Accounting policies

Statement of compliance

These consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) as at 31 December 2017, and in the areas not regulated by these standards, in accordance with the requirements of the Accounting Act of 29 September 1994 and the respective secondary legislation issued on its basis, as well as the requirements relating to issuers of securities registered or applying for registration on an official stock market.

Going concern

The consolidated financial statements of the Group have been prepared on the basis that the Group will continue as a going concern for a period of at least 12 months from the publication date, i.e. from 12 March 2018. As at the date of signing these consolidated financial statements, the Bank’s Management Board is not aware of any facts or circumstances that would indicate a threat to the Bank’s ability to continue in operation as a going concern for 12 months following the publication date as a result of any intended or compulsory discontinuation or significant limitation of the Group’s existing operations.

Basis of preparation of the financial statements

These consolidated financial statements have been prepared on a fair value basis in respect of financial assets and liabilities measured at fair value through profit or loss, including derivatives and available-for-sale financial assets, except for those for which the fair value cannot be reliably estimated. Other financial assets (including loans and advances) are measured at amortized cost less impairment or at purchase price less impairment. The other financial liabilities are recognized at amortized cost. Non-current assets are measured at acquisition cost less accumulated depreciation and impairment allowances. Non-current assets (or groups of such assets) classified as held for sale are measured at the lower of their carrying amount and fair value less costs to sell.

When preparing financial statements, the Group makes certain estimates and assumptions, which have a direct influence on both the financial statements and enclosed supplementary information. The estimates and assumptions that are used by the Group in determining the value of assets and liabilities as well as revenues and costs, are made based on historical data and other factors which are available and considered appropriate in the given circumstances. Assumptions regarding the future and the available data are used for assessing the carrying amounts of assets and liabilities which cannot be clearly determined using other sources. In making estimates the Group takes into consideration the reasons and sources of the uncertainties that are anticipated at the end of the reporting period. Actual results may differ from estimates.

Estimates and assumptions made by the Group are reviewed on an ongoing basis. Changes to estimates are recognized in the period to which they relate.

Summary of significant accounting policies

Major accounting policies and estimates and judgements applied in the preparation of these consolidated financial statements are presented in the notes and below. These policies were applied consistently in all the years presented. Below is a summary of accounting policies and major estimates and judgements for the individual items of the consolidated income statement and the consolidated statement of financial position.

Foreign currencies

Functional and presentation currency

Items included in the financial statements of the individual Group companies operating outside the territory of Poland are measured in the functional currency, i.e. the currency of the primary economic environment in which a given entity operates. The functional currency of the parent company and other entities included in these financial statements, except for the German Branch, the Czech Branch and entities conducting their activities outside of the Republic of Poland, is the Polish zloty. The functional currency of the entities operating in Ukraine is the Ukrainian hryvnia, the functional currency of the German Branch and the entities operating in Sweden is euro, and the functional currency of the Czech Branch is the Czech koruna.

Transactions and balances in foreign currencies

Transactions expressed in foreign currencies are translated into the functional currency using the exchange rates prevailing at the date of the transaction. At each balance sheet date items are translated by the Group using the following principles:

• cash items denominated in foreign currency are translated using a closing rate i.e. the average rate announced by the National Bank of Poland prevailing as at the end of the reporting period;
• non-cash items measured at historical cost expressed in a foreign currency are translated using the exchange rate as at the date of the transaction;
• non-cash items measured at fair value in a foreign currency are translated using the exchange rates prevailing as at the date of determination of the fair value.

Foreign exchange gains and losses arising from the settlement of such transactions and from the valuation of monetary and non-monetary assets and liabilities expressed in foreign currencies are recognized in the income statement.

Basis of consolidation

Subsidiaries

Subsidiaries are entities controlled by the parent company, which means that the parent company has a direct or indirect impact on the financial and operating policy of the given entity in order to gain economic benefits from its operations.

Acquisition accounting method

All entities of the PKO Bank Polski SA Group are consolidated using the acquisition accounting method.

The process of consolidation of financial statements of subsidiaries by the acquisition accounting method involves adding up the individual items of the income statements and statements of financial position of the parent company and the subsidiaries in the full amounts, and making appropriate consolidation adjustments and eliminations. The carrying amount of the Bank’s investments in subsidiaries and the equity of these entities at the date of their acquisition are eliminated at consolidation. The following items are eliminated in full at consolidation:

1) intercompany receivables and payables and other settlements between consolidated entities of a similar nature;

2) revenues and costs resulting from business transactions between consolidated entities;

3) profits or losses resulting from business transactions between consolidated entities contained in the value of the consolidated entities’’ assets, except for impairment losses;

4) dividends accrued or paid by subsidiaries to the parent company and other consolidated entities;

5) inter-company cash flows in the statement of cash flows.

The consolidated statement of cash flows has been prepared on the basis of the consolidated statement of financial position, consolidated income statement and additional notes and explanations.

Financial statements of subsidiaries are prepared for the same reporting periods as the financial statements of the parent company. Consolidation adjustments are made in order to eliminate any differences in the accounting policies applied by the Bank and its subsidiaries.

Acquisition method

The acquisition of subsidiaries by the Group is accounted for under the acquisition method.

In respect of mergers of the Group companies, i.e. the so-called transactions under common control, the predecessor accounting method is applied, i.e. the acquired subsidiary is recognized at the carrying amount of its assets and liabilities recognized in the Group’s consolidated financial statements in respect of the given subsidiary, including the goodwill arising from the acquisition of that subsidiary.

Associates and joint ventures

Associates are entities on which the Group exerts significant influence but which it does not control, which usually accompanies having from 20% to 50% of the total number of votes in the decision-making bodies of the entities.

