Notes to the Financial Statements

1. Reporting Entity

1.1 Corporate Information

Bank of Ceylon (“the Bank”) is a Government-owned bank domiciled in Sri Lanka, duly incorporated on 1 August 1939 under the Bank of Ceylon Ordinance No. 53 of 1938. It is a licensed commercial bank established under the Banking Act No. 30 of 1988 and amendments thereto. The Registered Office of the Bank is situated at “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 amounting to USD 500.0 million are listed on the Singapore Stock Exchange. The staff strength of the Bank as at 31 December 2017 was 7,587 (2016 – 7,569).

1.2 Consolidated Financial Statements

The Consolidated Financial Statements are prepared as at and for the year ended 31 December 2017 comprise the Bank (“Parent”), its Subsidiaries (together referred to as the “Group” and individually as “Group Entities”) and the Group’s interests in its associate companies. The Financial Statements of the companies in the Group have a common financial year which ends on 31 December, except the associate companies, Transnational Lanka Records Solutions (Private) Limited and Ceybank Asset Management Limited. The Bank is the ultimate parent of the Group.

1.3 Principal Activities

1.3.1 Bank

The principal activities of the Bank during the year were, personal banking, corporate banking, development banking, offshore banking, trade financing, lease financing, primary dealing, investment banking and treasury operations, correspondent banking and money remittances, Islamic banking, bancassurance, pawning, credit card facilities, foreign currency operations, and other financial services.

1.3.2 Subsidiaries

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

Name of the Company	Principal Business Activities
Property Development PLC	Own, maintain and manage the Bank of Ceylon head office building.
Merchant Bank of Sri Lanka & Finance PLC	Leasing, hire purchase, corporate and retail credit facilities, corporate advisory services, capital market operations, margin trading, microfinancing, agricultural credit facilities, real estate, pawning and accepting deposits.
BOC Management & Support Services (Private) Limited	Not in operation and in the process of liquidation.
BOC Property Development & Management (Private) Limited	Renting of office space of BOC Merchant Tower in Colombo 03 and Ceybank House in Kandy.
BOC Travels (Private) Limited	Engages in travel-related services.
Hotels Colombo (1963) Limited	Provides hotel services.
Ceybank Holiday Homes (Private) Limited	Maintaining of pilgrims rests/holiday homes/guest houses.
MBSL Insurance Company Limited	Underwriting of all classes of life and general insurance.
Koladeniya Hydropower (Private) Limited	Hydropower generation.
Bank of Ceylon (UK) Limited	Authorised licensed commercial bank by Prudential Regulation Authority of the United Kingdom, engages in retail and corporate banking, treasury operations, correspondent banking services and trade finance services.

1.3.3 Associates

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

Name of the Company	Principal Business Activities
Ceybank Asset Management Limited	Management of unit trust funds and other private portfolios.
Lanka Securities (Private) Limited	Registered stockbroker, engages in equity trading, debt trading and margin trading.
Transnational Lanka Records Solutions (Private) Limited	Renting properties and real estates.
Southern Development Financial Company Limited	Not in operation and in the process of liquidation.

There were no significant changes in the nature of principal activities of the Bank, Subsidiaries and Associates during the year under review. BOC Management & Support Services (Private) Limited (MSS) has not carried out its core business activities since 2007 and the Board of the Bank has granted the approval to wind-up the company. Southern Development Financial Company Limited (SDFCL) is also not in operations. The Board of Directors of SDFCL has decided to wind-up the company and is in the process of liquidation.

2. Directors’ Responsibility for Financial Statements

2.1 Preparation and Presentation of the
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 No. 53 of 1938 and its amendments, Banking Act No. 30 of 1988 and its amendments thereto and Sri Lanka Accounting Standards (SLFRSs and LKASs ). These Financial Statements comprises

• Statement of Profit or Loss
• Statement of Comprehensive Income
• Statement of Financial Position
• Statement of Changes in Equity
• Statement of Cash Flows
• Notes to the Financial Statements

2.2 Approval of Financial Statements

The Financial Statements for the year ended 31 December 2017 were authorised for issue on 27 March 2018
by the Board of Directors.

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 (SLFRSs) and Sri Lanka Accounting Standards (LKASs) laid down by The Institute of Chartered Accountants of Sri Lanka (together referred to as SLFRSs in these Financial Statements). The preparation and presentation of these Financial Statements are in compliance with the requirements of the Bank of Ceylon Ordinance, the Banking Act No. 30 of 1988 and the Companies Act No. 07 of 2007. The Group has prepared Financial Statements which comply with SLFRSs applicable for the year ended 31 December 2017, together with the comparative year data as at and for the year ended 31 December 2016, as described in the accounting policies.

