. The amortization is included in ‘Interest Income’ in the Income Statement. A sale or reclassification of a more than insignificant amount of held-to-maturity investments would result in the reclassification of all held-to-maturity investments as available for sale, and would prevent the Group from classifying investment securities as held to maturity for the current and the following two financial years. However, sales and reclassifications in any of the following circumstances would not trigger a reclassification:

4.4.5 Placements with Banks and Loans and Advances to Customers

‘Placements with banks ’ and ‘Loans and advances to customers’ include non–derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than:

After initial measurement, ‘Placements with banks’ and ‘Loans and advances to customers’ are subsequently measured at amortised cost using the EIR, less allowance for impairment. Amortised cost is calculated by taking into account any discount or premium on acquisition and fees and costs that are an integral part of the EIR. The amortisation is included in ‘Interest and similar income’ in the Income Statement. The losses arising from impairment are recognised in the Income Statement under ‘Impairment charge / (reversal) for loans and other losses’.

The Group writes off certain loans and advances and investment securities when they are determined to be uncollectible.

4.4.6 Available-for-Sale Financial Investments

Available for sale investments include equity and debt securities. Equity investments classified as available for sale are those which are neither classified as held for trading nor designated at fair value through profit or loss.

Debt securities in this category are intended to be held for an indefinite period of time and may be sold in response to needs for liquidity or in response to changes in the market conditions. The Group has not designated any loans or receivables as available for sale.

After initial measurement, available for sale financial investments are subsequently measured at fair value.

Unrealised gains and losses are recognised directly in equity (Other Comprehensive Income) in the ‘Available for sale reserve’. When the investment is disposed of, the cumulative gain or loss previously recognised in equity is recognised in the Income Statement under ‘Other operating income’. Where the Group holds more than one investment in the same security, they are deemed to be disposed of on a first–in first–out basis. Interest earned whilst holding available for sale financial investments is reported as interest income using the EIR. Dividends earned whilst holding available for sale financial investments are recognised in the Income Statement as ‘Other operating income’ when the right of the payment has been established. The losses arising from impairment of investments’ are removed from the ‘Available for sale reserve’.

4.4.7 ‘Day 1’ Profit or Loss

When the transaction price differs from the fair value of other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable markets, the group immediately recognizes the difference between the transaction price and fair value (a ‘Day 1’ profit or loss) in ‘Net trading income’. In cases where fair value is determined using data which is not observable, the difference between the transaction price and model value is only recognized in the income statement over the life of the instrument.

4.4.8 Debt Securities Issued and Other Borrowings

Financial instruments issued by the Group that are not designated at fair value through profit or loss, are classified as liabilities under ‘Debt securities issued’ and ‘Other borrowings’ , where the substance of the contractual arrangement results in the Group having an obligation either to deliver cash or another financial asset to the holder, or to satisfy the obligation other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of own equity shares.

After initial measurement, debt securities issued and other borrowings are subsequently measured at amortised cost using the EIR. Amortised cost is calculated by taking into account any discount or premium on the issue and costs that are an integral part of the EIR.

4.4.9 De-recognition

The Group derecognises a financial asset when the contractual rights to the cash flows from the financial asset expire, or when it transfers the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred or in which the Group neither transfers nor retains substantially all the risks and rewards of ownership and it does not retain control of the financial asset.

Any interest in transferred financial assets that qualify for derecognition that are created or retained by the Group is recognised as a separate asset or liability in the Statement of Financial Position. On derecognition of a financial asset, the difference between the carrying amount of the asset (or the carrying amount allocated to the portion of the asset transferred), and the sum of (i) the consideration received (including any new asset obtained less any new liability assumed) and (ii) any cumulative gain or loss that had been recognised in Other Comprehensive Income is recognised in the Income Statement.

The Group enters into transactions whereby it transfers assets recognised on its Statement of Financial Position, but retains either all or substantially all of the risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, then the transferred assets are not derecognised. Transfers of assets with retention of all or substantially all risks and rewards include, for example, securities lending and repurchase transactions.

When assets are sold to a third party with a concurrent total rate of return swap on the transferred assets, the transaction is accounted for as a secured financing transaction similar to repurchase transactions as the Group retains all or substantially all the risks and rewards of ownership of such assets.

In transactions in which the Group neither retains nor transfers substantially all the risks and rewards of ownership of a financial asset and it retains control over the asset, the Group continues to recognise the asset to the extent of its continuing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset.

In certain transactions the Group retains the obligation to service the transferred financial asset for a fee. The transferred asset is derecognised if it meets the derecognition criteria. An asset or liability is recognised for the servicing contract, depending on whether the servicing fee is more than adequate (asset) or is less than adequate (liability) for performing the service.

A financial liability is derecognised when the obligation under the liability is discharged or cancelled or expired. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability. The difference between the carrying value of the original financial liability and the consideration paid is recognised in the Income Statement.

4.4.10 Repurchase and Reverse Repurchase Agreements

Securities sold under agreements to repurchase at a specified future date are not derecognised from the Statement of Financial Position as the Group retains substantially all of the risks and rewards of ownership. The corresponding cash received is recognised in the Consolidated Statement of Financial Position as an asset with a corresponding obligation to return it, including accrued interest as a liability within ‘Other Borrowings’ , reflecting the transaction’s economic substance as a loan to the Group. The difference between the sale and repurchase prices is treated as interest expense and is accrued over the life of agreement using the EIR.

Conversely, securities purchased under agreements to resell at a specified future date are not recognised in the Statement of Financial Position. The consideration paid, including accrued interest, is recorded in the Statement of Financial Position, within ‘Reverse repurchase agreements’ ,reflecting the transaction’s economic substance as a loan by the Group. The difference between the purchase and resale prices is recorded in ‘Net interest income’ and is accrued over the life of the agreement using the EIR.

4.4.11 Determination of Fair Value

The fair value for financial instruments traded in active markets at the reporting date is based on their average quoted market price or average dealer price quotations, without any deduction for transaction costs. For all other financial instruments not traded in an active market, the fair value is determined by using appropriate valuation techniques. Valuation techniques include the discounted cash flow method, comparison with similar instruments for which market observable prices exist, and other relevant valuation models.

4.4.12 Offsetting

Financial assets and liabilities are offset and the net amount presented in the Statement of Financial Position when, and only when, the Group has a legal right to set off the recognised amounts and it intends either to settle on a net basis or to realise the asset and settle the liability simultaneously.

4.4.13 Impairment of Financial Assets

At each reporting date the Group assesses whether there is objective evidence that a financial assets or a group of financial assets is impaired. A financial asset or a group of financial assets is impaired when objective evidence demonstrates that a loss event has occurred after the initial recognition of the asset(s), and that the loss event has an impact on the future cash flows of the asset(s) that can be estimated reliably.

• Those Impairment of Financial Assets Carried at Amortized Cost

The Group assesses at each reporting date, whether there is any objective evidence that a financial asset or group of financial assets is impaired.

Objective evidence that financial assets (including equity securities) are impaired can include significant financial difficulty of the borrower or issuer, default or delinquency by a borrower, restructuring of a loan or advance by the Group on terms that the Group would not otherwise consider, indications that a borrower or issuer will enter bankruptcy, the disappearance of an active market for a security, or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers or issuers in the group, or economic conditions that correlate with defaults in the Group.

If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future expected credit losses that have not yet been incurred). The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the Income Statement. Interest income continues to be accrued on the reduced carrying amount and is accrued using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.The interest income is recorded as part of ‘Interest income’.

All individually significant loans and advances found not to be specifically impaired are then collectively assessed for any impairment that has been incurred but not yet identified. Loans and advances that are not individually significant are collectively assessed for impairment by grouping together loans and advances with similar risk characteristics. In assessing collective impairment the Group uses statistical modeling of historical trends of the probability of default, timing of recoveries and the amount of loss incurred, adjusted for management’s judgment as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical modeling.

Impairment of loans and advances portfolios are based on the judgments in past experience of portfolio behavior. However, this port folios are not gone through the full economic life cycle. It may not encounter any future uncertainties that could arise. Therefore, to avoid this limitation an economic factor adjustment has been incorporated in the Financial Statements.

Loans together with the associated allowance are written off when there is no realistic prospect of future recovery and all collateral has been realised or has been transferred to the Group. If, in a subsequent year, the amount of the estimated impairment loss increases or decreases because of an event occurring after the impairment was recognised, the previously recognised impairment loss is increased or reduced by adjusting the allowance account. If a write–off is later recovered, the recovery is recognized in the ‘Other Operating Income’.

• Impairment Assessment of Held to Maturity Financial Assets

Impairment losses on held to maturity financial assets measured at amortised cost are calculated as the difference between the carrying amount of the financial asset and the present value of estimated future cash flows discounted at the asset’s original effective interest rate. Impairment losses are recognised in the Income Statement and reflected in an impairment charges against loans and advances. Interest on impaired assets continues to be recognised through the unwinding of the discount. When a subsequent event causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through the Income Statement.

• Impairment Assessment of Available for Sale Investments

Impairment losses on available-for-sale investment securities are recognised by transferring the cumulative loss that has been recognised in Other Comprehensive Income to the Income Statement as a reclassification adjustment. The cumulative loss that is reclassified from Other Comprehensive Income to the Income Statement is the difference between the acquisition cost, net of any principal repayment and amortisation, and the current fair value, less any impairment loss previously recognised in the Income Statement. Changes in impairment provisions attributable to time value are reflected as a component of interest income.

If, in a subsequent period, the fair value of an impaired availablefor- sale debt security increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in the Income Statement, the impairment loss is reversed, with the amount of the reversal recognised in the Income Statement. However, any subsequent recovery in the fair value of an impaired available-for-sale equity security is recognised in Other Comprehensive Income.

• Renegotiated Loans

Where possible, the Group seeks to restructure loans rather than take possession of collateral. This may involve extending the payment arrangements and agreement of new loan conditions. Once the terms have been renegotiated, any impairment is measured using the original EIR as calculated before the modification of terms and the loan is no longer considered past due. Management continually reviews renegotiated loans to ensure that all criteria are met and that future payments are likely to occur. The loans continue to be subject to an individual or collective impairment assessment, calculated using the loan’s original EIR.

• Collateral Valuation

The Group seeks to use collateral, where possible, to mitigate its risks on financial assets. The collateral comes in various forms such as cash, securities, letters of credit / guarantees, real estate, receivables, inventories, other non-financial assets and credit enhancements such as netting agreements.

The fair value of collateral is generally assessed, at a minimum, at inception and based on the guidelines issued by the Central Bank of Sri Lanka.

Non-financial collateral, such as real estate, is valued based on data provided by third parties such as independent valuers and Audited Financial Statements.

• Collateral Repossessed

The Group’s policy is to determine whether a repossessed asset is best used for its internal operations or be sold. Assets determined to be useful for the internal operations are transferred to their relevant asset category at the lower of their repossessed value or the carrying value of the original secured asset.

4.5 Non – Financial Assets

4.5.1 Property, Plant and Equipment

4.5.1.1 Recognition and Measurement

Property, Plant and Equipment are recognised if it is probable that future economic benefits associated with the assets will flow to the Group and the cost of the asset can be reliably measured.

Cost includes expenditures that are directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials and direct labour, any other costs directly attributable to bringing the assets to a working condition for their intended use, the costs of dismantling and removing the items and restoring the site on which they are located. Purchased software that is integral to the functionality of the related equipment is capitalised as part of that equipment.

Items of property, plant and equipment are measured at cost less accumulated depreciation and accumulated impairment losses for plant and equipment. Revaluation model is applied for entire class of freehold land and buildings and buildings on leasehold lands.

Such properties that carried at revaluation amount being their fair value at the date of revaluation, less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Freehold and leasehold land and buildings of the Group are revalued every seven years on a roll over basis to ensure that the carrying amounts do not differ materially from the fair values at the reporting date. An surplus arising on revaluation of an asset is recognised in the Other Comprehensive Income except to the extent that surplus reverse a previous revaluation deficit on the same asset recognised in the Statement of Other Comprehensive Income, in which case the credit to that extent is recognised in the Statement of Other Comprehensive Income. Any deficit in on revaluation is recognised in the Statement of Other Comprehensive Income except to the extent of that it reverses a previous revaluation surplus on the same asset, in which case the debit to that extent is recognised in Other Comprehensive Income.