Joint ventures are commercial companies or other entities, which are jointly controlled by the Bank on the basis of the Memorandum or Articles of Association or an agreement concluded for a period longer than one year.

Investments in these entities are accounted for in accordance with the equity method and are initially stated at purchase cost. The investment includes goodwill determined as at the acquisition date, net of any accumulated impairment allowances. 

The Group’s share in the results of associates and joint ventures from the acquisition date is recorded in the income statement and its share in changes in the balance of other comprehensive income from the acquisition date is recorded in other comprehensive income. The carrying amount of investments is adjusted by the total movements in the individual equity items from the acquisition date. When the Group’s share in the losses of these entities becomes equal or higher than the Group’s interest in such entities, including unsecured receivables (if any), the Group discontinues recognizing further losses, unless it has assumed the obligation or made payments on behalf of the particular entity.

Unrealized gains on transactions between the Group and such entities are eliminated pro rata to the Group's interest in those entities. Unrealized losses are also eliminated, unless there is evidence of impairment of the asset transferred.

At each balance sheet date, the Group makes an assessment of whether there is any objective evidence of impairment in investments in associates and joint ventures. If any such evidence exists, the Group estimates the recoverable amount, i.e. the value in use of the investment or the fair value of the investment less costs to sell, whichever of these values is higher. If the carrying amount of an asset exceeds its recoverable amount, the Group recognizes an impairment allowance in the income statement.

Accounting for transactions

Financial assets and financial liabilities, including forward transactions and standardized transactions, which carry an obligation or a right to purchase or sell in the future an agreed number of specified financial instruments at a fixed price, are entered into the books of account under the date of execution of the contract, irrespective of the settlement date provided in the contract.

Derecognition of financial instruments from the statement of financial position

Financial assets are derecognized from the statement of financial position when contractual rights to the cash flows from the financial asset expire, or when the financial asset is transferred by the Group to another entity.  The financial asset is transferred when the Group:

• transfers the contractual rights to collect cash flows from that financial asset to another entity; or
• retains the contractual rights to receive cash flows from the financial asset, but assumes a contractual obligation to pay cash flows to an entity outside the Group.

When the Group transfers a financial asset, it evaluates the extent to which it retains the risks and rewards of ownership of the financial asset. In such case:

• if the Group transfers substantially all risks and benefits associated with holding a given financial asset, the financial asset is eliminated from the statement of financial position;
• if the Group retains substantially all risks and benefits associated with holding a given financial asset, the financial asset continues to be recognized in the statement of financial position;
• if substantially all risks and benefits associated with holding a given financial asset are neither transferred nor retained, the Group determines whether it has maintained control of that financial asset.

If the Group has retained control, it continues to recognize the financial asset in the statement of financial position to the extent of its continuing involvement in the financial asset; if control has not been retained, then the financial asset is derecognized from the statement of financial position.

The Group derecognizes a financial liability (or a part of a financial liability) from its statement of financial position when the obligation specified in the contract has been met or cancelled or has expired.

Usually the Group derecognizes loans when they have been extinguished, when they are expired, or when they are not recoverable. Loans, advances and other receivables are written off against impairment allowances that were recognized for these accounts. If no allowances were recognized or the amount of the allowance is less than the amount of the loan, advance or other receivable, the amount of the impairment allowance is increased by the difference between the value of the receivable and the amount of the allowances that have been recognized to date before the receivable is written off.

Changes in accounting policies

Amendments to published standards and interpretations that are effective as of 1 January 2017

IAS 7 Statement of cash flows

Changes to IAS 7, Statement of Cash Flows, were published in January 2016 and approved for application in the European Union on 6 November 2017 by the Commission Regulation (EU) 2017/1990. They must be applied to financial statements prepared for annual periods commencing on or after 1 January 2017. These changes concern presentation and are aimed at providing better information on the entity's financial activities to the users of the financial statements. Therefore, the consolidated financial statements of the Group contain more precise disclosures concerning cash flows from financing activities in the consolidated statement of cash flows.

Additionally, the notes on the Group's liabilities contain more extensive information on the financing activities presented in the consolidated statement of cash flows (issues of debt securities and subordinated bonds, received loans and advances).

New standards and interpretations and amendments thereto

New standards and interpretations and amendments thereto that have been published and adopted by the EU, but have not come into force yet and are not applied by the Group

The Management Board does not expect the adoption of the new standards, their changes and interpretations to have a significant impact on the accounting policies applied by the Group with the exception of IFRS 9. The Group intends to apply them in the periods indicated in the relevant standards and interpretations (without early adoption), provided that they are adopted by the EU.

IFRS 9 Financial Instruments

IFRS 9 Financial Instruments was published in July 2014 and endorsed for application in the EU Member States on 22 November 2016 by the Commission Regulation (EU) 2016/2067. It is mandatory for financial statements prepared for annual periods commencing on or after 1 January 2018 (with the exception of insurance companies, which may apply the standard from 1 January 2021). The standard replaces IAS 39 Financial Instruments: Recognition and Measurement. The amendments cover the classification and measurement of financial instruments, recognition and calculation of impairment and hedge accounting.

The total impact of the adjustments resulting from the implementation of IFRS 9 on the Group’s financial assets and liabilities and equity, net of tax, is presented in the following table:

According to our best knowledge, the impact of the adjustments resulting from the implementation of IFRS 9 on the Group’s financial assets, financial liabilities and equity presented here is the best estimate as at the date of the publication of these consolidated financial statements.

Implementation schedule

Since 2016, the Group has carried out the “IFRS 9” project, which has been divided into two stages: “Gap analysis” and “Implementation”.