3.2 Basis of Measurement

The Financial Statements have been prepared on the basis of historical cost convention which has been applied on a consistent basis, except for the following:

• Derivative financial instruments are measured at fair value (Notes 24 and 40)
• Financial instruments held for trading are measured at fair value (Note 25)
• Available for Sale financial investments are measured at fair value (Note 28)
• Owner-occupied freehold land and buildings and buildings on leasehold lands are measured at revalued amount less any subsequent accumulated depreciation and impairment losses (Note 33)
• Defined benefit obligations are actuarially valued and recognised at the present value of the defined benefit obligation less total of the fair value of plan assets (Note 46)

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

3.3 Presentation of Financial Statements

Items in the Financial Position of the Bank and the Group are grouped by nature of such item and presented broadly in order of their relative liquidity and maturity pattern. An analysis regarding recovery or settlement within 12 months after the reporting date (current) and more than 12 months after the reporting date (non-current) is presented in Note 56.

3.3.1 Functional and Presentation Currency

Items included in the Financial Statements are measured and presented in Sri Lankan Rupees (“LKR”) which is the functional currency of the primary economic environment in which the Bank operates.

3.3.2 Accrual Basis of Accounting

The Financial Statements, except for information on Statement of Cash Flows have been prepared following the accrual basis of accounting.

3.3.3 Offsetting

Financial assets and financial liabilities are generally reported gross in the Statement of Financial Position. They are only offset and reported net when, in addition to having an unconditional legally enforceable right to offset the recognised amounts without being contingent on a future event, the parties also intend to settle on a net basis in all of the following circumstances:

• The normal course of business
• The event of default
• The event of insolvency or bankruptcy of the Bank and/or its counterparties.

Income and expenses are not offset in the Statement of Profit or Loss unless required or permitted by any accounting standard or interpretation and as specifically disclosed in the accounting policies of the Group. Statement of Cash Flows has been prepared by using of “Indirect Method” in accordance with LKAS 7 – “Statement of Cash Flows”, whereby the profit is adjusted to derive the cash flows from operating activities. Cash and cash equivalents comprise cash in hand, other short-term highly liquid investments with maturity less than seven days from date of acquisition and bank overdrafts.

3.3.4 Comparative Information

The comparative information is provided in narrative and descriptive nature, if it is relevant to understand the current period’s Financial Statements and reclassified wherever necessary to conform to the current year’s presentation.

3.3.5 Materiality and Aggregation

In compliance with LKAS 1 – “Presentation of Financial Statements”, each material class of similar items are presented separately in the Financial Statements. Items of dissimilar nature
or functions are presented separately unless they are immaterial.

3.3.6 Rounding

The amounts in the Financial Statements have been rounded-off to the nearest Rupees thousands, except where otherwise indicated as permitted by the Sri Lanka Accounting Standard LKAS 1 – “Presentation of Financial Statements”.

3.3.7 Use of Significant Accounting Judgements, Estimates and Assumptions

The preparation of the Financial Statements requires management to exercise judgements, 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 judgements, 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 judgements, estimates and assumptions, which have the most significant effect on the amounts recognised in the Financial Statements.

3.3.7.1 Going Concern

The Management has made an assessment on the Group’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 Group’s ability to continue as a going concern. Therefore, the Financial Statements continue to be prepared on the going concern basis.

3.3.7.2 Commitment and Contingent Liabilities

All discernible risks are accounted for in determining the amount of all known and measurable liabilities. Contingent liabilities are possible obligations whose existence will be confirmed only by uncertain future events or present obligations where the transfer of economic benefit is not probable or cannot be reliably measured. Contingent liabilities are not recognised in the Statement of Financial Position but are disclosed unless its considered remote that the Group will be liable to settle the possible obligation.

3.3.7.3 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 a 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 judgement is exercised in establishing fair values which minimise the effect of use of unobservable inputs. The valuations of financial instruments are described comprehensively in Note 59.

3.3.7.4 Impairment Losses on Loans and Advances

The measurement of impairment of loans and advances requires management’s best estimate of the losses incurred in the portfolio at reporting date.

The Group reviews its individually significant loans and advances at each reporting date to assess whether an impairment loss should be recorded in the Statement of Profit or Loss. In particular, management’s judgement 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, all such 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 judgements on the effect of concentrations of risks and economic data (including levels of unemployment, real estate price indices, country risk and the performance of different individual groups). Details of impairment losses on loans and advances are given in Note 27.

3.3.7.5 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.

The Group also records impairment charges on equity investments classified as available for sale 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 judgement. In making this judgement, 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. Details of impairment of available for sale investments are given in Note 28.

3.3.7.6 Impairment of Investment in Subsidiaries, Other Financial Assets and Non-Financial Assets

The Group and the Bank follow the guidance of LKAS 36 – “Impairment of Assets” and LKAS 39 – “Financial Instruments: Recognition and Measurement” in determining whether
an investment or a financial asset is impaired. Determination and identification of impairment indicators require the Group and the Bank to evaluate duration and extent to which the fair value of an investment for a financial asset is less than its cost and the financial stability of the near term business outlook of the investment or the financial asset, considering the factors such as performance of the sector and industry, technology and operational environmental changes along with future cash flows. This process involves with significant judgement in aforesaid areas and details are given under respective Notes.