Accumulated depreciation as at revaluation date is eliminated against the gross carrying amount of assets and the net amount restated to the revalued amount of the assets. Where the carrying value of the property, plant and equipment are reviewed for impairment, when an event or changes in circumstances indicate that the carrying value may not be recoverable.

When parts of an item of Property, Plant or Equipment have different useful lives, they are accounted for as separate items (major components) of property plant and equipment.

4.5.1.2 Subsequent Costs

The cost of replacing a part of an item of property, plant and equipment is recognised in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to the Group and its cost can be measured reliably. The costs of the day-to-day servicing of property, plant and equipment are recognised in the Income Statement as incurred.

4.5.1.3 Depreciation

Depreciation is recognised in Income Statement on a straightline basis over the estimated useful lives of each part of an item of property, plant and equipment since this method most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. Leased assets under finance leases are depreciated over the shorter of the lease term and their useful lives. Land is not depreciated. Further , cost of expansion and major renovations on the building are depreciated over the remaining useful lives of the original buildings.

Provisioning for depreciation of property, plant and equipment is made on pro-rata basis.

The Group’s estimated useful lives for the current and comparative periods are as follows:

Freehold Building     Over 40 - 60 years
Office Equipment     Over 08 years
Furniture & Fittings     Over 08 years
Computer Equipment     Over 05 years
Motor Vehicles    Over 04 years

Depreciation methods, useful lives and residual values are reassessed at each financial year-end and adjusted if appropriate.

4.5.1.4 Derecognition

The carrying amount of an item of property, plant and equipment is derecognised on disposal, replacement or when no future economic benefits are expected from its use. The gain or loss arising from the derecognition of an item of property, plant and equipment is included in the Other operations income / expenses in the Income Statement in the year the item is derecognised.

4.5.1.5 Useful Life and Residual Values

Residual value is the amount that an entity could receive for the asset at the reporting date if the asset were already at the age and in the condition that it will be in when the entity expects to dispose of it. The residual and useful life of an asset are reviewed at least at each reporting date; changes in the residual value and useful life are accounted for prospectively as a change in an accounting estimate only if the residual value is material.

4.5.1.6 Capital Work in Progress

Capital work-in-progress is stated at cost. These are expenses of a capital nature directly incurred in the construction of buildings, awaiting capitalisation.

4.5.2 Leased Assets – Lessee

Leases in terms of which the Group assumes substantially all the risks and rewards of ownership are classified as finance leases. Upon initial recognition the leased asset is measured at an amount equal to the lower of its fair value and the present value of the minimum lease payments. Subsequent to initial recognition, the asset is accounted for in accordance with the Sri Lanka Accounting Standard (LKAS - 17 “Leases”).

Leases other than finance leases are considered as operating leases and, these leased assets are not recognised in the Group’s Statement of Financial Position.

4.5.3 Intangible Assets

Intangible assets represents the value of computer application software and licenses, other than software applied to the operation software system of computers.

Intangible assets acquired by the Group is stated at cost less accumulated amortisation and accumulated impairment losses.

Subsequent expenditure incurred on intangible assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed as incurred.

Amortisation is recognised in the Income Statement on a straight-line basis over the estimated useful lives of the intangible assets, from the date that it is available for use since this most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. The estimated useful life of intangible assets is five years or the best estimate of its useful economic life whichever is lower.

The unamortised balances of intangible assets with finite lives are reviewed for impairment whenever there is an indication for impairment and recognised as expenses in the Income Statement to the extent that they are no longer probable of being recovered from the expected future benefits.

Amortisation methods, useful lives and residual values are reviewed at each financial year-end and adjusted if appropriate. Intangible assets are derecognised when it reveals that they will not generate economic benefits or circumstances indicate that the carrying value is impaired.

Gains or losses arising from derecognition of an intangible assets are measured as the difference between the net disposal proceeds and the carrying amount of the assets and are recognised in Income Statement.

4.5.4 Impairment of non-financial assets

The Bank assesses at each reporting date whether there is an indication that an asset may be impaired. If any indication exists, or when annual impairment testing for an asset is required, the Bank estimates the asset’s recoverable amount. An asset’s recoverable amount is the higher of an asset’s or the fair value of the Cash Generating Unit’s (CGU) fair value less costs to sell and its value in use. Where the carrying amount of an asset or CGU exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount.

In assessing value in use, the estimated future cash flows are discounted to their present value using a pre- tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset, in determining fair value less costs to sell, an appropriate valuation model is used. These calculations are corroborated by valuation multiples, quoted share prices for publicly traded Subsidiaries or other valuable fair value indicators.

4.6 Employee Benefits

4.6.1 Defined Contribution Plans

A Defined Contribution Plan is a post-employment benefit plan under which an entity pays fixed contributions into a separate entity and will have no legal or constructive obligation to pay further amounts. Obligations for contributions to defined contribution pension plans are recognised as an expense in the Income Statement when they are due in respect of service rendered before the end of the reporting period. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in future payments is available. Contributions to a defined contribution plan that is due more than 12 months after the end of the reporting period in which the employees render the service are discounted to their present value at the reporting date.

• Bank of Ceylon Provident Fund

All employees of the Bank are members of the ‘Bank of Ceylon Provident Fund’ to which the Bank contributes 12% of employee’s monthly gross salary excluding overtime while employees contribute 8%. The Bank’s Provident Fund is an approved fund, which is independently administered.

• Employees’ Provident Fund

The Subsidiaries and their employees (other than Bank of Ceylon and its employees) contribute 12% (15% by Property Development PLC) and 8% respectively on salary of each employee to Employees’ Provident Fund, in terms of the Employees’ Provident Fund Act No. 15 of 1958 as amended.

• Employees’ Trust Fund

All employees of the Bank and its Subsidiaries are members of the Employees’ Trust Fund to which Bank / Group contributes 3% of employee’s monthly gross salary excluding overtime, in terms of Employees’ Trust Fund Act No. 46 of 1980.

4.6.2 Defined Benefit Plans

A Defined Benefit Plan is a post employment benefit plan other than a defined contribution plan. The Group’s net obligation in respect of defined benefit pension plans is calculated separately for each plan by estimating the amount of future benefit that employees have earned in return for their service in the current and prior periods and discounting that benefit to determine its present value, and then deducting the fair value of any plan assets. The discount rate is the yield at the reporting date on long term treasury bond rate for discount rates actually used that have maturity dates approximating the terms of the Group’s obligations. The calculation is performed by a qualified actuary using the projected unit credit method.

The Group recognises all actuarial gains and losses arising from defined benefit plans in the Statement of Other Comprehensive Income and the expenses related to defined benefit plans under personnel expenses in the Income Statement.

• Bank of Ceylon Pension Trust Fund

The ‘Bank of Ceylon Pension Trust Fund’ is a funded, non-contributory, defined retirement benefit plan, operated for the payment of pensions until death to the permanent employees who have completed a minimum of ten years of continuous service with the Bank, at their retirement on reaching the retirement age on or after 55 years or on medical grounds, before reaching retirement age. The pension is computed as a percentage of the last drawn salary excluding certain allowances.

Contributions to the Pension Trust Fund are made monthly, based on the advice of a qualified actuary, currently at 56.76% of gross salary.

The Fund is actuarially valued by a qualified actuary annually.

The Subsidiaries and Associate Companies of the Group do not have pension funds.

• Bank of Ceylon Widows’ / Widowers’ and Orphans’ Pension Fund

The Bank is liable for and guarantees the payments to the beneficiaries of the ‘Bank of Ceylon Widows’ / Widowers’ and Orphans’ Pension Fund’ to which the Bank’s employees monthly contribute 8% of their gross salary. The Bank’s liability towards the beneficiaries of the employees arises when an employee who has contributed to the fund for five continuous years dies while in service or on the death of a pensioner where the Bank will be liable to pay a monthly Widows’ and Orphans’ Pension to his / her beneficiaries. The pension to beneficiaries of an employee who dies while in service is based on the last drawn salary excluding certain allowances.

The Fund is valued by a qualified actuary annually. Funding would be done in consultation with the Actuary, Trustees and Beneficiaries. Both the Pension Fund and the Widows’ / Widowers’ and Orphans’ Pension Fund are approved by the Government and are independently administered.

• Provision for Gratuity

Provision has not been made in the Financial Statements for retirement gratuity payable under the Payment of Gratuity Act No.12 of 1983, to employees who joined the Bank prior to 1st January 1996 as the Bank has its own non-contributory retirement benefit scheme in force. However, employees whose services are terminated other than by retirement are eligible to receive a terminal gratuity under the Payment of Gratuity Act No. 12 of 1983, at the rate of one half of the basic or consolidated wage or salary, cost of living and all other allowances applicable to the last month of the financial year, for each year of continuous service. A provision is being made in this Financial Statements for retirement gratuities from the first year of service for all employees who joined the Bank on or after 1st January 1996, as they are not covered by the pension scheme of the Bank.

In terms of Sri Lanka Accounting Standard - LKAS 19 on “Employee Benefits”, The Bank and its Subsidiaries have calculated the post employment benefit obligations, based on the actuarial valuation method recommended in the Standard.

The Gratuity Liabilities are not externally funded.

4.7 Provisions

A provision is recognised if, as a result of a past event, the Group has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. If the effect of the time value of money is material, provisions are determined by discounting the expected future cash outflows at a current pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage at time is recognized as finance cost.

4. 8 Financial Guarantees

In the ordinary course of business, the Group gives financial guarantees, consisting of letters of credit, guarantees and acceptances. Financial guarantees are initially recognised in the Financial Statements (within ‘Other Liabilities’) at fair value, being the premium received. Subsequent to initial recognition, the Group’s liability under each guarantee is measured at the higher of the amount initially recognised less cumulative amortization recognised in the Income Statement, and the best estimate of expenditure required to settle any financial obligation arising as a result of the guarantee.

Any increase in the liability relating to financial guarantees is recorded in the Income Statement under ‘Impairment losses ’. The premium received is recognised in the Income Statement under ‘Fees and commission income’ on a straight line basis over the life of the guarantee.

4.9 Recognition of Income and Expenditure

4.9.1 Interest

Interest income and expense are recognised in Income Statement using the effective interest method. The effective interest rate is the rate that exactly discounts the estimated future cash payments and receipts through the expected life of the financial asset or liability (or, where appropriate, a shorter period) to the carrying amount of the financial asset or liability. When calculating the effective interest rate, the Group estimates future cash flows considering all contractual terms of the financial instrument, but not future credit losses.

The calculation of the effective interest rate includes all fees paid or received that are an integral part of the effective interest rate. Transaction costs include incremental costs that are directly attributable to the acquisition or issue of a financial asset or liability.

Interest income and expense presented in the Income Statement

include:

Interest income and expense on all trading assets and liabilities are considered to be incidental to the Group’s trading operations and are presented together with all other changes in the fair value of trading assets and liabilities in net trading income.

Fair value changes on derivatives held for risk management purposes, and other financial assets and liabilities carried at fair value through profit or loss, are presented in net income from other financial instruments at fair value through profit or loss in the Statement of Comprehensive Income.

4.9.2 Fees and Commission

The Group earns fee and commission income from a diverse range of services it provides to its customers.

Fee income can be divided into the following two categories:

• Fee income earned from services that are provided over a certain period of time

Fees earned for the provision of services over a period of time are accrued over that period. These fees include commission income and asset management, custody and other management and advisory fees. Credit related fees are deferred and recognised as an adjustment to the EIR on the loan.

• Fee income from providing transaction services

Fees arising from negotiating or participating in the negotiation of a transaction for a third party, such as the arrangement of the acquisition of shares or other securities or the purchase or sale of businesses, are recognised on completion of the underlying transaction. Fees or components of fees that are linked to a certain performance are recognised after fulfilling the corresponding criteria.

4.9.3 Net Trading Income

Net trading income comprises gains and losses related to trading assets and liabilities, and changes in fair value, interest, dividends and foreign exchange differences.

4.9.4 Net Income from Other Financial Instruments at Fair Value Through Profit or Loss

Net income from other financial instruments at fair value through profit or loss relates to non-trading derivatives held for risk management purposes that do not form part of qualifying hedge relationships and includes all realised and unrealised fair value changes, interest, dividends and foreign exchange differences.