The first stage comprised the business analysis of gaps in the preparation of the Group for the IFRS 9 implementation. The project is divided into two areas:

1) classification and measurement, including hedge accounting and reporting and tax issues; and

2) impairment.

The first area was managed by the Bank's Accounting Division, and the second by the Risk Division.  Additionally, the Bank established a Steering Committee whose task was to take key decisions and control the conduct of the project. The Steering Committee comprised the Directors of the Accounting Division, Risk Division and the following Departments: Credit Risk, Accounting and Reporting, Management Information and Development of Transactional Applications. The Steering Committee was supported by the Project Sponsors:  the Vice-President of the Management Board responsible for Risk Management and the Vice-President of the Management Board responsible for Finance and Accounting. Apart from the accounting and reporting area, tax and risk area employees, the business, settlements and IT department employees were also involved in the project. The representatives of PKO Bank Hipoteczny SA (accounting and risk area) also participated in the project.

Since the beginning of 2017, the second stage of the project has been carried out, aimed at implementing the changes resulting from IFRS 9.  As in the first stage, which covered the gap analysis, the project was divided into two cooperating areas:

1) classification and measurement, including hedge accounting and reporting and tax issues; and

2) impairment.

The second stage of the project comprised:

• developing solutions in IT systems and their implementation;
• determining business models and developing new business processes, including in the areas of: SPPI tests, benchmark tests and modifications of cash flows;
• amendments to the Bank’s internal regulations, including accounting policies and impairment calculation methods;
• calculating opening balance adjustments (as at 1 January 2018) resulting from implementing IFRS 9, including those that will be recognized in the Group’s equity as at 1 January 2018.

In order to adapt the Group's IT solutions to the requirements of IFRS 9 in the area of classification and measurement, the Group has developed and implemented solutions for the integrated computer system supporting credit products and applications supporting treasury transactions (securities). Categories of financial assets have been modified in the source systems to reflect IFRS 9 requirements and solutions regarding modification/elimination of financial assets have been provided.

As far as impairment is concerned, the Group has adjusted the applications dedicated to impairment measurement to the expected changes, in particular by modifying the scope of input and output data, implementing impairment measurement algorithms in accordance with the IFRS 9 requirements and optimizing the IT infrastructure to achieve efficiency of applications that is adequate to the scope of the calculations, which is significantly greater than under IAS 39.

The Group has also extended the available applications in order to ensure the calculation of fair value adjustments for credit exposures which will be derecognized from the books of account and which are classified for measurement at fair value, as well as to identify POCI exposures.

The Group developed methods for the business model, SPPI (cash flow characteristics) and benchmark testing (quantitative testing) and a method for the fair value measurement of financial assets. Moreover, the Group completed the implementation of changes in business, accounting and other operating processes.

At the same time, the Group worked on changes in the data warehouse and in the reporting applications constituting the basis for preparation of the financial statements.

Classification and measurement

a) The principles for classification of financial instruments

In connection with the application of IFRS 9, as of 1 January 2018 the Group classifies financial assets into the following categories:

• measured at amortized cost;
• measured at fair value through other comprehensive income (FVOCI);
• measured at fair value through profit or loss (FVP&L).

Classification as at the date of acquisition or origin depends on the business model adopted by the Group for the purposes of managing a particular group of assets and on the characteristics of the contractual cash flows resulting from a single asset or a group of assets. The Group identifies the following business models:

• the “held to collect cash flows” model, in which financial assets originated or acquired are held in order to collect gains from contractual cash flows – this model is typical for lending activities;
• the “held to collect cash flows and to sell” model, in which financial assets originated or acquired are held to collect gains from contractual cash flows, but they may also be sold (frequently and in transactions of a high value) – this model is typical for liquidity management activities;
• the residual model – other than the “held to collect cash flows” and “held to collect cash flows and to sell” model.

Financial instruments are classified at the moment of the first-time application of IFRS 9, i.e. as at 1 January 2018, and at the moment of recognition or modification of the instrument. A change in the classification of financial assets may be caused by a change in the business model or failing the SPPI test. Changes in the business model are caused by changes that occur within or outside the Group or by discontinuation of a particular activity, and therefore they will occur very rarely. Failing the SPPI test is a result of a change in the characteristics of contractual cash flows, as a result of which the return on the instrument does not correspond exclusively to the amount of principal and interest.

Business model

The business model is selected upon initial recognition of financial assets. The selection is performed at the level of individual groups of assets, in the context of the business area in connection with which the financial assets originated or were acquired, and is based, among other things, on the following factors:

• the method for assessment and reporting the financial assets portfolio;
• the method for managing the risk associated with such assets and the principles of remuneration of persons managing such portfolios.

In the “held to collect cash flows” business model, assets are sold occasionally, in the event of an increase in credit risk or a change in the laws or regulations. The purpose of selling the assets is to maintain the assumed level of regulatory capital. Assets are sold in accordance with the principles described in the portfolio management strategy or close to maturity, in the event of a decrease in the credit rating below the level assumed for a given portfolio, significant internal restructuring or acquisition of another business, execution of a contingency or recovery plan or another unforeseeable factor independent of the Group.

Assessment of contractual cash flow characteristics

The assessment of the contractual cash flow characteristics establishes, based on a qualitative test of contractual cash flows, whether contractual cash flows are solely payments of principal and interest (hereinafter ‘‘SPPI’’). Interest is defined as consideration for the time value of money, credit risk relating to the principal remaining to be repaid within a specified period and other essential risks and costs associated with granting loans, as well as the profit margin.