3.3.7.7 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 and assumptions used in the year are given in Note 46.

3.3.7.8 Fair Value of Land and Buildings

The freehold land and buildings and the buildings on leasehold land of the Group are reflected at fair value less accumulated depreciation. The Group engaged independent valuation specialists to determine fair value of such properties in terms of the SLFRS 13 – “Fair Value Measurement”. The details of valuation of freehold land and buildings and the buildings on leasehold land are given in Note 33.

3.3.7.9 Useful Life of the Property, Plant and Equipment and Intangible Assets

The Group reviews the residual values, useful lives and methods of depreciation of Property, Plant and Equipment and intangible assets at each reporting date. Judgement of the management is exercised in the estimation of these values, rates, methods and hence they are subject to uncertainty. The details of the depreciation methods and rates used for each assets category are given in Note 33.

3.3.7.10 Classification of Investment Properties

Management is required to use its judgement to determine whether a property qualified as an investment property. A property that is held to earn rentals or for capital appreciation or both and which generates cash flows largely independently of the other assets held by the Group are accounted for as investment properties. On the other hand, properties that are used for operations or for the process of providing services or for administration purposes and which do not directly generate cash flows as stand-alone assets are accounted as Property, Plant and Equipment.

3.3.7.11 Taxation

The Group is subject to income tax, Value Added Tax (VAT) and Nation Building Tax (NBT) and other applicable taxes.

A judgement is required to determine the total provision for current, deferred and other taxes due to the uncertainties that exists with respect to the interpretation of the applicable tax laws at the time of preparing these Financial Statements. The details on the applicable tax rates and other information are given under Notes 17 and 36.

The Group is subject to transfer pricing regulations and it is necessitated using management judgement to determine the impact of transfer pricing regulations. Accordingly, critical judgements and estimates were used in applying the regulations in aspects including but not limited to identifying associated undertakings, estimation of the respective arm’s length prices and selection of appropriate pricing mechanism. The current tax charge is subject to such judgements. Differences between estimated income tax charge and actual payable may arise as a result of Management’s interpretation and application of transfer pricing regulation.

4 Significant Accounting Policies

The significant accounting policies applied by the Bank and the Group in preparation of its Financial Statements are included below and have been consistently applied to all periods presented in these Financial Statements of the Group and the Bank, unless otherwise indicated. A more detailed description of policies adopted are set out in the respective notes, where relevant.

4.1 Basis of Consolidation

The Group’s Financial Statements comprise consolidation of the Financial Statements of the Bank and its Subsidiaries in terms of SLFRS 10 – “Consolidated Financial Statements” and LKAS 27 – “Consolidated and Separate Financial Statements” and the proportionate share of the profit or loss and net assets of its Associates in terms of the Sri Lanka Accounting Standard LKAS 28 – “Investments in Associates and Joint Ventures”.

The Bank’s Financial Statements comprise the amalgamation of the Financial Statements of the Domestic Banking Unit, the Offshore Banking Unit and the overseas operations of the Bank.

The detailed accounting policies pertaining to the consolidation of Subsidiaries and Associates are given in the Notes 30 and 31.

4.1.1 Business Combinations

The Group determines whether a transaction or other event is a business combination by applying the definition in SLFRS 3 – “Business Combination”, which requires that the assets acquired and liabilities assumed constitute a business. Business combinations are accounted for using the acquisition method. As of the acquisition date, the amount of non-controlling interest is measured either at fair value or at the non-controlling interests’ proportionate share of the acquirer’s identifiable net assets.

Acquisition related cost are costs the acquirer incurs to effect a business combination. Those costs include finder’s fees, advisory, legal, accounting, valuation and other professional consulting fees, general administrative costs, including the cost of maintaining an Internal Acquisition Department and cost of registering and issuing debt and equity securities.

Acquisition-related costs, other than those associated with the issue of debt or equity securities are expensed in the periods in which the costs are incurred and the services are received.

The Group elects on a transaction by transaction basis whether to measure non-controlling interests 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.

4.1.2 Loss of Control

When the Group loses control over a Subsidiary, it derecognises the assets and liabilities of the Subsidiary, and any related Non-Controlling Interest (NCI) and other components of equity. Any resulting gain or loss is recognised in profit or loss. Any interest retained in the former Subsidiary is measured at fair value when control is lost. Further, the Bank’s share of components previously recognised in Other Comprehensive Income (OCI) is reclassified to Profit or Loss or retained earnings as appropriate. Any surplus or deficit arising on the loss of control is recognised in the Profit or Loss. 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 depending on the level of influence retained.

4.2 Foreign Currency Translations

4.2.1 Foreign Currency Transactions and Balances

At the initial recognition, transactions in foreign currency are translated into the functional currency of the operation which is Sri Lankan Rupees (LKR) at the spot exchange rate at the date of the transaction. Monetary assets and liabilities denominated in foreign currency 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 Statement of Profit or Loss.

