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38 BANCO DE OROThe financial statements of subsidiaries are prepared, except for BDO Remittance, for the same reporting period as the parent company, usingconsistent accounting principles. BDO Remittance, however, has prepared financial statements using the same accounting period as theparent for consolidation purposes.In the consolidated financial statements, the minority interest component in the 2005 and 2004 financial statements are shown in thestatements of changes in capital funds.3.4 Segment ReportingA business segment is a group of assets and operations engaged in providing products or services that are subject to risks and returns that aredifferent from those of other business segments. A geographical segment is engaged in providing products or services within a particulareconomic environment that is subject to risks and returns that are different from those of segments operating in other economicenvironments.3.5 Cash and Cash EquivalentsFor purposes of the cash flows statement, cash and cash equivalents comprise balances with less than three months’ maturity from the dateof acquisition, including: cash and non-restricted balances with the BSP and amounts due from other banks. Cash and cash equivalents areinitially and subsequently measured at fair value.3.6 Financial AssetsFinancial assets include cash and financial instruments. The Group classifies its financial assets, other than hedging instruments, into thefollowing categories: financial assets at fair value through profit or loss, loans and receivables, held-to-maturity investments and available-forsalefinancial assets. Financial assets are assigned to the different categories by management on initial recognition, depending on the purposefor which the investments were acquired. The designation of financial assets is re-evaluated at every reporting date at which date a choiceof classification or accounting treatment is available, subject to compliance with specific provisions of applicable accounting standards.All financial assets that are not classified as at fair value through profit or loss are initially recognized at fair value, plus transaction costs.• Financial Assets at Fair Value Through Profit or Loss. This category includes derivative financial instruments and financial assets thatare either classified as held for trading or are designated by the entity to be carried at fair value through profit or loss upon initialrecognition. A financial asset is classified in this category if acquired principally for the purpose of selling in the short term or if sodesignated by management. Derivatives are also categorized as “held for trading” unless they are designated as hedges.Subsequent to initial recognition, the financial assets included in this category are measured at fair value with changes in fair valuerecognized in profit or loss. Financial assets originally designated as financial assets at fair value through profit or loss may notsubsequently be reclassified.• Loans and Receivables. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are notquoted in an active market. They arise when the Group provides money, goods or services directly to the debtor with no intentionof trading the receivables. Included in this category are those arising from direct loans to customers, interbank loans, sales contractreceivables, and all receivables from customers and other banks.Loans and receivables are subsequently measured at amortized cost using the effective interest method, less impairment losses.Securities Purchases Under Reverse Repurchase Agreement wherein the Bank and a subsidiary enter into short-term purchases ofsecurities under reverse repurchase agreements of substantially identical securities with the BSP, are included in this category. Thedifference between the sale and repurchase price is treated as interest and accrued over the life of the agreements using theeffective interest method.Impairment losses is the estimated amount of losses in the Group’s loan portfolio, based on the evaluation of the future cash flowsdiscounted at the loan’s original effective interest rates or the last repricing rate for loans issued at variable rates (see Note 3.18). Itis established through an allowance account which is charged to expense. Loans and receivables are written off against theallowance for impairment losses when management believes that the collectibility of the principal is unlikely, subject to BSPregulations.• Held-to-maturity Investments. This includes non-derivative financial assets with fixed or determinable payments and a fixed date ofmaturity. Investments are classified as held-to maturity if the Group has the positive intention and ability to hold them untilmaturity. Investments intended to be held for an undefined period are not included in this classification.Held-to-maturity investments consist of government and private debt securities. Should the Group sell other than an insignificantamount of held-to-maturity assets, the entire category would be tainted and reclassified as available-for-sale financial assets.Held-to-maturity investments are subsequently measured at amortized cost using the effective interest method. In addition, if thereis objective evidence that the investment has been impaired, the financial asset is measured at the present value of estimated cashflows (see Note 3.18). Any changes to the carrying amount of the investment due to impairment are recognized in profit or loss.