Contractual cash flow characteristics do not affect the classification of the financial asset if:

• their effect on the contractual cash flows from that asset could not be significant (de minimis characteristic);
• they are not genuine, i.e. they affect the contractual cash flows from the instrument only in the case of occurrence of a very rare, unusual or very unlikely event (non-genuine characteristic).

In order to make such a determination, it is necessary to consider the potential impact of the contractual cash flow characteristics in each reporting period and throughout the whole life of the financial instrument.

The SPPI test is performed for each financial asset in the “held to collect cash flows” or “held to collect cash flows and to sell” models upon initial recognition (and for modifications which are significant after subsequent recognition of a financial asset) and as at the date of change of the contractual cash flow characteristics.

If the qualitative assessment performed as part of the SPPI test is insufficient to determine whether the contractual cash flows are solely payments of principal and interest, a benchmark test (quantitative assessment) is performed to determine the difference between the (non-discounted) contractual cash flows and the (non-discounted) cash flows that would occur should the time value of money remain unchanged (the reference level of cash flows).

Financial assets measured at amortized cost

Financial assets (debt financial assets) are measured at amortized cost, provided that both the following conditions are met:

• the financial asset is held in accordance with the “held to collect cash flows” business model;
• the terms and conditions of an agreement concerning the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding (the SPPI test is passed).

The initial value of a financial asset measured at amortized cost is adjusted for any commissions and fees which affect the effective return on such asset and constitute a part of the effective interest rate on such asset (the commissions and fees associated with the operations performed by the Group which result in the origin of assets). Commissions and fees affecting the effective return on assets, which occur after the origination of the financial assets, result in changes in the schedules of future cash flows generated by such assets.

The present value of this category of assets is determined based on the effective interest rate described in item f, which is used for determining (calculating) the interest income generated by the asset in a given period. It is then adjusted for cash flows and allowances in respect of expected credit losses.

Assets for which a schedule of future cash flows necessary for calculating the effective interest rate cannot be determined are not measured at amortized cost. Such assets are measured at the amount of payment due, which comprises interest on the amount receivable, net of any allowance for expected credit losses. Commissions and fees arising upon the origin of such assets or determining their financial characteristics are settled over the asset's life on a straight-line basis and recognized in interest or commission income. Commissions and fees settled on a straight-line basis are recognized in the Bank's financial result regularly throughout the life of the asset. The specific commissions and fees are settled monthly.

Financial assets measured at fair value through other comprehensive income (FVOCI)

Financial assets (including debt instruments) are measured at fair value through other comprehensive income if both the following conditions are met:

• financial assets are held in the business model whose purpose is to collect contractual cash flows and to sell financial assets; and
• the terms and conditions of an agreement concerning the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding.

Financial assets measured at fair value through other comprehensive income are measured at the fair value net of the allowances for expected credit losses.

The effect of changes in the fair value of such financial assets is recognized in other comprehensive income until a given financial asset is derecognized or reclassified, with the exception of interest income, gain or loss resulting from the allowance for expected credit losses and foreign exchange gains or losses, which are recognized in profit or loss. If a financial asset is no longer recognized, accumulated gains or losses, which were previously recognized in other comprehensive income, are reclassified from other comprehensive income to profit or loss in the form of a reclassification adjustment.

Financial assets measured at fair value through profit or loss (FVP&L)

If financial assets do not satisfy any of the above-mentioned criteria of measurement at amortized cost or at fair value through other comprehensive income, they are classified as financial assets measured at fair value through profit or loss.

Additionally, upon initial recognition a financial asset may be irrevocably classified as measured at fair value through profit or loss, if such an approach eliminates or significantly reduces inconsistencies in the measurement or recognition (accounting mismatch). This option is available for debt instruments both in the “held to collect cash flows” and “held to collect cash flows and to sell” model.

Financial assets measured at fair value through profit or loss will be presented in the consolidated financial statements of the Group in the following manner:

1) held for trading – financial assets which:

• have been acquired mainly for the purpose of their sale or redemption in the short term;
• upon initial recognition constitute a part of a portfolio of financial instruments, which are managed jointly and which actually generate short-term gains on an ongoing basis, or
• are derivative instruments (other than financial guarantee contracts or designated and effective hedging instruments);

2) financial assets that are not held for trading and must be measured at fair value through profit or loss - financial assets that have not passed the test of cash flow characteristics (irrespective of the business model);

3) financial assets designated for measurement at fair value through profit or loss upon initial recognition (the fair value through profit or loss option).

Gains or losses on the financial assets measured at fair value through profit or loss are recognized in profit or loss.

Equity instruments

Investments in equity instruments and contracts concerning such instruments are measured at fair value through profit or loss. Upon initial recognition, the entity may make an irrevocable election to present in other comprehensive income subsequent changes in the fair value (the option of measurement at fair value through other comprehensive income) of an investment in an equity instrument that is not held for trading and does not constitute a contingent payment recognized by the Group as part of a business combination in accordance with IFRS 3. If the option of measurement at fair value through other comprehensive income is selected, any dividends resulting from the investment are recognized in profit or loss. In the case of such instruments, gains/losses on measurement recognized in other comprehensive income are not reclassified to profit or loss.

In the case of investments in equity instruments, the Group did not use the option of measurement at fair value through other comprehensive income.

b) Reclassification of financial assets

Financial assets are reclassified only in the event of a change in the business model relating to the asset or a group of assets resulting from the commencement or discontinuation of a significant part of the entity's operations. Such changes are very infrequent. Reclassification is presented prospectively, i.e. without changing the effects of fair value measurement, write-downs or accrued interest that have been recognized to date.