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 initial recognition.

Non-monetary assets and liabilities denominated in foreign currency that are measured at fair value are retranslated into the functional currency at the spot exchange rate including any exchange gain or loss component at the date on which the fair value is determined. When a gain or loss on a non-monetary item including exchange component is recognised in Other Comprehensive Income. Forward exchange contracts are valued at the forward market rates ruling on the reporting date and resulting net unrealised gains or losses are dealt within the Statement of Profit or Loss.

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 rate as at the reporting date. The income and expenses of foreign operations are translated at average rate for the period. Foreign currency differences on the translation of foreign operations are recognised in Other Comprehensive Income (OCI).

When a foreign operation is disposed off, the relevant amount in the translation reserve is transferred to the profit or loss as part of the profit or loss on disposal in other operating income or other operating expenses.

4.3 Classification of Financial Instruments between Debt and Equity

Classification of financial instruments between debt and equity depends on following characteristics of such instruments:

• Name or labels given to the instruments
• Presence or absence of a fixed maturity date
• Life of the instrument
• Source of payments
• Right to enforce payments
• Rights to participate in management
• Risk involved in the instruments
• Volatility of cash flows
• Securities given as collaterals

4.5 Provisions

A provision is recognised as a result of a past event, when 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. The amount recognised is the best estimate of the consideration required to settle the present obligation at the reporting date, taking into account the risks and uncertainties surrounding the obligation at that date. Where a provision is measured using the cash flows estimated to settle the present obligation, its carrying amount is determined based on the present value of those cash flows. A provision for onerous contracts is recognised when the expected benefits to be derived by the Group from a contract are lower than the unavoidable cost of meeting its obligations under the contract. The provision is measured as the present value of the lower of the expected cost of terminating the contract and the expected net cost of continuing with the contract.

4.6 Income Tax Expense
and Other Taxes

4.6.1 Income Tax Expense

Income tax expense comprises current and deferred tax. More details are given in Note 17.

4.6.2 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 Group’s total value addition was subjected to 15% (2016 – 15%) VAT as per Section 25 (a) of the Value Added Tax Act No. 14 of 2002 and amendments thereto. Also the Group is following value attributable method to compute VAT on financial services.

4.6.3 Withholding Tax (WHT) on Dividends

• Withholding tax on dividends distributed by the Bank.
  
  No withholding tax is paid by the Bank, since Bank distributes dividend to its sole shareholder, the Government of Sri Lanka.
• Withholding tax on dividends distributed by the Subsidiaries and Associates.

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, since it is treated as a final tax.

4.6.4 Economic Service Charge (ESC)

As per provisions of the Economic Service Charge (ESC) Act No.13 of 2006 and amendments thereafter, ESC is payable at 0.5% on Bank’s liable turnover and is deductible from income tax payable. With effect from 1 April 2012 as per the ESC Amendment Act No. 11 of 2012 ESC is payable on turnover of the Bank and is deductible from income tax payable.

4.6.5 Crop Insurance Levy (CIL)

As per the provisions of the Section 15 of the Finance Act No. 12 of 2013, the CIL was introduced with effect from 1 April 2013 and is payable 1% of the profit after tax to the National Insurance Trust Fund Board.

4.6.6 Nation Building Tax (NBT) on Financial Services

NBT on financial services is calculated
in accordance with Nation Building
Tax (NBT) Act No. 9 of 2009 and subsequent amendments. NBT on financial services is calculated at 2% of the value addition used for the purpose of VAT on Financial Services.

5 Insurance Business

5.1 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 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 Statement of Profit or Loss.

Premiums and claims are presented on a gross basis for reinsurance. Reinsurance assets or liabilities are derecognised when the contractual rights are extinguished or expire or when the contract is transferred to another party.

5.2 Insurance Receivables

Insurance receivables are recognised when due and measured on initial recognition at the fair value of the consideration 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 Statement of Profit or Loss.

5.3 Deferred Expenses

5.3.1 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 amortised in the same manner as the underlying assets amortisation is recorded in the Statement of Profit or Loss.

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 amortisation period and are treated as a change in an accounting estimate. DAC are derecognised when the related contracts are either expired or cancelled.

5.4 Reinsurance Commissions

Commissions receivable on outwards reinsurance contracts are deferred and amortised over the period of reinsurance.

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 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 Statement of Profit or Loss. 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 unrealised gains on assets in the fund.

Non-utilised contracts are subsequently carried at fair value, which is determined by using valuation techniques such as discounted cash flows and stochastic modelling. 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 contract, 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 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.

6 New Accounting Standards Issued But Not Effective as at the Reporting Date

The following Sri Lanka Accounting Standards were issued by The Institute of Chartered Accountants of Sri Lanka which are not yet effective as at 31 December 2017. Accordingly, these Accounting Standards have not been applied in the preparation of the Financial Statements for the year ended 31 December 2017.

