Financial Assets and Liabilities at Fair Value through Profit or Loss
A financial asset is held for trading if acquired or originated principally for the purpose of generating a profit from short-term fluctuations in price or if it is part of a portfolio of identified instruments that are managed together and for which there is intention of short-term profit-taking. Derivatives are always categorized as held for trading unless they are accounted for as hedges. This designation is irrevocable. The asset cannot be moved to another category during its life.
Securities in this category are measured at fair value at the balance sheet date. Changes in fair value (excluding accrued interest on fixed income securities) are presented in the profit and loss account under "Net gain/loss on financial instruments at fair value through profit or loss," along with dividends from variable-income securities and realized gains and losses on disposal. This implies that value changes affect directly the profit and loss of the bank.
Loans and Receivables
Loans and receivables are non-derivative financial assets with fixed or determined payments that are not quoted in listed markets. Loans and receivables include loan assets, trade receivables and other debt investments. They typically arise when an entity provides money directly to an obligor with no intention of trading the receivable. Income earned on fixed-income securities classified in this category is shown under "Interest income" in the profit and loss account.
Held-to-maturity Financial Assets
Held-to-maturity investments are financial assets with fixed or determined payments and fixed maturity (for example, debt securities and redeemable preference shares) that an entity has the positive intent and ability to hold to maturity. This category excludes loans and receivables. Equity securities cannot be classified as held-to-maturity because they do not have a fixed maturity date. The intent and ability is assessed not only when the assets are initially acquired but also at each subsequent balance sheet date. A positive intent to hold assets to maturity is a much stronger constraint than simply having no present intention to sell.
The assets held under this category are subject to severe restrictions. Rules impose that any sale of such asset might lead to reclassification of the entire portfolio into available-for-sale assets. If an entity sells more than an insignificant amount of held-to-maturity securities, other than in exceptional circumstances, this casts doubt on its intent or ability to hold investments to maturity. All held-to-maturity investments are reclassified as available for sale and measured at fair value. There is a possibility to revert again to this classification only after a period (originally, two years).
Available-for-sale Financial Assets
All financial assets that are not classified in another category are classified as available for sale. The available-for-sale category includes all equity securities other than those classified as at fair value through profit or loss. An entity also has the right to designate any asset, other than a trading one, to this category at inception.
Available-for-sale financial assets are fixed-income and equity securities other than those classified as "fair value through profit or loss" or "held-to-maturity." Assets included in the available-for-sale category are initially recorded at fair value plus transaction costs. At the balance sheet date, they are re-valued to fair value, with changes in fair value (excluding accrued interest) shown on a separate line in shareholders' equity, "Unrealized or deferred gains or losses." In other words, the gains or losses of those assets appear explicitly in the capital, but do not appear in the bottom line of profit and loss statement because they are unrealized. On disposal, or on recognition of an impairment loss, these unrealized gains and losses are transferred from shareholders' equity to the profit and loss account, where they are shown on the line "Net gain/loss on available-for-sale financial assets."
Income recognized using the effective interest method 11 derived from fixed-income available-for-sale securities is recorded in "Interest income" in the profit and loss account. Dividend income from variable-income securities is recognized in "Net gain/loss on available-for-sale financial assets" when the group's right to receive payment is established.