The following are not treated as changes in the business model:

1) changes in the intentions regarding specific financial assets (even in the event of significant changes in market conditions);

2) temporary discontinuation of a specific market for financial assets;

3) a transfer of financial assets between business areas that apply different business models.

No financial liabilities are reclassified.

In the event of reclassification of a financial asset from amortized cost to measurement at fair value through profit or loss, the fair value of the asset is determined as at the reclassification date. Any gains or losses arising from a difference between the previously recognized amortized cost of the financial asset and its fair value are recognized in the income statement.

In the event of reclassification of a financial asset from the fair value through profit or loss category to the amortized cost category, the fair value of the asset becomes its new gross carrying amount as at the reclassification date. The effective interest rate is determined based on the fair value of the asset as at the reclassification date.

In the event of reclassification of a financial asset from amortized cost to measurement at fair value through other comprehensive income, the fair value of the asset is determined as at the reclassification date. Any gains or losses arising from a difference between the previously recognized amortized cost of the financial asset and its fair value are recognized in other comprehensive income. The effective interest rate and expected credit losses are not adjusted as a result of such reclassification.

In the event of reclassification of a financial asset from the measurement at fair value through other comprehensive income category to the amortized cost category, the asset is reclassified at the fair value as at the reclassification date. Accumulated gains or losses previously recognized in other comprehensive income are removed from equity and adjusted based on the fair value of the financial asset as at the reclassification date. As a result, the financial asset is measured as at the reclassification date in such a manner as if it has always been measured at amortized cost. This adjustment concerns other comprehensive income and it does not affect the financial result; therefore, it is not a reclassification adjustment in accordance with IAS 1. The effective interest rate and expected credit losses are not adjusted as a result of such reclassification.

In the event of reclassification of a financial asset from the fair value through profit or loss category to the fair value through other comprehensive income category, the Group continues to measure the asset at fair value. The effective interest rate is determined based on the fair value of the asset as at the reclassification date.

In the event of reclassification of a financial asset from the fair value through other comprehensive income category to the fair value through profit or loss category, the Group continues to measure the asset at fair value. Accumulated gains or losses previously recognized in other comprehensive income are reclassified from equity to profit or loss in the form of a reclassification adjustment in accordance with IAS 1 as at the reclassification date.

c) Changes in the estimated contractual cash flows - modifications

Modification – a change in the contractual cash flows in respect of a financial asset based on an annex to the contract. A modification may be significant or insignificant. A change in the contractual cash flows resulting from execution of the terms of the contract is not a modification.

If the contractual cash flows associated with a financial asset are renegotiated or otherwise modified, and such renegotiation or modification does not lead to such a financial asset no longer being recognized (“an insignificant modification”), the carrying amount of the financial asset is recalculated and gain or loss arising from such modification is recognized in the financial result. Adjustment of the carrying amount of a financial asset resulting from the modification is recognized in the interest income/ expenses over time using the effective interest rate method. The carrying amount of a financial asset is calculated as the present value of renegotiated or modified contractual cash flows, discounted using the original effective interest rate on the financial asset (or, in the case of credit-impaired purchased or issued financial assets, the effective interest rate adjusted for credit risk) or, if applicable (e.g. with respect to gain or loss on a hedged item resulting from hedging), the updated effective interest rate. Any costs or fees incurred adjust the carrying amount of the modified financial asset and are amortized over the remaining part of the life of the modified financial asset.

In certain circumstances, renegotiation or modification of contractual cash flows associated with a financial asset may lead to derecognition of the financial asset. If an existing financial asset is derecognized due to its modification, and a modified asset is subsequently recognized, the modified asset is treated as a “new” financial asset (“a significant modification”). The new asset is recognized at the fair value and a new effective interest rate applicable to the new asset is calculated. If the characteristics of a modified new financial asset (after signing an annex) comply with the arm’s length conditions, the carrying amount of that financial asset is equal to its fair value.

The assessment whether a given modification of financial assets is a significant or an insignificant modification depends on satisfaction of certain quantitative and qualitative criteria.

The following qualitative criteria have been adopted:

• Currency translation;
• Change of debtor, other than caused by the debtor’s death;
• Introducing or removing a contractual characteristic that adversely affects the test of cash flow characteristics;
• Concluding a composition or restructuring agreement with respect to a terminated contract.

The occurrence of at least one of these criteria results in a significant modification.

The quantitative criterion consists of a 10% test analysing the change in the contractual terms of a financial asset resulting in a difference between the amount of future cash flows arising from the changed financial asset discounted using the original effective interest rate and the amount of the future cash flows that would arise from the original financial asset discounted using the same interest rate.

In the event of the occurrence of a quantitative criterion (a difference) of more than 10%, the modification is considered significant, whereas a quantitative criterion of 10% or less means that the modification is considered insignificant.

The quantitative criterion is not applicable to loans that are subject to a restructuring process (i.e. their modification is treated as insignificant).

d) Measurement of purchased or originated credit impaired assets (POCI)

IFRS 9 distinguished a new category of purchased or originated credit-impaired assets (POCI).