We have identified following Standards where this applies to the Group and further details are set out below:

(i) SLFRS 9 – “Financial Instruments”:

SLFRS 9 – “Financial Instruments” will replace LKAS 39 for annual periods on or after 1 January 2018 with early adoption permitted. In 2016, the Bank set up a multidisciplinary implementation team (“the Team”) with members from its Risk, Finance and Operations teams to prepare for SLFRS 9 implementation (“the Project”). The Project implementation is continuously monitored by the Project Steering Committee which is headed by the Chief Financial Officer.

The Project has clear individual work streams within two sub-teams for classification and measurement and impairment. The initial assessment and analysis stage was completed for impairment in 2016, and the sub-team is finalising the classification and measurement phase.

The Bank performed the Diagnostic Phase (Preliminary Impact Assessment Exercise) and Implementation Phase (Solution Development) on SLFRS 9 – “Financial Instruments”.

The Bank has undertaken a significant analysis of how SLFRS 9 should be implemented and has taken tentative accounting policy decisions.

Classification and Measurement

From a classification and measurement perspective, the new Standard will require all financial assets, except equity instruments and derivatives, to be assessed based on a combination of the entity’s business model for managing the assets and the instruments’ contractual cash flow characteristics.

Business Model Assessment

The Bank determines its business model at the level that best reflects how it manages the financial assets to achieve its objectives. The Bank’s business model is not assessed on an instrument by instrument basis, but at a higher level of aggregated portfolios and is based on observable factors such as:

• How the performance of the business model and the financial asset held within that business model are evaluated and reported to the entity’s Key Management Personnel
• The risks that affects the performance of the business model (and the financial asset held within that business model) and, in particular, the way those risks are managed
• How managers of the business are compensated (for example, whether the compensation is based on the fair value of the assets managed or on the contractual cash flow collected)
• The expected frequency, value and timing of sales are also important aspect of the Bank’s assessment

The business model assessment is based on reasonably expected scenarios without taking “Worst Case” or “Stress Case” scenarios into account. If cash flows after initial recognition are realised in a way that is different from the Bank’s original expectation, the Bank does not change the classification of the remaining financial assets held in that business model, but incorporates such information when assessing newly originated or newly purchased financial assets.

Contractual Cash Flow Characteristic Test

As the second test of the classification process the Bank assesses the contractual terms of the financial asset to identify whether they meet Solely the Payment of Principle and Interest (SPPI) Principle for the purpose of this test is defined as the fair value of the financial asset at initial recognition and may change over the life of the financial asset (for example, if there are repayments of principle or amortisation of the premium/discount).

The most significant elements of interest within a lending arrangement are typically the consideration for the time value of money and credit risk. To make SPPI assessment, the Bank applies judgement and considers relevant factors such as currency in which the financial asset is denominated and the period for which the interest rate is set.

In contrast to contractual exposures that introduce a more than deminimise exposure to risk or volatility, in the contractual cash flows that are unrelated to a basic lending arrangement do not give rise to contractual cash flows that are solely the payment of principal and interest on the amount outstanding. In such cases, the financial asset is required to be measured at “Fair Value Through Profit or Loss”.

Impairment of Financial Assets

Overview of Expected Credit Loss Principle (ECL) SLFRS 9 will principally change the Bank’s loan loss provision method by replacing LKAS 39 – “Financial Instrument Recognition and Measurement’s” incurred loss approach with a forward looking ECL Approach.

ECL allowance will be based on credit losses expected to arise over the life of the asset (Lifetime expected credit loss or LTECL), unless there has been no significant increase in credit risk since origination in which case the loss allowance will be 12 month expected credit loss (12mECL)

12mECL is the portion of LTECL that represent the ECL that results from default events on a financial instrument that are possible within 12 months after the reporting date.

The Bank has established a policy to perform an assessment, at the end of each reporting period of whether a financial instrument's credit risk has increased significantly since initial recognition. Based on such process the Bank groups loans into Stage 1, Stage 2, and Stage 3 as described below:

• Stage 1: When loans are first recognised, the Bank recognises an allowance based on 12mECL. Stage 1 loans also include the facilities where the credit risk has improved and the loans has been reclassified from Stage 2. Assessment of Stage 1 will be performed collectively.
• Stage 2: When a loan has shown a significant increase in credit risk since origination, the Bank records an allowance for the LTECL. Stage 2 loans also include facilities, where the credit risk has improved and the loan has been reclassified from Stage 3. Assessment of Stage 2 will be performed collectively.
• Stage 3: Loan considered to be credit impaired/contains objective evidence of incurred losses records an allowance for the LTECL. Stage 3 assessment will be performed Individually/Collectively Significant Increase in Credit Risk.