4.9.5 Dividends

Dividend income is recognised when the right to receive income is established.

4.9.6 Rental Income

Rental income is recognised on an accrual basis.

4.9.7 Other Income

Other income is recognised on an accrual basis.

4.9.8 Lease Payments

Payments made under operating leases are recognised in the Income Statement on a straight-line basis over the term of the lease. Lease incentives received are recognised as an integral part of the total lease expense, over the term of the lease.

Minimum lease payments made under finance leases are apportioned between the finance expense and the reduction of the outstanding liability. The finance expense is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability.

Contingent lease payments are accounted for by revising the minimum lease payments over the remaining term of the lease when the lease adjustment is confirmed.

4.9.9 Other Expenses

All other expenses have been recognised in the Financial Statements as they are incurred in the period to which they relate. All expenditure incurred in the operation of the business and in maintaining the capital assets in a state of efficiency has been charged to revenue in arriving at the Group’s Profit for the year.

4.10 Income Tax Expense

4.10.1 Current Tax and Deferred Tax

Income tax expense comprises current and deferred tax. Current tax and deferred tax are recognised in the Income Statement except to the extent that it relates to items recognised directly in equity or in Other Comprehensive Income.

Current tax is the expected tax payable or receivable on the taxable income or loss for the year, using tax rates enacted or substantively enacted at the reporting date, and any adjustment to tax payable in respect of previous years.

Deferred tax is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes.

Deferred tax is not recognised for the following temporary differences:

Deferred tax is measured at the tax rates that are expected to be applied to the temporary differences when they reverse, based on the laws that have been enacted or substantively enacted by the reporting date. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities against current tax assets, and they relate to income taxes levied by the same tax authority on the same taxable entity, or on different tax entities, but they intend to settle current tax liabilities and assets on a net basis or their tax assets and liabilities will be realised simultaneously.

A deferred tax asset is recognised for unused tax losses, tax credits and deductible temporary differences to the extent that it is probable that future taxable profits will be available against which they can be utilised. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realised.

4.10.2 Value Added Tax (VAT) on Financial Services

The base for Value Added Tax computation is arrived by aggregating the accounting profit before income tax and emoluments of employees, which is adjusted for the depreciation computed on prescribed rates. During the year, the Bank’s total value addition was subjected to a 12% (12% in 2011) Value Added Tax as per Section 25 (a) of the Value Added Tax Act No.14 of 2002 and amendments thereto. And the Bank is following value attributable method to compute VAT on financial services which is one of two methods prescribed in the Act.

4.10.3 Withholding Tax on Dividends

Dividend distributed out of taxable profit of the Subsidiaries and Associate Companies attracts a 10% deduction at source and is not available for set off against the tax liability of the Bank, since it is treated as a final tax. Thus, the withholding tax deducted at source is added to the tax expense in preparing the Consolidated Financial Statements as a consolidation adjustment.

4.11 Stated Capital and Reserves

The Group classifies capital instruments as financial liabilities or equity instruments in accordance with the substance of the contractual terms of the instruments. Accordingly they are presented as a component of equity.

4.12 Earnings Per Share

The Group presents Basic and Diluted Earnings Per Share (EPS) data for its ordinary shares. Basic EPS is calculated by dividing the profit or loss attributable to ordinary shareholders of the Bank by the weighted average number of ordinary shares outstanding during the period. Diluted EPS is determined by adjusting the profit or loss attributable to ordinary shareholders and the weighted average number of ordinary shares outstanding for the effects of all dilutive potential ordinary shares, which comprise share options granted to employees.

4.13 Segment Reporting

An operating segment is a component of the Group that engages in business activities from which it may earn revenues and incur expenses, including revenues and expenses that relating to transactions with any of the Group’s other components.

The Group comprises the following major business segments: Retail banking, Corporate banking, International treasury and investments, Government of Sri Lanka, other non banking and group functions. The Government of Sri Lanka is considered as a major customer of the Group and considered as a separate segment.

4.14 Events after the Reporting Period

Where necessary all material events after the reporting date have been considered and appropriate adjustments / disclosures have been made in the Financial Statements as per the Sri Lanka Accounting Standards –LKAS 10 Events after the Reporting Period.

5.1 Insurance Business

5.1.1 Reinsurance

The Group cedes insurance risk in the normal course of business for all of its businesses. Reinsurance assets represent balances due from reinsurance companies. Amounts recoverable from reinsurers are estimated in a manner consistent with the outstanding claims provision or settled claims associated with the reinsurer’s policies and are in accordance with the related reinsurance contract.

Reinsurance assets are reviewed for impairment at each reporting date or more frequently when an indication of impairment arises during the reporting year. Impairment occurs when there is an objective evidence as a result of an event that occurred after initial recognition of the reinsurance asset that the Group may not receive all outstanding amounts due under the terms of the contract and the event has a reliably measurable impact on the amounts that the Group will receive from the reinsurer. The impairment loss is recorded in the Income Statement.

The Group also assumes reinsurance risk in the normal course of business for life insurance and non-life insurance contracts where applicable. Premiums and claims on assumed reinsurance are recognised as revenue or expenses in the same manner as they would be if the reinsurance were considered direct business, taking into account the product classification of the reinsured business. Reinsurance liabilities represent balances due to reinsurance companies. Amounts payable are estimated in a manner consistent with the related reinsurance contract.

Premiums and claims are presented on a gross basis for both ceded and assumed reinsurance.

Reinsurance assets or liabilities are derecognised when the contractual rights are extinguished or expire or when the contract is transferred to another party.

5.1.2 Insurance Receivables

Insurance receivables are recognised when due and measured on initial recognition at the fair value of the consideration received or receivable. The carrying value of insurance receivables is reviewed for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable, with the impairment loss recorded in the Income Statement.

5.2 Deferred Expenses

5.2.1 Deferred Acquisition Costs (DAC)

The costs of acquiring new businesses including commission, underwriting, marketing and policy issue expenses, which vary with and directly related to production of new businesses and/or investment contracts with Discretionary Participation Features (DPF), are deferred to the extent that these costs are recoverable out of future premiums. All other acquisition costs are recognised as an expense when incurred. Subsequent to initial recognition, DAC for general insurance is amortised over the period on the basis Unearned Premium is amortised. The reinsurances’ share of deferred acquisition cost is amortized in the same manner as the underlying assets amortization is recorded in the Income Statement

Changes in the expected useful life or the expected pattern of consumption of future economic benefits embodied in the assets are accounted for by changing the amortization period and are treated as a change in an accounting estimate.

DAC are derecognized when the related contracts are either expired or cancelled.

5.3 Reinsurance Commissions

Commissions receivable on outwards reinsurance contracts are deferred and amortized.

5.4 Insurance Contract Liabilities

5.4.1 Life Insurance Contract Liabilities

Life insurance liabilities are recognised when contracts are entered into and premiums are received. These liabilities are measured by using the net premium method. The liability is determined as the sum of the discounted value of the expected future benefits, claims handling and policy administration expenses, policyholder options and guarantees and investment income from assets backing such liabilities, which are directly related to the contract, less the discounted value of the expected theoretical premiums that would be required to meet the future cash outflows based on the valuation assumptions used.

The liability is either based on current assumptions or calculated using the assumptions established at the time the contract was issued, in which case a margin for risk and adverse deviation is generally included. A separate reserve for longevity may be established and included in the measurement of the liability. Furthermore, the liability for life insurance contracts comprises the provision for unearned premiums and unexpired risks, as well as for claims outstanding, Which includes an estimate of the incurred claims that have not yet been reported to the Group. Adjustments to the liabilities at each reporting date are recorded in the Income Statement. Profits originated from margins of adverse deviations on run-off contracts are recognised in the Income Statement over the life of the contract, whereas losses are fully recognised in the Income Statement during the first year of run-off. The liability is derecognised when the contract expires, is discharged or is cancelled.

At each reporting date, an assessment is made of whether the recognised life insurance liabilities are adequate, net of related Present Value Interest Factor (PVIF) and DAC, by using an existing liability adequacy test. The liability value is adjusted to the extent that it is insufficient to meet future benefits and expenses. In performing the adequacy test, current best estimates of future contractual cash flows, including related cash flows such as claims handling and policy administration expenses, policyholder options and guarantees, as well as investment income from assets backing such liabilities, are used. A number of valuation methods are applied, including discounted cash flows, option pricing models and stochastic modeling. To the extent that the test involves discounting of cash flows, the interest rate applied may be based on management’s prudent expectation of current market interest rates. Any inadequacy is recorded in the Income Statement, initially by impairing PVIF and DAC and, subsequently, by establishing a technical reserve for the remaining loss. In subsequent periods, the liability for a block of business that has failed the adequacy test is based on the assumptions that are established at the time of the loss recognition. The assumptions do not include a margin for adverse deviation.

5.4.2 Non-Life Insurance Contract Liabilities

Non-life insurance contract liabilities are recognised when contracts are entered into and premiums are charged. These liabilities are known as the outstanding claims provision, which are based on the estimated ultimate cost of all claims incurred but not settled at the reporting date, whether reported or not, together with related claims handling costs and reduction for the expected value of salvage and other recoveries. Delays can be experienced in the notification and settlement of certain types of claims, therefore the ultimate cost of these cannot be known with certainty at the reporting date. The liability is calculated at the reporting date using a range of standard actuarial claim projection techniques, based on empirical data and current assumptions that may include a margin for adverse deviation. The liability is not discounted for the time value of money. No provision for equalisation or catastrophe reserves is recognised. The liabilities are derecognised when the contract expires, is discharged or is cancelled.

The liabilities are derecognised when the contract expires, is discharged or is cancelled.

This calculation uses current estimates of future contractual cash flows after taking account of the investment return expected to arise on assets relating to the relevant non-life insurance technical provisions. If these estimates show that the carrying amount of the unearned premiums (less related deferred acquisition costs) is inadequate, the deficiency is recognised in the Income Statement by setting up a provision for liability adequacy.

The provision for unearned premiums represents premiums received for risks that have not yet expired. Generally the reserve is released over the term of the contract and is recognized as premium income. At each reporting date the Group reviews its unexpired risk and a liability adequacy test is performed to determine whether there is any overall excess of expected claims and deferred acquisition costs over unearned premiums. This calculation uses current estimates of future contractual cash flows after taking account of the investment return expected to arise on assets relating to the relevant non-life insurance technical provisions. If these estimates show that the carrying amount of the unearned premiums (less related deferred acquisition costs) is inadequate, the deficiency is recognised in the Income Statement by setting up a provision for liability adequacy.

5.5 Investment Contract Liabilities

Investment contracts are classified between contracts with and without DPF. The accounting policies for investment contract liabilities with DPF are the same as those for life insurance contract liabilities. Investment contract liabilities without DPF are recognised when contracts are entered into and premiums are charged. These liabilities are initially recognised at fair value this being the transaction price excluding any transaction costs directly attributable to the issue of the contract. Subsequent to initial recognition investment, contract liabilities are measured at fair value through profit or loss.

Deposits and withdrawals are recorded directly as an adjustment to the liability in the Statement of Financial Position. Fair value adjustments are performed at each reporting date and are recognised in the Income Statement. Fair value is determined through the use of prospective discounted cash flow techniques. For unitised contracts, fair value is calculated as the number of units allocated to the policyholder in each unit-linked fund multiplied by the unit-price of those funds at the reporting date. The fund assets and fund liabilities used to determine the unit-prices at the reporting date are valued on a basis consistent with their measurement basis in the Statement of Financial Position adjusted to take account of the effect on the liabilities of the deferred tax on unrealized gains on assets in the fund.

Non-unitised contracts are subsequently also carried at fair value, which is determined by using valuation techniques such as discounted cash flows and stochastic modeling. Models are validated, calibrated and

periodically reviewed by an independent qualified person.

The liability is derecognised when the contract expires, is discharged or is cancelled. For a contract that can be cancelled by the policyholder, the fair value cannot be less than the surrender value.

When contracts contain both a financial risk component and a significant insurance risk component and the cash flows from the two components are distinct and can be measured reliably, the underlying amounts are unbundled. Any premiums relating to the insurance risk component are accounted for on the same bases as insurance.