POCI comprise debt financial assets measured at amortized cost and measured at fair value through other comprehensive income, i.e. loans and debt securities. Such assets are initially recognized at the net carrying amount (net of write-downs), which corresponds to their fair value. Interest income on POCI assets is calculated based on the net carrying amount using the effective interest rate adjusted for credit risk recognized for the whole life of the asset. The interest rate adjusted for credit risk is calculated taking into account future cash flows adjusted for the effect of credit risk recognized over the whole life of the asset. Any changes in the estimates of future profits in the subsequent reporting periods are charged or credited to profit or loss.

e) Measurement of off-balance sheet instruments

Financial guarantees are recognized at fair value. In the subsequent periods, financial guarantees are measured at the higher of the following two amounts:

• the amount of allowance for expected credit losses; or
• the amount of initially recognized commission, amortized in accordance with IFRS 15.

f) Interest income

Interest income is calculated using the effective interest rate used for determining (calculating) interest income generated by the asset in a given period based on the carrying amount of the financial assets, except for:

1) purchased or originated credit-impaired financial assets (see item d). With respect to such financial assets, the Group applies the effective interest rate adjusted for credit risk to the amount of amortized cost of the financial asset (net carrying amount) from the date of initial recognition (POCI assets);

2) financial assets other than purchased or originated credit-impaired financial assets, which subsequently became credit-impaired financial assets. With respect to such financial assets, the Group applies the original effective interest rate (as at the date of recognition of an indication of impairment) to the amount of amortized cost of the financial asset (the net carrying amount) in the subsequent reporting periods.

g) Assets of impact – classification and measurment

 Change in the classification and measurement of financial assets concerns:

• NBP bills, which were measured at fair value through profit or loss on a portfolio basis in accordance with IAS 39. In accordance with IFRS 9, a portfolio of bills is measured at the fair value through other comprehensive income due to the fact that the “held to collect cash flows and to sell” model is applied;
• due to the occurrence of the leverage component (an interest formula based on a multiple that is higher than 1) in the interest rate formula for selected loan portfolios, the SPPI test has not been passed: ARiMR (the Agency for Restructuring and Modernization of Agriculture) investment loans, selected working capital loans, student loans, preferential housing loans with BGK financing, housing loans (Alicja), selected loans granted to local government units. If the SPPI test has not been passed despite the application of the “held to collect cash flows” model, it is necessary to change the measurement category for such loan portfolios from amortized cost to fair value through profit or loss;
• due to the SPPI test not being met, despite the application of the “held to collect cash flows” model, the fair value measurement through profit or loss will be applied to selected tranches of corporate bonds acquired by the Group (one entity). The classification of corporate bonds (which were previously recognized in investment securities available for sale) with an embedded option of conversion for shares (presented in derivatives) was also changed.  In accordance with IFRS 9, they are collectively measured at the fair value through profit or loss. 
• corporate and municipal debt securities, which were previously presented under “Loans and advances granted to customers” and measured at amortized cost, are now recognized under securities measured at amortized cost (this reclassification does not affect the measurement).

In the case of investments in equity instruments, the Group did not use the option of measurement at fair value through other comprehensive income.

The implementation of IFRS 9 as of 1 January 2018 has not affected the classification and measurement of the Group's financial liabilities.

The Group has estimated that, in connection with the IFRS 9 implementation on 1 January 2018, the total effect of adjustments arising from changes in the measurement and classification on equity (retained earnings or other comprehensive income) as at 1 January 2018 will amount to PLN 64 million (PLN 52 million after tax).

Furthermore, the Group prospectively applied a method of recognition of modifications in cash flows from financial assets, which will be recognized in profit or loss on a one-off basis as at the date of the modification, and the change in the measurement as at the balance sheet date will be calculated using the original effective interest rate. Up to 31 December 2017, the effect of modifications was spread over time using the effective interest rate method throughout the remaining part of the product's life.

As the main POCI category, the Group recognized impaired exposures acquired as a result of mergers and business combinations as at the date of the merger/business combination (the mergers with Nordea Bank Polska and SKOK “Wesoła” in Mysłowice) and exposures to corporate entities and lease receivables that satisfy the POCI criteria in the net carrying amount of PLN 603 million.

Impairment

A fundamental change in the area of impairment is that IAS 39 is based on the concept of incurred losses, whereas IFRS 9 is based on the concept of expected losses.

IFRS 9 has introduced new concepts concerning impairment:

• credit-impaired financial asset – a financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred;
• credit loss – the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. all cash shortfalls), discounted at the original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets);
• expected credit losses – the weighted average of credit losses with the respective risks of a default occurring as the weights;
• lifetime expected credit losses – the expected credit losses that result from all possible default events over the expected life of a financial instrument;
• 12-month expected credit losses – the portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date;
• loss allowance – the allowance for expected credit losses on financial assets measured at amortized cost, lease receivables and contract assets, the accumulated impairment amount for financial assets measured at fair value through other comprehensive income and the provision for expected credit losses on loan commitments and financial guarantee contracts.

The new impairment model is applicable to financial assets that are not measured at fair value through profit or loss, comprising:

• debt financial instruments comprising credit exposures and securities;
• lease receivables;
• off-balance sheet financial and guarantee liabilities.

In accordance with IFRS 9, expected credit losses are not recognized with respect to investments in equity instruments.

In accordance with the general principle, impairment will be measured as 12-month expected credit losses or lifetime expected credit losses. The basis of measurement will depend on whether a significant increase in credit risk has occurred since initial recognition. Loans will be allocated to 3 categories (stages):

In order to assess a significant increase in credit risk, in the case of mortgage and other retail exposures, the Group applies a model based on the marginal PD calculation, i.e. calculation of the probability of default in a specific month from the moment of commencement of the exposure. As a result, it is able to reproduce the credit quality diversification over the lifetime of the exposure that is characteristic of credit exposures to individuals. The Group identifies the evidence of a significant increase in risk based on a comparison of the default probability curves over the life of an exposure as at the date of initial recognition and as at the reporting date. For each reporting date, only the parts of the original and current default probability curves which correspond to the period starting from the reporting date to the maturity of the exposure are compared. The comparison is based on the value of the average probability of default in the period analysed, adjusted for the current and forecast macroeconomic ratios.