The Bank continuously monitors all assets subject to ECL, in order to determine whether an instrument or a portfolio of instruments is subject to 12mECL or LTECL, the Bank assess whether there has been a significant increase in credit risk since initial recognition. The Bank considers an exposure to have significantly increased in credit risk when the either of the following criteria are met:

• Facilities exceeding 30 days past due
• Counterparties/facilities reflected coded any elevated risk industries as per the assessment performed by the Credit Risk Management Team
• Restructured facilities Secondary qualitative indicators triggering a significant increase in credit risk for an asset, such as moving a customer/facility to watch list

Individually Significant Assessment and Not Impaired Individually

The Bank will individually assess all customer exposures which are above the predetermined threshold. Individual assessment will be performed for all the customers with Objective evidence of incurred losses (under Stage 3). Loans which are individually significant but not impaired will be assessed collectively for impairment either under Stage 1 or Stage 2 based on the criteria whether there has been significant credit deterioration since origination.

While establishing significant credit deterioration the Bank will consider the following criteria:

• Other changes in the rates or terms
  of an existing financial instrument that would be significantly different if the instrument was newly originated.
• Significant changes in external market indicators of credit risk for a particular financial instrument or similar financial instrument.
• Other Information related to the borrower, such as changes in the price of a borrower’s debt/equity instrument.
• An actual/expected internal credit rating downgrade for the borrower or decrease in behavioural score used to assess credit risk internally.
• Existing or forecast adverse changes in business, financial or economic condition that are expected to cause significant change in the borrower’s ability to meet its obligation.
• An actual or expected significant change in the operating results of the borrower in relating to actual/expected decline in revenue, increase in operating risk, working capital deficiency, decrease in asset quality, increase in gearing, liquidity management problems.
• Significant increase in credit risk on other financial instruments of the same borrower.
• An actual or expected significant adverse change in the regulatory, economic or technological environment of the borrower that result in a significant change in the borrower’s ability to meet the debt obligation.

Grouping Financial Assets Measured on a Collective Basis

As explained above, the Bank calculates ECL either on a collective or individual basis. Asset classes where the Bank calculates ECL on an individual basis includes all individually significant assets which are belong to Stage 3. All assets which belong to Stages 1, 2 and individually non-impaired assets will be assessed collectively for impairment.

The Bank groups these exposures for smaller homogeneous exposures, based on a combination of internal and external characteristics of the loan as described below:

• Product Type
• Type of Collateral
• Days Past Due
• Industry

The Calculation of ECL

The Bank calculates ECL-based on three probability weighted scenarios to measure expected cash shortfalls, discounted at an approximation to the EIR. A cash shortfall is the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity expects to receive.

The mechanics of the ECL calculation are outlined below and the key elements are as follows:

• PD: The Probability of Default is an estimate of the likelyhood of default over a given time horizon. A default may only happen at a certain time over the assessed period, if the facility has not been previously derecognised and is still in the portfolio.
• EAD: Exposure At Default is the estimate of the exposure at a future default date, taking into account expected changes in the exposure after the reporting date, including repayments of the principle and interest, whether scheduled by contract or otherwise, expected draw downs on committed facilities.
• LGD: Loss Given Default is an estimate of the loss arising in the case where a default occurs at a given time. It is based on the difference between the contractual cash flows due and those that the lenders would expect to receive, including realisation of any collateral. It is usually expressed as a percentage of the EAD.

When estimating the ECL, the Bank considers three scenarios (Base Case, Best Case and Worst Case). Each of these scenarios associated with different loss rates. For all products, the maximum period of which the credit losses are determined is the contractual life of a financial instrument.

Forward Looking Information

In the ECL model the Bank relies on broad range qualitative/quantitative forward looking information as economic input such as:

Quantitative	Qualitative
GDP Growth	Government Policies
Inflation	Status of the Industry Business
Unemployment	Regulatory Impact
Interest Rates
Exchange Rates

Impact to the Bank on SLFRS 9 is presented in below table in a summarised format:

Impacted Area	Requirement under LKAS 39	Requirement under SLFRS 9	Possible impact
Financial asset classification and measurement	Classification is based on ability and intention to hold and the marketability of the instrument. There are four categories as follows: Held to Maturity Loans and Receivables Fair Value Through Profit or Loss Available for Sale	Classification is based on characteristics of financial instruments and the business model of the portfolio. There are three categories as follows: Amortised cost Fair Value Through Profit or Loss Fair Value Through OCI	Any gain/loss on fair value cannot be recognised in Profit or Loss, if equity instrument is classified as Fair Value Through OCI. No significant impact
Financial liabilities	Two categories has been defined as: Fair Value Through Profit or Loss Amortised cost	Two categories has been defined as: Fair Value Through Profit or Loss Amortised cost	No change
Impairment	Incurred loss model	Expected loss model	Sri Lanka Development Bond (SLDB) and corporate debentures are subject to impairment Under performing loans which are having significant deterioration in credit risk are considered for life time expected loss Undrawn and unutilised exposures are subject to impairment Forward looking information is incorporated through economic factor adjustment
Hedge accounting	Retrospective effectiveness of the hedging instrument is considered and the results should be within the range of 80%-125%	Quantitative threshold of 80%-125% is removed and qualitative threshold is used for recognising effectiveness of the hedge	No impact

The transition work has not been finalised yet since the Bank is refining and finalising its models for expected credit loss calculations and the new accounting policies, assumptions, judgements and estimation techniques employed are subject to change until the Bank finalises its first Financial Statements that include the date of initial application. The Bank is in the process of assessing the impact for the balances as at 31 December 2017,
therefore the quantified impact of the above is not disclosed. The Group also has not quantified the impact of the above as at 31 December 2017.