5.6 Discretionary Participation Features (DPF)

A DPF is a contractual right that gives holders of these contracts the right to receive as a supplement to guaranteed benefits, significant additional benefits which are based on the performance of the assets held within the DPF portfolio. Under the terms of the contracts surpluses in the DPF funds can be distributed to policyholders and shareholders on a 90/10 basis. The Group has the discretion over the amount and timing of the distribution of these surpluses to policyholders. All DPF liabilities including unallocated surpluses, both guaranteed and discretionary, at annually are held within insurance or investment contract liabilities as appropriate.

5.7 Classification of Financial Instruments between Debt and Equity

A financial instrument is classified as debt if it has a contractual obligation to:

under conditions that are potentially unfavorable to the Group. If the Group does not have an unconditional right to avoid delivering cash or another financial asset to settle its Contractual obligation, the obligation meets the definition of a financial liability.

5.8 Other Financial Liabilities and Insurance Payables

Other financial liabilities are recognized when due and measured on initial recognition at the fair value of the consideration received less directly attributable transaction costs. Subsequent to initial recognition, they are measured at amortized cost using the effective interest rate method.

5.9 De-recognition of Financial Liabilities and Insurance Payables

Financial liabilities and insurance payables are derecognised when the obligation under the liability is discharged, cancelled or expired.

5.10 Income Recognition

5.10.1 Gross Premiums

Gross recurring premiums on life and investment contracts with DPF are recognised as revenue when receivable from the policyholder. For single premium business, revenue is recognised on the date on which the policy is effective.

Gross general insurance written premiums comprise the total premiums receivable for the whole period of cover provided by contracts entered into during the accounting period and are recognised on the date on which the policy commences.

5.10.2 Reinsurance Premiums

Gross reinsurance premiums on life and investment contracts are recognised as an expense when the date on which the policy is effective.

Gross general reinsurance premiums written comprise the total premiums payable for the whole cover provided by contracts entered into the period and are recognised on the date on which the policy incepts. Premiums include any adjustments arising in the accounting period in respect of reinsurance contracts incepting in prior accounting periods.

Unearned reinsurance premiums are those proportions of premiums written in a year that relate to periods of risk after the balance sheet date. Unearned reinsurance premiums are deferred over the term of the underlying direct insurance policies for risks-attaching contracts and over the term of the reinsurance contract for losses occurring contracts.

5.11 Unearned Premium Reserve

Unearned premium reserve represents the portion of the premium written in the year but relating to the unexpired term of coverage. Unearned premiums are calculated on the 1/24th basis except for marine policies which is computed on a 60-40 basis.

5.12 Benefits, Claims and Expenses Recognition

5.12.1 Gross Benefits and Claims

Gross benefits and claims for life insurance contracts and for investment contracts with DPF include the cost of all claims arising during the year including internal and external claims handling costs that are directly related to the processing and settlement of claims and policyholder bonuses declared on DPF contracts, as well as changes in the gross valuation of insurance and investment contract liabilities with DPF. Death claims and surrenders are recorded on the basis of notifications received. Maturities and annuity payments are recorded when due. Interim payments and surrenders are accounted at the time of settlement. General insurance include all claims occurring during the year, whether reported or not, related internal and external claims handling costs that are directly related to the processing and settlement of claims, a reduction for the value of salvage and other recoveries, and any adjustments to claims outstanding from previous years.

Claims expenses and liabilities for outstanding claims are recognised in respect of direct and inward reinsurance business. The liability covers claims reported but not yet paid, Incurred But Not Reported (IBNR) claims and the anticipated direct and indirect costs of settling those claims. Claims outstanding are assessed by review of individual claim files and estimating changes in the ultimate cost of settling claims. The provision in respect of IBNR is actuarially valued on an annual basis to ensure a more realistic estimation of the future liability based on past experience and trends. While the Directors consider that the provision for claims is fairly stated on the basis of information currently available, the ultimate liability will vary as a result of subsequent information and events. This may result in adjustment to the amounts provided. Such amounts are reflected in the Financial Statements for that period. The methods used and the estimates made are reviewed regularly.

5.12.2 Reinsurance Claims

Reinsurance claims are recognised when the related gross insurance claim is recognised according to the terms of the relevant contract.

6. NEW ACCOUNTING STANDARDS ISSUED BUT NOT EFFECTIVE AS AT THE REPORTING DATE

Standards issued but not yet effective up to the date of issuance of the Consolidated Financial Statements are set out below. The Group will adopt these Standards when they become effective. Pending a detailed review, the financial impact is not reasonably estimable as at the date of publication of these Financial Statements.

(i) SLFRS 9 – Financial Instruments: Classification and Measurement

SLFRS 9, as issued reflects the first phase of work on replacement of LKAS 39 and applies to classification and measurement of financial assets and liabilities.

(ii) SLFRS 10 – Consolidated Financial Statements

SLFRS 10 establishes a single control model that applies to all entities including special purpose entities. The changes introduced by SLFRS 10 will require management to exercise significant judgment to determine which entities are controlled and therefore are required to be consolidated by a parent, compared with the requirements in LKAS 27.

(iii) SLFRS 11 – Joint Arrangements

SLFRS 11 replaces LKAS 31 and SIC 13. SLFRS 11 uses the principle of control in SLFRS 10 to define control, and accordingly the determination of whether joint control exists may change.

(iv) SLFRS 12 – Disclosure of Interests in Other Entities

SLFRS 12 encompasses all disclosures related to consolidated Financial Statements in LKAS 27, 28 and 31. These disclosures relate to an entity’s interest in subsidiaries, joint arrangements, associates and structured entities.

(v) SLFRS 13 – Fair Value Measurement

SLFRS 13 establishes and provides a single source of guidance under SLFRS for all fair value measurements.

SLFRS 9 will be effective for financial periods beginning on or after 1st January 2015 whilst SLFRS 10, 11, 12 and 13 will be effective for financial periods beginning on or after 1st January 2014.

(* In accordance with the agreement with Board of Investment (BOI), Koladeniya Hydropower (Private) Limited is exempted from taxation for years 2011 & 2012).

17.4 Notional tax credit for withholding tax on Government securities on secondary market transactions

In terms of the Section 137 of the Inland Revenue Act No. 10 of 2006 and the amendment thereto, a company which derives interest income from the secondary market transactions in Government securities would be entitled to a notional tax credit (being one ninth (1/9) of the net interest income), provided such interest income form a part of statutory income of the company for that year of assessment. Accordingly, the net income earned by the Bank and the Group on the secondary market transactions in Government securities for the year has been grossed up in the Financial Statements and the resulting notional tax credit amounted to sum of LKR 874.2 million (2011 : LKR 792.9 million) for the Bank and LKR 893.2 million (2011 : LKR 814.3 million) for the Group.

18. EARNINGS PER SHARE (EPS) AND DIVIDEND PER SHARE (DPS)
18.1 Basic earnings per share

In accordance with the Sri Lanka Accounting Standard - LKAS 33 “Earnings Per Share”, Basic earnings per share is calculated by dividing the profit or loss attributable to ordinary shareholders of the parent entity (the numerator) by the weighted average number of ordinary shares in issue (the denominator) during the year.

19. ANALYSIS OF FINANCIAL INSTRUMENTS BY MEASUREMENT BASIS
19.1 Bank
19. ANALYSIS OF FINANCIAL INSTRUMENTS BY MEASUREMENT BASIS (Contd.)
19.1 Bank
19. ANALYSIS OF FINANCIAL INSTRUMENTS BY MEASUREMENT BASIS (Contd.)
19.2 Group
19. ANALYSIS OF FINANCIAL INSTRUMENTS BY MEASUREMENT BASIS (Contd.)
19.2 Group
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
24. FINANCIAL ASSETS - HELD FOR TRADING (Contd.)
24.1 Quoted investments (Contd.)
25. FINANCIAL INVESTMENTS - LOANS AND RECEIVABLE
26. LOANS AND ADVANCES TO CUSTOMERS
26.1 Loans and advances - Summary
26.2 Movement in impairment for loans and advances
26. LOANS AND ADVANCES TO CUSTOMERS (Contd.)
27. FINANCIAL INVESTMENTS - AVAILABLE FOR SALE (Contd.)
27. FINANCIAL INVESTMENTS - AVAILABLE FOR SALE (Contd.)
28. FINANCIAL INVESTMENTS - HELD TO MATURITY
29. INVESTMENTS IN SUBSIDIARY COMPANIES (Contd.)
30. INVESTMENTS IN ASSOCIATE COMPANIES
30. INVESTMENTS IN ASSOCIATE COMPANIES (Contd.)
30. INVESTMENTS IN ASSOCIATE COMPANIES (Contd.)
30.5 The Group’s interest in the summarised financial information of Associate Companies are as follows:
31. INVESTMENT PROPERTIES
31. INVESTMENT PROPERTIES (Contd.)
31.1 Investment properties held by the Group

Note :

* The fair value of the investment properties as at 31st December 2012 was based on market valuations carried out by Mr. D N Dhammika Baranage [RICS (UK), DIV AIS (SL)] and Mr. H A W Perera [B Sc Estate Management & Valuation (Special)] who are independent valuers. The directors have reviewed values of the investment properties as at 31st December 2012 and concluded that there were no impairment.

** Professional valuation has been carried out by Mr A G Gunarathna, [B Sc Estate Management and Valuation, FIV (Sri Lanka)] incorporated valuer on the basis of Market Approach (Direct Comparison Method) with effect from 24th July 2009.

32. PROPERTY, PLANT AND EQUIPMENT
32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.3 Title restriction on property, plant and equipment

There were no restrictions that existed in the title of the property, plant and equipment of the Bank and the Group as at the reporting date.

32.4 Property, plant and equipment pledged as security for liabilities

No freehold property, plant and equipment have been pledged as security for any liability.

32.5 Compensation from third parties for items of property, plant and equipment

There were no compensation received / receivable from third parties for items of property, plant and equipment which were impaired or given up.

32.6 Fully depreciated property, plant & equipment

The initial cost of fully depreciated property, plant & equipment, which are still in use are as follows :

32.7 Temporarily idle property, plant & equipment

There were no temporarily idle property, plant and equipment as at the reporting date.

32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.8 Property, plant & equipment retired from active use

The Bank held no property, plant and equipment retired from active use and which were not classified as held for sale in accordance with SLFRS 5 -” Non-current assets held for sale and discontinued operations”

32.9 Freehold properties

The carrying value of the freehold revalued properties, if they were carried at cost less accumulated depreciation would be as follows :

32.10 Revaluation of freehold properties

The following freehold land and buildings of the Bank were revalued by professionally qualified independent valuers and taken into account as at 31st December 2012.

32.11 Revaluation of buildings on leasehold land
32.11.1 Bank

The following buildings on leasehold land were revalued by professionally qualified independent valuers as at 31st December 2012 and the revaluation surplus of LKR 193.3 million was recognised in the Financial Statements of the year 2012.

32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.11 Revaluation of buildings on leasehold land (Contd.)
The details of the revaluation is given below :
32.11.2 Group

The following buildings on leasehold lands of the Subsidiaries were revalued by professionally qualified independent valuers.

32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.12 Equipment
32.12.1 Bank
32.12.2 Group
32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.13 Freehold land and building

The details of freehold land and buildings held by the Bank as at 31st December 2012 are as follows:

32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.13 Freehold land and building (Contd.)

The details of freehold land and buildings held by the Bank as at 31st December 2012 are as follows:

32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.13 Freehold land and building (Contd.)

The details of freehold land and buildings held by the Bank as at 31st December 2012 are as follows:

32. PROPERTY, PLANT AND EQUIPMENT (Contd.)
32.13 Freehold land and building (Contd.)

The details of freehold land and buildings held by the Bank as at 31st December 2012 are as follows:

33. LEASEHOLD PROPERTIES

Leasehold properties represents the leasehold interest in the lands held for own use. The value of buildings situated in the leasehold land is shown separately under property, plant & equipment. The interest on leasehold land is stated at cost less accumulated amortisation.

34. INTANGIBLE ASSETS

Intangible assets represent the value of computer application software systems and subsequent modifications including costs directly attributable in customising for its intended use, and are carried at cost less accumulated amortisation and any impairment losses.