2005 ANNUAL REPORT39• Available-for-sale Financial Assets. This includes non-derivative financial assets that are either designated to this category or do notqualify for inclusion in any of the other categories of financial assets.All financial assets within this category are subsequently measured at fair value, unless otherwise disclosed, with changes in valuerecognized in capital funds, net of any effects arising from income taxes. Gains and losses arising from securities classified asavailable-for-sale are recognized in the statements of income when they are sold or when the investment is impaired.In the case of impairment, any loss previously recognized in capital funds is transferred to the statements of income (see Note 3.18).Losses recognized in the statements of income on equity investments are not reversed through the statements of income. Lossesrecognized in prior period statements of income resulting from the impairment of debt instruments are reversed through thestatements of income, when there is recovery in the amount of previously recognized impairment losses.The fair values of quoted investments in active markets are based on current bid prices. If the market for a financial asset is not active (andfor unlisted securities), the Group establishes fair value by using valuation techniques, which include the use of recent arm’s lengthtransactions, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants.Gains and losses arising from changes in the fair value of the financial assets at fair value through profit or loss category are included in Tradingand Securities Gain – net account in the statements of income in the period in which they arise. Gains and losses arising from changes in thefair value of available-for-sale financial assets are recognized directly in capital funds, until the financial asset is derecognized or impaired atwhich time the cumulative gain or loss previously recognized in capital funds shall be recognized in profit or loss. However, interest calculatedusing the effective interest method is recognized in the statements of income. Dividends on available-for-sale equity instruments arerecognized in the statement of income when the entity’s right to receive payment is established.Non-compounding interest and other cash flows resulting from holding financial assets are recognized in profit or loss when received,regardless of how the related carrying amount of financial assets is measured.Derecognition of financial assets occurs when the rights to receive cash flows from the financial instruments expire or are transferred andsubstantially all of the risks and rewards of ownership have been transferred.3.7 Derivative Financial Instruments and Hedge AccountingThe Group is a party to various foreign currency forward and swap contracts and cross-currency and interest rate swaps. These contracts areentered into as a service to customers and as a means of reducing or managing the Group’s foreign exchange and interest rate exposures aswell as for trading purposes.Derivatives are initially recognized at fair value on the date on which derivative contract is entered into and are subsequently measured attheir fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and valuationtechniques, including discounted cash flow models and option pricing models, as appropriate. All derivatives are carried as assets when fairvalue is positive and as liabilities when fair value is negative.The best evidence of the fair value of a derivative at initial recognition is the transaction price (the fair value of the consideration given orreceived) unless the fair value of that instrument is evidenced by comparison with other observable current market transactions in the sameinstrument or based on a valuation technique whose variables include only data from observable markets. When such evidence exists, theGroup recognizes profits at initial recognition.Certain derivatives embedded in other financial instruments, such as the conversion option in a convertible bond and credit default swap in acredit linked note, are considered as separate derivatives when their economic characteristics and risks are not closely related to those of thehost contract and the host contract is not carried at fair value through profit or loss. These embedded derivatives are measured at fair valuewith changes in fair value recognized in the statements of income.Except for derivatives that qualify as a hedging instrument, change in the fair value of derivatives are recognized in profit or loss. The methodof recognizing the resulting fair value gain or loss on derivatives that qualify as hedging instrument depends on the hedging relationshipdesignated by the Group. The Group designates certain derivatives as either: (1) hedges of the fair value of recognized assets or liabilities orfirm commitments (fair value hedge); or (2) hedges of highly probable future cash flows attributable to a recognized asset or liability, or aforecasted transaction (cash flow hedge). Hedge accounting is used for derivatives designated in this way provided certain criteria are met.The Group documents, at the inception of the transaction, the relationship between hedging instruments and hedged items, as well as its riskmanagement objective and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at hedgeinception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changesin fair values or cash flows of hedged items.• Fair value hedge. Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in thestatements of income, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedgedrisk.If the hedge no longer meets the criteria for hedge accounting, the adjustment to the carrying amount of a hedged item for whichthe effective interest method is used is amortized to profit or loss over the period to maturity. The adjustment to the carryingamount of a hedged equity security remains as part of capital funds until the disposal of the equity security.• Cash flow hedge. The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flowhedges are recognized in capital funds. The gain or loss relating to the ineffective portion is recognized immediately in thestatements of income.
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Page 32 and 33: 30 BANCO DE OROThe following reconc
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