(ii) SLFRS 15 – “Revenue from Contracts with Customers”

SLFRS 15 states the principles that an entity shall apply to report useful information to users of Financial Statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with
a customer.

SLFRS 15 introduces a five step approach for revenue recognition from contracts with customers and replaces all other currently applicable revenue standards and related interpretations (LKAS 18 – “Revenue”, LKAS 11 – “Construction Contracts”, IFRIC 13 – “Customer
Loyalty Programs”).

SLFRS 15 will become effective on
1 January 2018, with early adoption is permitted. However, the Group does not expect significant impact on its Financial Statements resulting from SLFRS 15.

(iii) SLFRS 16 – “Leases”

SLFRS 16 eliminates the current
dual accounting model for lessees which distinguishes between On-Balance Sheet finance leases and Off-Balance Sheet operating leases. Instead there will be a single On-Balance Sheet accounting model that is similar to current finance lease accounting. This Standard will be replaced LKAS 17 – “Leases”, IFRIC 4 – “Determining whether an Arrangement Contains a Lease”, SIC 15 – “Operating Leases – Incentives” and SIC 27 – “Evaluating the Substance of Transactions Involving the Legal Form of a Lease”.

18 Earnings Per Share and Dividend Per Share

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 Bank (the numerator) by the weighted average number of ordinary shares in issue (the denominator) during the year.

	Bank		Group
For the year ended 31 December	2017	2016	2017	2016
Profit attributable to ordinary shareholder of the Bank (LKR ’000)	21,312,284	24,790,996	21,470,163	23,496,656
Weighted average number of ordinary shares in issue [Note 18.1.1]	11,479,452	10,000,000	11,479,452	10,000,000
Basic earnings per share (LKR)	1,856.56	2,479.10	1,870.31	2,349.67

18.1.1 Weighted Average Number of Ordinary Shares in Issue

	Bank		Group
	2017	2016	2017	2016
Number of ordinary shares in issue as at 1 January	10,000,000	10,000,000	10,000,000	10,000,000
Weighted average number of ordinary shares issued during the year	1,479,452	–	1,479,452	–
Weighted average number of ordinary shares in issue as at 31 December	11,479,452	10,000,000	11,479,452	10,000,000

18.2 Diluted Earnings Per Share

Diluted earnings per share is calculated by dividing the profit or loss attributable to ordinary shareholder of the Bank (the numerator) by the weighted average number of ordinary shares in issue during the year after adjusting for effect of all dilutive potential ordinary shares (the denominator).

	Bank		Group
For the year ended 31 December	2017	2016	2017	2016
Profit attributable to ordinary shareholder of the Bank (LKR ’000)	21,312,284	24,790,996	21,470,163	23,496,656
Weighted average number of ordinary shares after adjusting for dilution [Note 18.2.1]	15,068,493	10,164,384	15,068,493	10,164,384
Diluted earnings per share (LKR)	1,414.36	2,439.01	1,424.84	2,311.67

18.2.1 Weighted Average Number of Ordinary Shares After Adjusting for Dilution

	Bank		Group
For the year ended 31 December	2017	2016	2017	2016
Weighted average number of ordinary shares in issue	11,479,452	10,000,000	11,479,452	10,000,000
Weighted average number of potential ordinary shares under pending allotment during the year	3,589,041	164,384	3,589,041	164,384
Weighted average number of ordinary shares after adjusting for dilution	15,068,493	10,164,384	15,068,493	10,164,384

19 Analysis of Financial Instruments by Measurement Basis

All financial assets and liabilities are measured under the following headings as per the LKAS 39 – “Financial Instruments: Recognition and Measurement”.

19.1 Bank

As at 31 December	2017
	Fair Value through Profit or Loss LKR ’000	Fair Value through OCI LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Assets
Cash and cash equivalents	–	–	72,843,108	72,843,108
Balances with central banks	–	–	68,689,012	68,689,012
Placements with banks	–	–	8,067,490	8,067,490
Securities purchased under resale agreements	–	–	18,455,555	18,455,555
Derivative financial instruments	1,618,823	–	–	1,618,823
Financial instruments – Held for trading	8,359,274	–	–	8,359,274
Financial investments – Loans and receivables	–	–	213,167,048	213,167,048
Loans and advances to customers	–	–	1,163,160,914	1,163,160,914
Financial investments – Available for sale	–	17,921,170	–	17,921,170
Financial investments – Held to maturity	–	–	308,256,082	308,256,082
Total financial assets	9,978,097	17,921,170	1,852,639,209	1,880,538,476