34.1 Fully depreciated intangible assets

The initial cost of fully depreciated intangible assets which are still in use as follows;

35. DEFERRED TAX (ASSETS) / LIABILITIES

The following table shows deferred tax recorded on the statement of financial position and charge / (reversal) recorded in the income tax expense.

36. OTHER ASSETS
39. DUE TO CUSTOMERS (Contd.)
41. DEBT SECURITIES ISSUED (Contd.)
41.2 Types of senior debentures

Notes :

(a) Weighted average 6 months treasury bill interest rate before deducting 10% withholding tax at the primary quotations as announced by the Central Bank of Sri Lanka, at the preceding week of the interest resetting date.

(b) Weighted average 12 months treasury bill interest rate before deducting 10% withholding tax at the primary quotations as announced by the Central Bank of Sri Lanka, at the preceding week of the interest resetting date.

42. INSURANCE PROVISION
43. OTHER LIABILITIES
44. CONTRIBUTIONS TO DEFINED BENEFIT PLANS

The Bank has a Pension Scheme established under an Industrial Award which is solely funded by the Bank. There is also a Widows’ / Widowers’ & Orphans’ Pension Scheme established by the members. Both these funds have been closed to new entrants from 1st January 1996.

The assets of these two plans are held independently of the Bank’s assets and administered by Boards of Trustees / Managers, representing the management and the employees, as provided in the Trust Deed / Rules of the respective funds. Both funds are subject to annual audits independent to the audit of the Bank, by a firm/s of Chartered Accountants appointed by the members and actuarial valuations are carried out at least once in three years, as per the rules governing these funds.

44. CONTRIBUTIONS TO DEFINED BENEFIT PLANS (Contd.)
44.1.1 Bank of Ceylon Pension Trust Fund

An actuarial valuation of the Pension Fund as at 31st December 2012 was carried out by Messers Piyal S Goonetilleke and Associates. The valuation has been done using the “Projected Unit Credit Method”, which is recommended in the Sri Lanka Accounting Standard - LKAS 19 “Employee Benefits”. The benefit is available to all permanent employees who have joined the Bank prior to 1st January 1996. The results of the actuarial valuation of the Pension Trust Fund is summarised as follows:

44. CONTRIBUTIONS TO DEFINED BENEFIT PLANS (Contd.)
44.2.1 Bank of Ceylon Widows’ / Widowers’ and Orphans’ Pension Fund

An actuarial valuation of the Widows’ / Widowers’ and Orphans’ Pension Fund as at 31st December 2012 was carried out by Messers Piyal S Goonetilleke and Associates. The valuation has been done using the “Projected Unit Credit Method”, which is recommended in the Sri Lanka Accounting Standard - LKAS 19 “Employee Benefits”. The results of the actuarial valuation of the Fund is summarised as follows:

44. CONTRIBUTIONS TO DEFINED BENEFIT PLANS (Contd.)
44.3.1 Gratuity Fund

Provision is made to meet the Bank’s obligation to pay gratuity in terms of the Payment of Gratuity Act No 12 of 1983, to all those employees who have joined after 1st January 1996. Provision also includes those who have joined the Bank prior to 1st January 1996 and leave the Bank without being entitled to a pension. An actuarial valuation of the Gratuity Fund as at 31st December 2012 was carried out by Messers Piyal S Goonetilleke and Associates a firm of professional actuaries.

The valuation has been done using the “Projected Unit Credit Method”, which is recommended in the Sri Lanka Accounting Standard - LKAS 19 “Employee Benefits”.

The results of the actuarial valuation of the Gratuity Fund indicates that LKR. 294.2 million as at 31st December 2012 (2011 : LKR. 248.3 million). The provision made by the Bank is adequate to meet its gratuity obligations in full. The principal actuarial assumptions used in the valuation were as follows :

45. SUBORDINATED TERM DEBTS
45. SUBORDINATED TERM DEBTS (Contd.)
45.2 Type of debentures (Contd.)

Notes :

(a) Debentures that are listed in the Colombo Stock Exchange. Some of these have been traded in the Colombo Stock Exchange during the year 2012. 2008/2013 - (Highest price - Rs. 166.02/- , lowest price - Rs. 105.00/-, last transaction price - Rs. 166.02/-)

(

b) Weighted average 6 months Treasury Bill interest rate before deducting 10% withholding tax at the primary quotations as announced by the Central Bank of Sri Lanka, at the preceding week of the interest resetting date.

(c) Weighted average 12 months Treasury Bill interest rate before deducting 10% withholding tax at the primary quotations as announced by the Central Bank of Sri Lanka, at the preceding week of the interest resetting date.

(d) 6 months London Inter Bank Offered Rate (LIBOR) for US Dollar plus 3% per annum

46. SHARE CAPITAL
47. PERMANENT RESERVE FUND (Contd.)

The Permanent Reserve Fund is maintained as required by Bank of Ceylon Ordinance (Chapter 397) whereby the Bank must, out of net profit after taxation but before any dividend is declared, transfer to a reserve a sum equivalent to not less than 20% of such profit until the reserve is equivalent to 50% of the issued and paid up capital and thereafter, an appropriate amount determined at 2% per annum in terms of Section 20(1) and (2) of the Banking Act No. 30 of 1988 until the reserve is equal to the paid up capital.

In order to meet the requirement, an amount of LKR. 277.9 million was transferred to the reserve during the year (2011 : LKR. 230.5 million).

The balance in the permanent reserve fund will be used only for the purposes specified in the Section 20 (2) of the Banking Act No. 30 of 1988.

48. OTHER RESERVES
48.1 Investment Fund Account (IFA)

As per the guidelines issued by the Central Bank of Sri Lanka, based on Government budget proposals of 2011, every business in banking or financial services is required to establish and operate a fund, titled as “Investment Fund Account” with effect from 1st January 2011.

Accordingly , as and when the taxes are paid after 1st January 2011, the tax savings (5.0% of income tax and 8.0% of value added tax), is transferred to the IFA and utilisation of such fund is made as per the guidelines of the Central Bank of Sri Lanka.

48.3 Utilisation of funds as at 31st December 2012 are as follows:

(a) Loans granted

The Bank funded the following infrastructure development projects initiated by Road Development Authority of Sri Lanka, utilizing the Investment Fund Account.

Bank

48. OTHER RESERVES (Contd.)
48.3 Investment fund account (Contd.)
(b) Investments in treasury bills and treasury bonds

Investment on treasury bills and treasury bonds made by the Bank and the Group are as follows:

48. OTHER RESERVES (Contd.)
49. NOTES TO THE STATEMENT OF CASH FLOWS
49. NOTES TO THE STATEMENT OF CASH FLOWS (Contd.)
50. COMMITMENTS and CONTINGENCIES
50.1 Undrawn and undisbursed facilities

The unutilised value of irrevocable commitments which cannot be withdrawn at the discretion, without risk of incurring significant penalties or expenses are as follows :

50.2 Contingent liabilities

In the normal course of business, the Bank undertakes commitments and incurs contingent liabilities with legal recourse to its customers to accommodate the financial and investment needs of clients, to conduct trading activities, and to manage its own exposure to risk . These financing instruments generate interest or fees and carries elements of credit risk in excess of those amounts recognised as assets and liabilities in the balance sheet. However no material losses are anticipated as a result of these transactions. These commitments are quantified below :

50.3 Capital commitments

Capital expenditure approved by the Directors for which no provision has been made in the Financial Statements, amounts to:

50. COMMITMENTS and CONTINGENCIES (Contd.)
50.4 Lease commitments
50.4.1 Operating lease commitments

Future minimum lease payments under non cancellable operating leases where the Bank is the lessee are as follows;

50.4.2 Financing lease commitments

Future minimum lease payments under non cancellable financing leases where the Bank is the lessee are as follows;

51. LITIGATION

The Bank and its Group companies are involved in various legal actions in the ordinary course of business. The Group has an established controls for dealing with such legal claims. Once professional advice has been obtained on the certainty of the outcome and the amount of losses reasonably estimated, the Group make adjustments to Financial Statements for any adverse effects which the claims may have on its financial standing.

At year end, the Group had several unresolved legal claims. While the outcome of these matters are inherently uncertain, management believes that none of these outstanding matters are material, either individually or in aggregate.

52. ASSETS PLEDGED AS SECURITY

The securities sold under repurchase agreement and debentures are debt securities issued by the Bank and the Group and details of assets pledged by the Bank and the Group, to secure those liabilities are given below.

53. EVENTS AFTER THE REPORTING DATE

Mergers of Subsidiaries The Bank has commenced two merger initiatives for it’s subsidiaries. Firstly the Ceylease Limited in which the Bank has 55% stake will be merged with MCSL Financial Services Limited in which the Bank holds 49% directly and 36.79% indirectly through Bank ‘s main subsidiary Merchant Bank of Sri Lanka PLC. This merger is now awaiting the final regulatory clearance for its completion.

Secondly, the Bank’s subsidiary, Merchant Bank of Sri Lanka PLC in which the Bank holds 72.14% has initiated a merger with one of its subsidiaries, MBSL Savings Bank Limited, which operates as a Licensed Specialised Bank. This merger also awaits the final regulatory approval for its completion. Upon completion of this merger, the Merchant Bank of Sri Lanka PLC will be operating under specialised banking license.

54. MATURITY ANALYSIS OF ASSETS AND LIABILITIES
54.1 Bank

The analysis of total assets and liabilities of the bank in to relevant maturity groupings based on the remaining period as at 31st December 2012 to the contractual maturity date is given in the table below :

54. MATURITY ANALYSIS OF ASSETS AND LIABILITIES (Contd.)
54.1 Bank (Contd.)
54.2 Group

The analysis of total assets and liabilities of the group into relevant maturity groupings based on the remaining period as at 31st December 2012 into the contractual maturity date is given in the table below :

54. MATURITY ANALYSIS OF ASSETS AND LIABILITIES (Contd.)
54.2 Group (Contd.)
55. RELATED PARTY DISCLOSURES

In 2012, the Bank entered into transactions with the parties who are defined as related parties in Sri Lanka Accounting Standard - LKAS 24 - ‘Related Party Disclosures’ i.e. significant investors, Subsidiary & Associate Companies, post employment benefit plans for the Bank’s employees, Key Management Personnel (KMPs), Close Family Members (CFMs) of KMPs and other related entities. Those transactions include lending activities, acceptance and placements, off-balance sheet transactions and provision of other banking and financial services that are carried out in the ordinary course of business on an arm’s length basis at commercial rates, except for the transactions that KMPs have availed under schemes uniformly applicable to all the staff at concessionary rates.

55.1 Parent and the ultimate controlling party

The Bank does not have an identifiable parent of its own.

55.2.1 Compensation to Key Management Personnel

As per the Sri Lanka Accounting Standard - LKAS 24 - “Related Party Disclosures”, the KMPs include those who are having authority and responsibility for planning, directing and controlling the activities of the Bank. Accordingly, the Board of Directors and members of the Corporate Management of the Bank have been classified as KMPs of the Bank.

55. RELATED PARTY DISCLOSURES (Contd.)
55.2.2 Transactions, arrangements and agreements involving Key Management Personnel (KMPs), their Close Family Members (CFMs) and other related entities

CFMs are defined as family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity, i.e. spouse, children under 18 years of age and dependants of KMPs. Dependant is defined as anyone who depends on the respective KMP for more than 50% of his or her financial needs.

Other entities are those entities in which the KMPs and / or their CFMs have an interest over 50% of total shareholding.

55.3 Transactions with Group related parties

The Group related parties include the Subsidiaries & Associate Companies of the Bank.

55. RELATED PARTY DISCLOSURES (Contd.)
55.3.1 Transactions with Subsidiaries and Associate Companies of the Bank

The aggregate amount of income and expenses arising from the transactions during the year and amount due to and due from the relevant related parties and total contract sum of off-balance sheet transactions at the year end are summerised below.

55. RELATED PARTY DISCLOSURES (Contd.)
55.3.2 Transactions with Subsidiaries and Associate Companies of the Group

In addition to the transactions between the Bank and its Subsidiaries and Associate Companies, transactions which were taken place between the Subsidiaries and Associate Companies are also included in the section below:

55. RELATED PARTY DISCLOSURES (Contd.)
55.4 Transactions with the significant investors having significant influence over the Bank and the post employment benefit plans for Bank’s employees.