In order to assess a significant credit risk increase for corporate customers, the Group uses a model based on Markov chains. The curve of maximum acceptable credit quality deterioration in time, which is not identified as a significant credit risk increase, is calculated based on default probabilities estimated on the basis of customer migrations between rating and scoring categories.

In order to identify other evidence of a significant increase in credit risk, the Group makes use of the full quantitative and qualitative information available, including:

• restructuring measures involving granting concessions to the debtor due to its financial difficulties – forbearance;
• a delay in repayments of more than 30 days;
• early warning signals identified as part of the monitoring process, indicating a significant increase in credit risk;
• a dispute in progress with a customer;
• an assessment by an analyst as part of the individualized analysis process;
• no credit risk assessment available for an exposure as at the date of initial recognition, preventing the Group from assessing whether credit risk has increased;
• quarantine in Stage 2 for exposures in respect of which impairment indications ceased to exist in the last 3 months.

The expected loss is determined as the product of the following credit risk parameters: probability of default (PD), loss given default (LGD) and exposure at default (EAD), where each of these parameters has the form of a vector of the number of months representing the credit loss horizon. In the case of exposures classified as Stage 1, the Group estimates the expected loss over a period of up to 12 months. In the case of exposures classified as Stage 2, the expected loss is estimated for a period up to the maturity or renewal of the exposure. With respect to retail exposures without a repayment schedule, the Group determines the horizon based on historical behavioural data. The loss expected both during the life of an exposure and in a 12-month period is the total of the losses expected in the individual periods, discounted using the effective interest rate. In order to determine the value of an asset as at the default date in a given period, the Group adjusts the parameter which determines the amount of the exposure as at the default date for future scheduled repayments and potential overpayments/underpayments. 

In accordance with IFRS 9, the calculation of expected credit losses must take into account the estimates concerning forecast macroeconomic conditions. As regards the portfolio analysis, the impact of macroeconomic scenarios is included in the amounts of the individual parameters. The methodology of calculation of the individual risk parameters involves examining the relationship between these parameters and macroeconomic conditions based on historical data. For the purposes of calculating an expected loss, as in the case of identifying the indications of a significant credit risk increase, three macroeconomic scenarios developed based on the Group's forecasts are used: the base scenario and two alternative scenarios. The forecast ratios include the GDP growth ratio, the unemployment rate, WIBOR 3M, Libor CHF 3M, CHF/PLN exchange rate, the real estate price index and the NBP reference rate. The ultimate expected loss is the probability-weighted average of losses expected in the individual scenarios. The Group ensures the consistency of the macroeconomic scenarios used for calculating risk parameters with the macroeconomic scenarios used in credit risk budgeting processes. Both the process of assessing a significant credit risk increase and the process of expected loss calculation will be performed monthly for the individual exposures. Due to the significantly higher complexity of the calculations compared with the process of calculating provisions under IAS 39, the Group has significantly extended its IT infrastructure by adding a dedicated calculation environment, which allows obtaining results in comparable time and their distribution to the Group's internal entities.

Impact assessment – impairment

The Group estimates that the implementation of IFRS 9 will result in a decrease in the net asset value of PLN 832 million (PLN 674 million after tax).

Hedge accounting

IFRS 9 increases the range of items that can be designated as hedged items, as well as allows designating as a hedging instrument financial assets or liabilities measured at fair value through profit or loss. The obligation of retrospective measurement of hedge effectiveness together with the previously applicable threshold of 80%-125% were eliminated (the condition to the application of hedge accounting is the economic relationship between the hedging instrument and the hedged item). In addition, the scope of required disclosures regarding risk management strategies, cash flows arising from hedging transactions and the impact of hedge accounting on the financial statements were extended.

Due to the fact that the standard is still being worked on to introduce amendments relating to accounting for macro hedges, entities have a choice of applying hedge accounting provisions: they can either continue to apply IAS 39 or apply the new IFRS 9 standard with the exception of fair value macro hedges relating to interest rate risk.

Having completed an analysis of risks and benefits associated with adopting the hedge accounting solutions introduced in IFRS 9, the Group decided to continue to apply IAS 39 with respect to hedge accounting and to continue the hedging relationships.

Disclousers and comparative data

In the Group’s opinion, the application of IFRS 9 requires making considerable changes to the manner of presentation and the scope of disclosures concerning the area of financial instruments, including in the first year of its application, when extensive information about the opening balance and restatements made is required. The Group intends to use the IFRS 9 provisions which exempt entities from the obligation to restate the comparative data for the prior periods with regard to changes resulting from classification and measurement as well as impairment. Differences in the carrying amounts of financial assets and liabilities resulting from the application of IFRS 9 will be recognized in retained earnings/accumulated losses in equity as at 1 January 2018.

The impact of IFRS 9 on own founds and capital adequacy measures

The impact of IFRS 9 on own funds and capital adequacy measures results from the following factors:

• a change in the classification and measurement of financial assets, which as at 1 January 2018 was recognized in own funds under retained earnings/accumulated losses and other comprehensive income (impact of adjustments in respect of fair value measurement of loans measured at fair value through profit or loss);
• a change in the impairment model as at 1 January 2018, whose effect was also recognized in own funds under retained earnings/accumulated losses;
• any changes in the net value of deferred tax assets (adjustment of deferred income tax assets corresponding to retained earnings). The amount of the above-mentioned net deferred tax asset is taken into account in the calculation of risk exposure in accordance with the CRR requirements (applying the 250% risk weight or decreasing the amount of own funds). It is generally assumed that such assets are based on future profitability and result from temporary differences.

