23. Sound accounting principles require the selection and application of accounting policies and procedures to be governed by certain fundamental accounting concepts, such as prudence and consistency. These overall guiding concepts are established in the accounting literature and in concepts statements issued by leading accounting standard-setters ¹⁶. They are also discussed in the Basle Committee's recently issued report on Enhancing Bank Transparency. Normally, these concepts apply irrespective of whether the accounting information is produced for the purposes of published financial statements, the calculation of regulatory solvency requirements, or the determination of distributable profits. Moreover, they apply equally to accounting for loans and other economic activities conducted by banks. Some of the more fundamental accounting concepts that should be applied in the accounting for loans are discussed below.

24. A bank's financial reporting should convey a true and fair view, or present fairly, the financial position and financial performance of the bank (true and fair view / fair presentation) ¹⁷. Financial reporting should include adequate disclosure and reasonable detail, and should be free from bias. Where compliance with applicable accounting standards is not in itself sufficient to give a true and fair view or a fair presentation, additional disclosure should be given.

25. A bank should have a realistic view of its business activities and adequately consider uncertainty and risks inherent in those activities in preparing and presenting accounting information (prudence and conservatism). From a safety and soundness perspective, it is important that the accounting principles used by a bank reflect prudent and conservative valuations. Provisions or allowances should be made for all expenses and losses that are probable and can be reasonably estimated on the basis of available information. Judgements needed to make estimates should include a reasonable degree of caution, so that assets, equity or income are not overstated and liabilities or expenses are not understated. However, this does not justify the establishment of hidden (undisclosed) reserves through undervaluation of assets or overaccrual of liabilities.

26. A bank should select and apply accounting policies in a way that ensures that accounting information is reliable (reliability). In particular, accounting information should:
    • represent faithfully that which it purports to represent or could reasonably be expected to represent;
    • reflect the economic substance of events and transactions and not merely their legal form;
    • be verifiable;
    • be neutral, i.e., free from material error or bias;
    • be prudent, and
    • be complete in all material respects.

27. Bank's financial reports should present or disclose each material item separately (materiality). Information is material if its omission or misstatement could have changed or influenced the judgement or decision of a user relying on that information. Magnitude by itself, without regard to the nature of the item and the circumstances in which the judgement has to be made, is not generally a sufficient basis for a materiality judgement.

28. A bank should use consistent accounting policies and procedures from period to period, and consistent measurement concepts and procedures for related items (consistency). Changes should not be made unless they can be justified as being more appropriate, e.g., because of a revision in accounting standards issued by a competent standard-setter. The consistency requirement does not preclude items being reclassified, e.g., because of a change in their use.

29. A bank should recognise transactions and events when they occur and not as cash or its equivalent is received or paid, and they should record and report them in the periods to which they relate (accrual basis of accounting). Expenses should be reported in the period in which they are incurred and income in the period in which it is earned. Expenses should be matched against the income they relate to, so that net income is measured by the difference between income over associated expenses during the same period.

30. Finally, a bank should select and apply accounting policies in a way that promotes comprehensiveness, relevance and timeliness of accounting information.

Footnotes:

16. E.g., International Accounting Standard (IAS) No. 1 (revised 1997), IASC Framework for the Preparation and Presentation of Financial Statements, Canadian Institute of Chartered Accountants' (CICA) Handbook Section 1000 on Financial Statement Concepts, UK Accounting Standards Board's Exposure Draft Statement of Principles for financial reporting, U.S. Financial Accounting Standards Board's (FASB) Statements of Financial Accounting Concepts No. 2 and 5, and certain provisions in the EU Accounting Directives.

17. Supervisory reports should also follow this principle. However, to the extent supervisory reports are more timely or frequent than audited financial statements, supervisors may permit banks to make more use of estimates in the preparation of the accounting information in these reports.