Significant investor of the Bank is the Government as it is a state owned entity. Government refers to the Government of Sri Lanka, Government Corporations, Provincial Councils, Local Government bodies and other Government entities. Transactions and arrangements entered in to by the Bank with the Government and Government controlled entities which are individually significant and for other transactions that are collectively, but not individually significant are as follows:

55. RELATED PARTY DISCLOSURES (Contd.)
55.4.1 Transactions which are collectively significant (Contd.)
55.4.2 Transactions which are individually significant

The Bank uses internal assessments methodology in order to identify significance of the transactions with the Government and Government related entities. Accordingly, the transactions which have been considered normal day to day business operations which are carried on normal market conditions are considered individually significant transactions reported below:

i The Bank issued a USD denominated bond for USD 500 million in May 2012, of which USD 250 million was converted to LKR through a SWAP arrangement with the Central Bank of Sri Lanka. Both the Dollar proceeds and Rupee proceeds were used in commercial lending purpose.

ii The Bank received LKR 60 billion treasury bonds from the Government in order to set off the dues payable by State Owned Enterprises (SOEs). Out of these bonds LKR 9.2 billion worth of bonds were sold in the open market while the remainder is included in the financial investments.

55.4.3 Transactions with the Significant Investor - Group

Other than the transactions carried out by the Bank and balances held by the Bank with the Government, Subsidiaries of the Group have carried out following transactions with the Government and balances held with the Government as follows:

Apart from the transactions listed above, the Group carried out

transactions with the Government of Sri Lanka and other Government related entities in the form of providing services, payment of taxes, payment of utility bills , investments in shares for trading purpose and other financial service transactions including inter bank placements during the year ended 31st December 2012 on comparable terms which are applicable to transactions between the Group and its unrelated customers.

56. FINANCIAL REPORTING BY SEGMENT

Segmental information is presented in respect of Group business distinguishing the component of the Group that is engaged in different business segments or operations within a particular economic environment which is subject to risk and returns that are different from those of other segments.

56.1 Primary segment information - business segments - Group

Operating segments provide products and services whose risk and returns are different from other segments which represents Retail banking, Corporate banking, International, treasury and investment, Government, Group function and other.



56. FINANCIAL REPORTING BY SEGMENT (Contd.)
56.2 Secondary segment information - Geographical segments

Geographical segments provide products or services within a particular economic environment where risk and returns are different from those of other economic environment.

These segment comprise domestic operations, Off-shore Banking Divisions and Off shore Banking Units (Overseas branches).

57. FIRST-TIME ADOPTION OF SLFRS

As stated in Note 3.1 (Statement of compliance) of Accounting policies, the Financial Statements for the year ended 31st December 2012, are the first, the Bank and the Group have prepared in accordance with SLFRS.

Accordingly, the Group has prepared financial statements which comply with SLFRS applicable for periods ending on or after 31st December 2012, together with the comparative period data as at and for the year ended 31st December 2011, as described in the accounting policies. In preparing these Financial Statements, the Group’s opening Statement of Financial Position was prepared as at 1st January 2011, the Group’s date of transition to SLFRS. This note explains the principal adjustments made by the Bank/Group in restating its Statement of Financial Position as at 1st January 2011 and its previously published Financial Statements as at and for the year ended 31st December 2011.

57.1 Bank

Income Statement

Reconciliation of profit for the year ended 31st December 2011 - SLFRS 1 Disclosure

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
Notes to the reconciliation of Income Statement for the year ended 31st December 2011 (SLFRS 1)
A Interest income

As per SLFRS, amortized cost of the financial assets includes cumulative amortisation using Effective Interest Rate (EIR). Accordingly, the difference between previously recognised interest income and interest measured as per EIR is adjusted in arriving at the SLFRS balance. The measurement change has resulted in an adjustment of LKR 477 million.

B Interest expense

Under SLFRS, interest expense on due to customers (depositors), due to banks, other borrowings, subordinated term debts and debt securities issued are recognised based on EIR. A measurement change of LKR 13 million was recognised as a result of EIR adjustment.

C Fee and commission income

In accordance with previous SLAS, the Bank had recognised fee income on upfront basis. However upon adoption of SLFRS requires the Bank to defer and recognise such fee income as revenue over the period during which the service is performed. As a result of that LKR 466 million has been recognised as a measurment change.

D Net trading income / (expense)

As per SLFRS, trading securities are valued as per market price and the gain / (loss) from the valuation is reported in net trading income. A measurement change of LKR 89 million was recognised as a result of mark to market valuation.

E Impairment for loans and other losses

Under previous SLAS provision for credit losses were computed based on the guidelines issued by Central Bank of Sri Lanka. Under SLFRS, provision for impairment is determined based on impairment indicators.

F Personnel expenses

Under SLFRS, benefits given to staff by way of loans at concessionary rates, were valued at fair value initially and benefit to staff considered as personnel cost. Further, the employee defined benefit plans have been valued by an actuary as per the provisions of SLFRS. Net measurement change of LKR 95 million was recognised as a result of fair value adjustment.

G Income tax expense

The deferred tax liability previously identified under SLAS, Financial Statements was reversed and relevant liability was recognised where necessary.

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
57.1.1 Bank

First time adoption of SLFRS

Reconciliation of equity as at 31st December 2011

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
Notes to the reconciliation of Statement of Financial Position as at 31st December 2011 (SLFRS 1)
A     Placements with banks

Under previous SLAS, “Placements with and loans to other banks” was recorded at cost. However, as per SLFRS “Placements with and loans to other banks” was reclassified as “Placements with banks” and recorded at amortised cost, measured using Effective Interest Rate (EIR).

B     Reverse repurchase agreements

“Securities purchased under resale agreements” was reclassified as “Reverse repurchase agreements” and are recorded at amortized cost, measured using EIR.

C     Financial assets - Held for trading

According to SLFRS, Treasury bills of LKR 23,460 million, treasury bonds of LKR 10,655 million, Sri Lanka sovereign bonds of LKR 2,607 million and quoted equity investments of LKR 3,573 million are reclassified and reported as “Financial assets - Held for trading”. Those items were previously reported in “Treasury bills, bonds, other eligible bills”, “Treasury bonds maturing after one year” and “Dealing securities”. As per SLFRS, all held for trading instruments were measured at fair value. Due to the market valuation a measurement adjustment of LKR 30 million has been incorporated.

D     Financial investments - Loans and receivable

As per SLFRS, investment of LKR 76,912 million in “Sri Lanka Development Bonds”, investment of LKR 8,968 million in “Government of Sri Lanka Restructuring Bonds”, investment of LKR 1,003 million in debentures, investment of LKR 224 million in of trust certificates and investment of LKR 2,632 million in “Government Securities” are classified as “Financial investments - Loans and receivable” and reported at amortised cost. Under previous SLAS, investment in “Government of Sri Lanka Restructuring Bonds” was reported as a separate line item in the balance sheet, and other items were reported under “Investment securities” and “Treasury bills, bonds, other eligible bills”.

E     Loans & advances to customers

Under previous SLAS, interest receivable as at reporting date occurring from non-impaired (performing) loans were reported under other assets as interest receivable. However, under SLFRS, commercial loans and receivables are measured at amortized cost and interest receivable of performing loans are reclassified from other assets to loans and receivable.

Under SLFRS, all staff loans were recognised at fair value. The difference between the fair value and previous SLAS carrying amount, was recognised as prepaid staff cost and reported under other assets.

The measurement change has resulted in an adjustment of LKR 8,263 million.

F     Financial investments - Available for sale

As per previous SLAS, investment portfolio which were held as strategic investments were recognised at cost. As per SLFRS such investments are classified as “Financial investments - Available for sale” and measured at fair value. Such investments include, unlisted equity shares, quoted strategic equity shares, units in unit trusts, treasury bills held o/a of Investment Fund Account and investments in Indian Government securities. The aggregate value of the investment portfolio has increased by LKR 4,169 million due to change of valuation base from cost to market value.

F1     Financial investments - Held to maturity

Treasury bills of LKR 10,658 million and treasury bonds of LKR 40,728 million were reported as financial investments - Held to maturity at amortised cost measured using EIR. Those items were previously reported under “Treasury bills, bonds, other eligible bills” and “Treasury bonds maturing after one year” whilst the corresponding interest receivable have been classified under other assets. A measurement change of LKR 11 million has recognised as a result of EIR.

G     Other assets

Under SLAS, interest receivable pertaining to loans and advances, held to maturity financial investments, held for trading financial assests and available for sale financial investments were classified under other assets. However as per SLFRS, loans and advances and held to maturity financial investments were measured at amortised cost. Held for trading financial assets and available for sale financial investments were reported at fair value. Hence the interest receivable which was recorded under other assets has been reclassifed to respective financial instrument in arriving at amortised cost and total of that amounts to LKR 12,434 million. In addition to that prepaid staff cost arose due to the remeasurement of staff loan under SLFRS has resulted in a measurement change amounting to LKR 7,767 million.

H     Securities sold under repurchase agreements

Under SLFRS, “Repurchase agreements” are reported at amortized cost, measured using EIR and has been reported under other borrowings.

I     Due to customers

Under previous SLAS, “Deposits due to customers” was reported separately and corresponding interest payable was reported under other liabilities. Under SLFRS “Deposits due to customers” and the respective interest is aggregated together in arriving at amortised cost. Further interest payable on fixed maturity term deposits were calculated based on EIR. A measurement change of LKR 219 million has recognised as a result of EIR.

J     Other borrowings

Under SLFRS, other borrowings are reported at amortised cost based on EIR. However, under previous SLAS, interest payables were measured based on simple interest method, are recorded under other liabilities. A measurement change of LKRs 16 million has been recognised as a result of EIR.

K     Debt securities issued and subordinated term debts

Under previous SLAS, debentures were reported as a separate line item and measured using simple interest rate. Under SLFRS, debentures were reclassified in two reporting line items namely, “Debt securities issued” and “Subordinated term debts”. Further as per SLFRS those have been measured using EIR. A measurement change of LKR 28 million has been recognised as a result of interest measurement using EIR.

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
57.1.2 Bank

First time adoption of SLFRS

Reconciliation of equity as at 1st January 2011 (Date of transition to SLFRS)

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
Notes to the reconciliation of Statement of Financial Position as at 1st January 2011 (SLFRS 1)
A     Placements with banks

Under previous SLAS, “Placements with and loans to other banks” was recorded at cost. However, as per SLFRS ‘Placements with and loans to other banks’ was reclassified as “Placements with banks” and recorded at amortized cost, measured using Effective Interest Rate (EIR).

B     Reverse repurchase agreements

“Securities purchased under resale agreements” was reclassified as “Reverse repurchase agreements” and are recorded at amortized cost, measured using EIR.

C     Financial assets - Held for trading

According to SLFRS, treasury bills of LKR 26,742 million, treasury bonds of LKR 14,537 million, Sri Lanka sovereign bonds of LKR 2,679 million and quoted equity investments of LKR 3,232 million are reclassified and reported as “Financial assets - Held for trading”. Those items were previously reported in “Treasury bills, bonds, other eligible bills”, “Treasury bonds maturing after one year” and “Dealing securities”. As per SLFRS all held for trading instruments were measured at fair value. Due to the market valuation a measurement adjustment of LKR 119 million has been incorporated.

D     Financial assets - Loans and receivable

As per SLFRS, investment of LKR 74,237 million in “Sri Lanka Development Bonds”, investment of LKR 9,400 million in “Government of Sri Lanka Restructuring Bonds”, investment of LKR 36 million in debentures, investment of LKR 199 million in trust certificates and investment of LKR 4,575 million in “Government Securities” are classified as “Financial investments - Loans and receivable” and reported at amortized cost. Under SLAS, investment in “Government of Sri Lanka Restructuring Bonds” was reported as a separate line item in the balance sheet and other items were reported under “investment securities” and “treasury bills, bonds, other eligible bills”.

E     Loans & advances to customers

Under previous SLAS, interest receivable as at balance sheet date occurring from non-impaired (performing) loans were reported under other assets as interest receivable. However, under SLFRS, commercial loans and receivables are measured at amortized cost and interest receivable of performing loans are reclassified from other assets to loans and receivable. Under SLFRS, all staff loans were recognised at fair value. The difference between the fair value and previous SLAS carrying amount, was recognised as prepaid staff cost and reported under other assets.