The impact of the provisions of IFRS 9 concerning changes in the impairment model on own funds and capital adequacy measures is regulated by Regulation (EU) 2017/2395 of the European Parliament and of the Council of 12 December 2017 amending Regulation (EU) No 575/2013 as regards transitional arrangements for mitigating the impact of the introduction of IFRS 9 on own funds and for the large exposures treatment of certain public sector exposures denominated in the domestic currency of any Member State. In accordance with this regulation, banks may apply transitional provisions with respect to own funds and increase Tier 1 capital associated with the implementation of a new impairment model in the period of 5 consecutive years from 1 January 2018. The scaling factor shall decrease from one period to another.

The Group has decided to apply the transitional provisions in full and to spread the impact of adjustments resulting from IFRS 9 implementation on own funds and capital adequacy measures over time.

At the same time, in accordance with the above-mentioned Regulation of the European Parliament and of the Council of 12 December 2017, in the event of applying the transitional provisions the Group is additionally obliged to disclose the following values as they would have been in the event that the transitional provisions are not applied: the amounts of own funds, Common Equity Tier 1 capital and Tier 1 capital, the Common Equity Tier 1 capital ratio, the Tier 1 capital ratio, the total capital ratio and the leverage ratio.

As a result of adjusting the calculations of regulatory capital requirements that take into account the transitional solutions aimed at easing the impact of the IFRS 9 implementation as at 1 January 2018, the Group's own funds calculated for capital adequacy purposes increased by approx. PLN 86 million; at the same time, due to impairment adjustments resulting from the implementation of IFRS 9, own funds decreased by approx. PLN 33 million, and due to adjustments relating to changes in measurement methods it increased by approx. PLN 46 million. At the same time, the Group's own funds increased by approx. PLN 72 million due to the fact that the transitional period provided for in the CRR for removing a specific percentage of unrealized gains on securities measured at fair value from own funds ended (as at 31.12.2017, 20% of such gains was removed).

Had the transitional solutions not been applied, the Group's own funds would be PLN 555 million lower. This decrease would comprise a decrease of PLN 674 million resulting from impairment adjustments, an increase of PLN 46 million resulting from changes in measurement methods, and a simultaneous increase of PLN 72 million resulting from the end of the transitional period provided for in the CRR.

As a result, the total capital ratio of the Group will decrease by 3 base points. If the transitional solutions relating to IFRS 9 were not applied and the total impact of the implementation of IFRS 9 was recognized, the total capital ratio would decrease by 30 base points.

According to our best knowledge, the impact of the adjustments resulting from the implementation of IFRS 9 on capital adequacy presented here is the best estimate as at the date of the publication of these financial statements/ consolidated financial statements.

IFRS 15 revenue from contracts with customers

IFRS 15 replaces IAS 11 Construction contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the construction of real estate, IFRIC 18 Transfers of Assets from Customers, SIC 31 Revenue – barter transactions involving advertising services.

The main principle is to recognize revenue in such way as to reflect the transaction of transfer to the customer of goods or services in an amount that reflects the value of remuneration, which the company expects in exchange for those goods or services. For the purpose of recognizing revenue at the appropriate moment and amount, the standard presents  five-level analysis model, consisting of: identification of the contract with a customer and binding commitment, determination of the transaction price, its appropriate allocation and recognition of revenue when the obligation is met.

The scope of the standard does not include financial instruments (IAS 39), insurance contracts (IFRS 4) and leases (IAS 17). The current accounting treatment of sales is consistent with the presentation provided in IFRS 15; therefore, in the Group's opinion, the new standard will not affect the recognition of revenues from contracts with customers in the consolidated financial statements of the Group.

IFRS 16 Leasing

IFRS 16 was published by the International Accounting Standards Board on 13 January 2016 and it is mandatory for annual periods beginning on or after 1 January 2019. The new standard will replace the current IAS 17, Leases.

IFRS 16 introduces new principles for recognizing leases. The main change concerns elimination of the classification of leases by the lessee as either operating or financial. A single accounting model for leases is introduced instead. Under the single model, the lessee is obliged to recognize the leased assets and the corresponding liabilities in the statement of financial position, unless the lease term is 12 months or less or the underlying asset has a low value. The lessee is also obliged to recognize in the income statement depreciation of a leased asset separately from interest expenses on the lease liability.

The lessor continues to classify leases as either operating or financial and account for them as two separate types of lease.

In the Group’s opinion, the application of the new standard will affect the recognition, presentation, measurement and disclosure of assets held by the Group as the lessee under operating lease contracts, as well as the corresponding liabilities, in the financial statements of the Group.

New and amended standards and interpretations, which have been published, but not yet adopted by the European Union

• The amendments to IAS 12 concern clarification of the method of recognizing deferred tax assets relating to debt instruments measured at fair value. The amendments to IFRS 10 and IAS 28 concern the sale or contribution of assets by an investor to a joint venture or an associate. The Group does not expect the impact of the amendments to IAS 12, IAS 28 and IFRS 10 to be significant. The impact of the amendments to IFRS 4 (associated with IFRS 9) on the Group's insurance activities has not yet been estimated.
• Amendments to IAS 40 and improvements to IFRS 2014-2016 (IFRS 1, IAS 28) will have no impact on the financial statements of the Group.

Explanation of the differences between previously published financial statements and these consolidated financial statements

There are no differences between the data published in the financial statements of the Group for the year ended 31 December 2016 and the data presented in these financial statements.

The financial data included in the consolidated financial statements of the PKO Bank Polski SA Group for the year ended 31 December 2016 was presented in PLN millions, with one decimal place. In these financial statements, the comparative data has been rounded to one million zlotys and any differences in relation to previously published data may result from such rounding.