As at 31 December	2017
	Fair Value through Profit or Loss LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Liabilities
Due to banks	–	2,203,199	2,203,199
Securities sold under repurchase agreements	–	44,487,462	44,487,462
Derivative financial instruments	70,715	–	70,715
Due to customers	–	1,546,832,036	1,546,832,036
Other borrowings	–	178,191,089	178,191,089
Debt securities issued	–	–	–
Subordinated term debts	–	42,570,457	42,570,457
Total financial liabilities	70,715	1,814,284,243	1,814,354,958

As at 31 December	2016
	Fair Value through Profit or Loss LKR ’000	Fair Value through OCI LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Assets
Cash and cash equivalents	–	–	67,705,791	67,705,791
Balances with central banks	–	–	56,387,741	56,387,741
Placements with banks	–	–	11,674,664	11,674,664
Securities purchased under resale agreements	–	–	1,901,618	1,901,618
Derivative financial instruments	5,300,844	–	–	5,300,844
Financial instruments – Held for trading	8,474,041	–	–	8,474,041
Financial investments – Loans and receivables	–	–	191,874,638	191,874,638
Loans and advances to customers	–	–	1,000,082,574	1,000,082,574
Financial investments – Available for sale	–	10,463,046	–	10,463,046
Financial investments – Held to maturity	–	–	243,178,400	243,178,400
Total financial assets	13,774,885	10,463,046	1,572,805,426	1,597,043,357

As at 31 December	2016
	Fair Value through Profit or Loss LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Liabilities
Due to banks	–	2,042,322	2,042,322
Securities sold under repurchase agreements	–	59,424,629	59,424,629
Derivative financial instruments	171,663	–	171,663
Due to customers	–	1,256,589,490	1,256,589,490
Other borrowings	–	195,469,853	195,469,853
Debt securities issued	–	3,427,058	3,427,058
Subordinated term debts	–	38,645,546	38,645,546
Total financial liabilities	171,663	1,555,598,898	1,555,770,561

19.2 Group

As at 31 December	2017
	Fair Value through Profit or Loss LKR ’000	Fair Value through OCI LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Assets
Cash and cash equivalents	–	–	78,005,362	78,005,362
Balances with central banks	–	–	68,689,012	68,689,012
Placements with banks	–	–	5,319,602	5,319,602
Securities purchased under resale agreements	–	–	19,872,247	19,872,247
Derivative financial instruments	1,618,823	–	–	1,618,823
Financial instruments – Held for trading	8,596,548	–	–	8,596,548
Financial investments – Loans and receivables	–	–	214,349,624	214,349,624
Loans and advances to customers	–	–	1,194,294,394	1,194,294,394
Financial investments – Available for sale	–	22,552,292	–	22,552,292
Financial investments – Held to maturity	–	–	308,750,317	308,750,317
Total financial assets	10,215,371	22,552,292	1,889,280,558	1,922,048,221

As at 31 December	2017
	Fair Value through Profit or Loss LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Liabilities
Due to banks	–	2,194,266	2,194,266
Securities sold under repurchase agreements	–	44,628,686	44,628,686
Derivative financial instruments	70,715	–	70,715
Due to customers	–	1,566,376,418	1,566,376,418
Other borrowings	–	184,330,181	184,330,181
Debt securities issued	–	5,667,514	5,667,514
Subordinated term debts	–	42,226,067	42,226,067
Total financial liabilities	70,715	1,845,423,132	1,845,493,847

As at 31 December	2016
	Fair Value through Profit or Loss LKR ’000	Fair Value through OCI LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Assets
Cash and cash equivalents	–	–	73,244,043	73,244,043
Balances with central banks	–	–	56,387,741	56,387,741
Placements with banks	–	–	12,931,605	12,931,605
Securities purchased under resale agreements	–	–	2,350,704	2,350,704
Derivative financial instruments	5,300,844	–	–	5,300,844
Financial instruments – Held for trading	8,804,647	–	–	8,804,647
Financial investments – Loans and receivables	–	–	191,984,082	191,984,082
Loans and advances to customers	–	–	1,027,768,110	1,027,768,110
Financial investments – Available for sale	–	16,263,641	–	16,263,641
Financial investments – Held to maturity	–	–	243,253,967	243,253,967
Total financial assets	14,105,491	16,263,641	1,607,920,252	1,638,289,384

As at 31 December	2016
	Fair Value through Profit or Loss LKR ’000	Amortised Cost LKR ’000	Total LKR ’000
Financial Liabilities
Due to banks	–	2,053,945	2,053,945
Securities sold under repurchase agreements	–	58,925,801	58,925,801
Derivative financial instruments	171,663	–	171,663
Due to customers	–	1,273,631,287	1,273,631,287
Other borrowings	–	204,485,301	204,485,301
Debt securities issued	–	8,360,333	8,360,333
Subordinated term debts	–	38,295,318	38,295,318
Total financial liabilities	171,663	1,585,751,985	1,585,923,648