The measurement change has resulted in an adjustment of LKR 8,101 million.

F     Financial investments - Available for sale

As per previous SLAS, investment portfolio which were held as strategic investments were recognised at cost. As per SLFRS such investments are classified as “Financial investments - Available for sale” and measured at fair value. Such investments include, unlisted equity shares, quoted strategic equity shares, units in unit trusts, treasury bills held o/a of Investment Fund Account and investments in Indian Government securities. The aggregate value of the investment portfolio has increased by LKR 6,002 million due to change of valuation base from cost to market value.

F1     Financial investments - Held to maturity

Treasury bills of LKR 130 million and treasury bonds of LKR 51,511 million were reported as “Financial investments - Held to maturity” at amortised cost measured using EIR. Those items were previously reported under “Treasury bills, bonds, other eligible bills” and “Treasury bonds maturing after one year” whilst the corresponding interest receivable have been classified under other assets. A measurement change of LKR 8 million has recognised as a result of EIR.

G     Other assets

Under SLAS interest receivable pertaining to loans and advances, held to maturity financial investments, held for trading financial assests and available for sale financial investments were classified under other assets. However as per SLFRS, loans and advances and held to maturity financial investments were measured at amortised cost. Held for trading financial assets and available for sale financial investments were reported at fair value. Hence the interest receivable which was recorded under other assets has been reclassifed to respective financial instrument in arriving at amortised cost and total of that amounts to LKR 8,914 million.

In addition to that prepaid staff cost arose due to the remeasurement of staff loan under SLFRS has been reflected as measurement change and amounting to LKR 6,743 million.

H     Securities sold under repurchase agreements

Under the SLFRS, “Repurchase agreements” are reported at amortized cost, measured using EIR and has been reported under other borrowings.

I     Due to customers

Under previous SLAS, deposits due to customers was reported separately and corresponding interest payable was reported under other liabilities. Under SLFRS, “Deposits due to customers” and the respective interest is aggregated together in arriving at amortised cost. Further interest payable on fixed maturity term deposits were calculated based on EIR. A measurement change of LKR 221 million has recognised as a result of EIR.

J     Other borrowings

Under SLFRS, other borrowings are reported at amortised cost based on EIR. However, under previous SLAS, interest payables were measured based on simple interest method are recorded under other liabilities. A measurement change of LKR 244 million has been recognised as a result of EIR.

K     Debt securities issued and subordinated term debts

Under previous SLAS, debentures were reported as a separate line item and measured using simple interest rate. Under SLFRS, debentures were reclassified in two reporting line items namely, “Debt securities issued” and “Subordinated term debts”. Further as per SLFRS those have been measured using EIR. A measurement change of LKR 20 million has been recognised as a result of interest measurement using EIR.

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
57.2 Group

Consolidated Income statement

Reconciliation of Profit for the Year Ended 31st December 2011 - SLFRS 1 Disclosure

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
Notes to the reconciliation of Income Statement for the year ended 31st December 2011 - Group (SLFRS 1)
A     Interest income

As per SLFRS, amortized cost of the financial assets includes cumulative amortisation using Effective Interest Rate (EIR). Accordingly, the difference between previously recognised interest income and interest measured as per EIR is adjusted in arriving at the SLFRS balance.

B     Interest expense

Under SLFRS, other borrowed funds and debt securities in issue (debentures) are reported at amortised cost based on EIR.

C     Fee and commission income

According to SLFRS, commission income recovered from services was amortised over the service period.

D     Net trading income / (expense)

According to SLFRS, trading securities are valued as per market price and gain / (loss) from the valuation is reported in net trading income.

E     Impairment for loans and other losses

Under previous SLAS provision for credit losses were computed based on the guidelines issued by Central Bank of Sri Lanka. Under SLFRS, provision for impairment is determined based on impairment indicators.

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
57.3.1 Group

First time adoption of SLFRS

Reconciliation of equity as at 31st December 2011

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
Notes to the reconciliation of Statement of Financial Position as at 31st December 2011- Group (SLFRS 1)
A     Placements with banks

LKR 18,811 million which was recorded at cost in “Placements with and loans to other banks” under previous SLAS, was recorded at amortised cost as per SLFRS under the line item “Placements with banks”.

B     Financial assets - Held for trading

LKR 40,717 million which was recorded under “Treasury bills, bonds, other eligible bills”, “Treasury bonds maturing after one year” and “Dealing securities” now have been recorded under Financial assets - Held for trading according to SLFRS. LKR 35 million of remeasurement effect has been identified when restating the figures at fair value.

C     Loans & advances to customers

Under previous SLAS, interest receivable as at reporting date occurring from non - impaired (performing) loans were reported under other assets as interest receivable. However, under SLFRS, commercial loans and receivables are reported at amortized cost and interest receivable of performing loans are reclassified from other assets to loans and receivable. Under SLFRS, all staff loans were recognised at fair value. The difference between the fair value and the previous SLAS carrying amount, was recognised as prepaid staff cost and reported under other assets.

D     Financial investments - Available for sale

As per SLAS, investment portfolio which were held as strategic investments were recognised at cost. As per SLFRS such investments are classified as “Financial investments - Available for sale” and measured at fair value. Such investments include, unlisted equity shares, quoted strategic equity shares, units in unit trusts and investments in Indian Government securities. The aggregate value of the investment portfolio has increased by LKR 5,005 million due to change of valuation base from cost to market value.

E     Financial investments - Held to maturity

Under SLAS, interest receivable of held to maturity financial investments was classified under other assets. However as per SLFRS, Held to maturity financial investments were measured at amortised cost using EIR. A measurement change of LKR 296 million has recognised as a result of EIR.

F     Other assets

Under SLAS, interest receivable pertaining to loans and advances and held to maturity financial investments were classified as other assets. However, as per SLFRS, loans and advances and held to maturity financial investments were measured at amortised cost. Hence respective interest receivable which was recorded under other assets was transferred to the respective financial instrument in arriving at amortised cost.

G     Property, plant & equipments

Revaluation gain of LKR 4,760 million was recognised by revaluing buildings of Property Development PLC and Property Development & Management PLC as per the group accounting policy. Further Minority interest and deferred tax liability have been adjusted accordingly.

H     Due to customers

Under previous SLAS, “Deposits due to customers” had been reported separately and corresponding interest payable was reported under other liabilities. Under SLFRS, “Deposits due to customers” and the respective interest is aggregated together in arriving at amortized cost. Further interest payable on fixed maturity term deposits were calculated based on EIR.

I     Other borrowings

Under SLFRS, other borrowings are reported at amortized cost based on EIR. However, under previous SLAS, interest payable on those items were reported as at the reporting date based on the simple interest method, under other liabilities.

J     Debt securities issued and subordinated term debts

Under previous SLAS, debentures worth of LKR 42,527 million was reported under the line item “Debentures”, and measured using simple interest rate. Under SLFRS debentures were reclassified in two reporting line items namely, “Subordinated term debts” and “Debt securities issued”. Further as per SLFRS those have been measured using EIR.

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
57.3.2 Group

First time adoption of SLFRs.

Reconciliation of equity as at 1st January 2011 (Date of transition to SLFRS)

57. FIRST-TIME ADOPTION OF SLFRS (Contd.)
Notes to the reconciliation of Statement of Financial Position as at 1st January 2011- Group (SLFRS 1)
A     Placements with banks

LKR 47,773 million which had been recorded at cost in “Placements with and loans to other banks” under SLAS, was recorded at amortised cost as per SLFRS under the line item “Placements with banks”.

B     Financial assets - Held for trading

LKR 46,348 million which was recorded under “Treasury bills, bonds, other eligible bills”, “Treasury bonds maturing after one year” and “Dealing securities” now have been recorded under Financial assets - Held for trading according to SLFRS. Due to the market valuation a measurement adjustment of LKR 142 million has been incorporated.

C     Loans & advances to customers

Under SLAS interest receivable as at reporting date occurring from unimpaired (performing) loans were reported under other assets as interest receivable. However, under SLFRS, commercial loans and receivables are reported at amortised cost and interest receivable of performing loans are reclassified from other assets to loans and receivable.

Under SLFRS, all staff loans were recognised at fair value. The difference between the fair value and the previous SLAS carrying amount, was recognised as prepaid staff cost and reported under other assets.

D     Financial investments - Available for sale

As per SLAS, investment portfolio which was held as strategic investments were recognised at cost. As per SLFRS such investments are classified as “Financial investments - Available for sale” and measured at fair value. Such investments include, unlisted equity shares, quoted strategic equity shares, units in unit trusts and investments in Indian Government securities. The aggregate value of the investment portfolio has increased by LKR 6,429 million due to change of valuation base from cost to market value.

E     Financial investments - Held to maturity

Under SLAS interest receivable of held to maturity financial investments was classified under other assets. However as per SLFRS, Held to maturity financial investments were measured at amortised cost using EIR. A measurement change of LKR 8 million has recognised as a result of EIR adjustment.

F     Other assets

Under SLAS, interest receivable pertaining to loans and advances and held to maturity financial investments were classified as other assets. However, as per SLFRS, loans and advances and held to maturity financial investments were measured at amortised cost. Hence respective interest receivable which was recorded under other assets was transferred to the respective financial instruments in arriving at amortised cost.

G     Property, plant & equipments

Revaluation gain of LKR 3,998 million was recognised by revaluing buildings of Property Development PLC and Property Development & Management PLC as per the group accounting policy. Further, minority interest and deferred tax liability have been adjusted accordingly.

H     Due to customers

Under previous SLAS, deposits due to customers had been reported separately and corresponding interest payable was reported under other liabilities. Under SLFRS, “Deposits due to customers” and the respective interest is aggregated together in arriving at amortised cost. Further interest payable on fixed maturity term deposits were calculated based on EIR.

I     Other Borrowings

Under SLFRS, other borrowings are reported at amortised cost based on EIR. However, under previous SLAS interest payable on those items were reported as at the reporting date based on the simple interest method, under other liabilities.

J     Debt securities issued and subordinated term debts

As per previous SLAS, debentures worth of LKR 39,452 million was reported under the line item “Debentures”, and measured using simple interest rate. Under SLFRS, debentures were reclassified in two reporting line items namely, “Subordinated term debts” and “Debt securities issued”. Further as per SLFRS those have been measured using EIR.

58. DETERMINATION OF FAIR VALUE AND FAIR VALUE HIERARCHY

For all financial instruments where fair values are determined by referring to externally quoted prices or observable pricing inputs to models, independent price determination or validation is obtained. In an inactive market, direct observation of a traded price may not be possible. In these circumstances, the Bank uses alternative market information to validate the financial instrument’s fair value, with greater weight given to information that is considered to be more relevant and reliable.

Fair values are determined according to the following hierarchy:

Level 1
Quoted market price (unadjusted) : financial instruments with quoted price in active markets.

Level 2
Valuation technique using observable inputs : financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets and financial instruments are valued using models where all significant inputs are observable.

Level 3
Valuation technique with significant unobservable inputs : financial instruments are valued using valuation techniques where one or significant inputs are observable.

The following tables show an analysis of financial instruments recorded at fair value by level of the fair value hierarchy.

58. DETERMINATION OF FAIR VALUE AND FAIR VALUE HIERARCHY (Contd.)
59. RISK MANAGEMENT
59.1 Introduction
Overview

The Bank considers Credit risk, Market risk, Liquidity risk and Operational risk as key risks faced by the Bank.

Information presented in this note focuses on the Bank’s exposure to above risks, since the Bank (ultimate parent) accounts for more than 95% of total assets, liabilities, income and expenses of the Group.

Risk management framework

Risk management governance structure of the Bank begins with oversight of the Board of Directors, which assures the performance of overall risk management framework. The Board establishes the risk appetite and set strategic direction through risk management policies. The Board is assisted in discharging its duties on risk management by Integrated Risk Management Committee (IRMC).

The Bank’s Independent Integrated Risk Management Division (IIRMD) is headed by the Chief Risk Officer (CRO), who directly reports to the IRMC. CRO is a member of executive level committees such as Credit Committee, Asset and Liability Committee (ALCO), Operational Risk Management Executive Committee (ORMEC), IT Steering Committee and Non Performing Advances Monitoring Committee, which assist in managing the various risks that the Bank is exposed to.

Risk measurement and reporting systems

The Bank’s risks are measured using methods that reflect both the expected loss likely to arise in normal circumstances and unexpected losses, which is an estimate of the ultimate actual loss based on statistical models.

The IRMC receives a comprehensive risk report, which provides necessary information to assess risks of the Bank.

Moreover, Stress Testing and Internal Capital Adequacy Assessment Process (ICAAP) give an in-depth understanding of the expected as well as unexpected losses of the Bank. Considering the nature, size and complexity of the operation, the Bank has introduced a capital assessment process to understand the optimum capital level required to meet unforeseen contingencies.

59. RISK MANAGEMENT (Contd.)
59.1 Introduction (Contd.)
Risk measurement and reporting systems
Risk mitigation

As part of its overall risk management framework, the Bank uses mitigation techniques and strategies to minimize the risk. For instance, in managing credit risk, the Bank actively uses pre-sanction credit evaluation and monitoring as well as post sanction monitoring and credit risk review programmes to mitigate the risk. However the Bank recognises a well-secured loan has less credit risk than an otherwise equivalent unsecured loan and therefore the Bank encourages obtaining adequate collateral whenever it is possible.

The Bank uses derivatives to manage exposures resulting from changes in market conditions and exposures arising from forecasted transactions.

59.2 Credit risk

Credit risk arises when a bank’s borrower or counterparty fails to meet it’s obligations in accordance with agreed terms. Board approved credit risk management policy and lending guidelines establish the framework for lending and guides the credit-granting activities of the Bank. This covers credit risk identification, acceptance, measurement, monitoring, reporting and control at both transaction level as well as portfolio level.

59.2.1 Maximum exposure to credit risk
(i) Type of collateral or credit enhancement

The Bank holds collateral against loans and advances to customers in the form of mortgage interests over immovable assets, other registered securities over assets and guarantees. Collaterals are valued at the time of granting the facilities and fair value of collaterals are periodically obtained according to the regulatory requirements.

(ii) Credit quality by class of financial assets

IIRMD internally developed a corporate borrower rating system and credit scoring models. The borrower rating system categorises all credits into various classes on the basis of underlying credit quality.

For consumer lending, the Bank has developed several credit-scoring models for processing loan applications and monitoring credit quality. The Bank continuously review credit applications rigorously.

59. RISK MANAGEMENT (Contd.)
59.2 Credit risk (Contd.)
59.2.1 Maximum exposure to credit risk
59.2.2 Impairment assessment

At each reporting date the Bank assesses whether there is objective evidence that financial assets are impaired. A financial asset or a group of financial assets is impaired when objective evidence demonstrates that a loss event has occurred after the initial recognition of the asset, and that the loss event has an impact on the future cash flows of the asset that can be estimated reliably.

The Bank considers evidence of impairment for loans and advances at both individual asset and collective level. All significant loans and advances are individually assessed for impairment. Those loans and advances found not to be individually impaired are then collectively assessed for any impairment that has been incurred but not yet identified.

Loans and advances that are not individually significant are collectively assessed for impairment by grouping together with similar risk characteristics. In assessing collective impairment, the Bank uses statistical modelling of historical trends of the probabilities of default, timing of recoveries and the amount of loss incurred, adjusted for management’s judgement as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical modelling. Default rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure that they remain appropriate.

Impairment losses

Impairment losses on assets carried at amortised cost are measured as the difference between the carrying amount of the financial asset and the present value of estimated future cash flows discounted at the asset’s original effective interest rate. Impairment losses are recognised in the Income Statement and reflected in impairment charges against loans and advances, in the Statement of Financial Position.

The Bank writes off certain loans and advances to customers and financial investments when they are determined to be uncollectible.

59.2.3 Analysis of risk concentration

At the portfolio level, credit risk includes concentration risk arising from interdependencies between counterparties (large credit exposures) and concentration of exposures to industry sectors and geographical regions.

Risk concentrations of the Bank are monitored within the scope of risk appetite limits approved by the Board of Directors.

59.2.3.1 Industry wise exposure
59. RISK MANAGEMENT (Contd.)
59.2 Credit risk (Contd.)
59.2.3.2 Country wise exposure

The Bank maintains exposures outside Sri Lanka mainly due to its two branches in India and Maldives and the subsidiary operating in United Kingdom (UK).

The exposure in India is mainly coming from the branch which operates in Chennai while Maldive exposure is mainly from Branch in Male and few credits granted directly from Colombo head office through the off-shore banking unit. Both these entities are operating with pre-set limits (credit limits as well as country limits) and are approved by the Board of Directors of Bank of Ceylon while the credits are managed through delegated authority where the higher levels of authority is retained within Head Office in Colombo.

UK exposure is the total assets of the Bank’s fully owned subsidiary operating under regulatory purview of UK Financial Services Authority and the credit decisions are decentralized with Head Office having its control through the Board of Directors appointed by the Bank. The key staff including Chief Executive Officer and Deputy Chief Executive Officer are employees seconded from Bank of Ceylon.  UK operations have established risk exposure levels as part of its risk management framework.

Exposures in other countries include correspondent bank balances whose risks are managed through Board approved bank limits and country limits.

59.2.4 Commitments and guarantees

To meet the financial needs of customers, the Bank enters into various irrevocable commitments and contingent liabilities. Even though these obligations have not been recognised on the Statement of Financial Position, they do contain credit risk and are therefore part of the overall risk of the Bank.

The maximum exposure to credit risk relating to a guarantee is the maximum amount the Bank could have to pay if the guarantee is called upon. The maximum exposure to credit risk relating to a loan commitment is the full amount of the commitment. In both cases, the maximum risk exposure is significantly greater than the amount recognized as a liability in the Statement of Financial Position.

The table below shows the Bank’s maximum credit risk exposure for commitments and guarantees.

59. RISK MANAGEMENT (Contd.)
59.2.4 Commitments and guarantees (Contd.)
59.3 Liquidity risk and funding management

Being the largest commercial bank, Bank of Ceylon plays a pivotal role in the economy by holding the largest asset base of all commercial banks in Sri Lanka. Proper management of assets and liabilities would optimise the asset quality and the profitability of the Bank.

ALCO being the main management committee for taking important decisions on managing liquidity and market risk, reviews Bank’s funding plan monthly and proposes remedial measures to rectify any material deviation which might lead to a stress liquidity situation.

Treasury Division prepares the Maturity Gap Analysis on each quarter as per the statutory requirement of CBSL. Assets and liabilities of the Bank are positioned in to pre-defined time bands according to their residual term to maturity.

The table in Note 54 indicates the contractual expiry by maturity of the Bank’s assets and liabilities as at 31st December 2012.

59.4 Market risk

Market risk is the risk that the fair value or future cash flows of financial instruments will fluctuate due to changes in market variables such as interest rates, foreign exchange rates and equity prices. The Bank classifies exposures to market risk into either trading or non–trading portfolios and manages each of those portfolios separately. The market risk for the Foreign Exchange and Equity trading portfolio are managed and monitored based on a Value–at–Risk (VaR) methodology that reflects the interdependency between risk variables. The market risk for the interest rate risk related trading portfolio is managed and monitored based on Price Value of Basis Points (PVBP) and Duration Analysis. Non–trading positions are managed and monitored using stress testing.

59.4.1 Objectives and limitations of the VaR methodology

The Bank uses variance - covariance VaR model to assess possible changes in the market value of the trading portfolio based on historical data from the past 370 days. The VaR models are designed to measure foreign exchange risk & equity price risk in a normal market environment. The models assume that any changes occurring in the risk factors affecting the normal market environment will follow a normal distribution.

Due to the fact that VaR relies heavily on historical data to provide information and does not clearly predict the future changes & modifications of the risk factors and the probability of large market moves that may be underestimated if changes in risk factors fail to align with the normal distribution assumption. VaR may also be under– or over–estimated due to the assumptions placed on risk factors and the relationship between such factors for specific instruments. Even though positions may change throughout the day, the VaR only represents the risk of the portfolios at the close of each business day, and it accounts only for losses that may occur at the 99% confidence level.

In practice, the actual trading results will differ from the VaR calculation. In particular, the calculation does not provide a meaningful indication of profits and losses in stressed market conditions. To determine the reliability of the VaR models, actual outcomes are monitored regularly to test the validity of the assumptions and the parameters used in the VaR calculation.

VaR assumptions

The VaR that the Bank measures is an estimate, using a confidence level of 99%, of the potential loss that is not expected to be exceeded if the current market risk positions were to be held unchanged for one day. The use of a 99% confidence level means that, within a one-day horizon, losses exceeding the VaR figure should occur, on average under normal market conditions, not more than once in every hundred days.

Since VaR is an integral part of the Bank’s market risk management, VaR limits have been established for equity & foreign exchange trading operations and exposures are monitored daily against the limits.

59.4.2 Market risk - Trading
59.4.2.1 Currency risk

The Bank does not carry foreign currency trading open positions and therefore does not have significant sensitivity to profit and loss over foreign currency trading transactions.

59. RISK MANAGEMENT (Contd.)
59.4.2 Market risk - Trading (Contd.)
59.4.2.2 Equity risk

Equity price risk is the risk that the fair value of equities decreases as the result of changes in the level of equity indices and individual stocks.

Equity VaR 2012
LKR’000
Highest 210,304
Lowest 122,083
Average 158,438
31st December
129,979

59.4.2.3 Interest rate risk

PVBP is calculated weekly to monitor the impact of interest rate changes on Bank’s trading portfolios of treasury bonds and bills. Following tables depicts the results as at 31st December 2012.

59.4.3 Market risk – non trading
59.4.3.1 Currency risk

Currency risk is the risk that the value of financial instruments will fluctuate due to changes in foreign exchange rates. The Board has set limits on currency positions. In accordance with the Bank’s policy and CBSL directions, positions are monitored on a daily basis.

The Bank monitors non trading currency risk through Value at Risk and currency VaR as at 31st December 2012 was only LKR 529,010

59.4.3.2 Equity risk

The non trading equity price risk arises from equity securities classified as Available for sale. A 10% decrease in the equity price level would cause a potential negative impact of LKR 47.5 million.

59.4.3.3 Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or the fair value of the financial instruments.

The table in Note 54 analyses the Bank’s interest rate risk exposure on non-trading financial assets and liabilities. The Bank’s assets & liabilities are included at carrying amount and categorized by the earlier of contractual re-pricing or maturity date.

Contractual Maturities of Financial Assets and Liabilities

The following table presents a maturity analysis of the earliest contractual undiscounted cash flows for financial liabilities as at 31st December 2012.

59. RISK MANAGEMENT (Contd.)
59.5 Operational Risk

Operational risk is the risk of loss resulting from inadequate or failed processes, people and systems or external events. This includes legal risk, but excludes strategic risk and reputation risk.

The Bank recognises the significance of operational risk, which is inherent in all areas of business. The Bank seeks to minimize exposure to operational risk, through implementing improved management and measurement approaches.

Bank uses Basic Indicator Approach (BIA) to allocate capital for operational risk, even though the capital allocated for operational risk was significant, it was apparent that actual operational loss was far below the allocated capital.

59.6 Capital Management

The primary objective of Capital Management is to ensure maintenance of minimum regulatory capital requirement. The Bank ensures that adequate capital has been allocated to achieve strategic objectives and within the Risk Appetite of the Bank.

59.6.1 Capital Adequacy

Capital Adequacy Ratio (CAR), also called Capital to Risk weighted Assets Ratio (CRAR), is a measure of the Bank’s capital expressed as a percentage of risk weighted assets of credit, market and operational aspects of the banking business. It is a measure of financial strength of the Bank which indicates its ability to maintain adequate capital to face with unforeseen scenarios.

The objective of capital adequacy is to protect the bank itself, its customers and the economy, by establishing rules to make sure that the Bank holds sufficient capital to ensure continuity of a safe and efficient market and able to withstand any foreseeable problems.

Central Bank of Sri Lanka (CBSL) defines and monitors CAR to ensure that banks are not participating or holding investments that increase the risk of default and that they have enough capital to sustain operating losses and thereby maintaining confidence in the banking system.