2. Summary of significant accounting policies and estimates and judgements

2.1 Compliance with accounting standards

These consolidated financial statements have been prepared in accordance with the International Financial Reporting Standards (IFRS) as adopted by the EU as at 31 December 2014, and in the areas not regulated by these standards, in accordance with the requirements of the Accounting Act of 29 September 1994 (Journal of Laws of 2013, item 330, uniform text with subsequent amendments) 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 quotations market.

The European Commission has adopted IAS 39 ‘Financial Instruments: Recognition and Measurement’ except some decisions concerning hedge accounting. Due to the fact that the Bank applies IFRS as adopted by the European Union (‘EU’), the Bank has applied the IAS 39 OS.99C in the form adopted by the EU, which allows to designate as a hedged item a portion of cash flows from variable rate deposits for which the effective interest rate is lower than the reference interest rate (not including margins). The IAS 39 as issued by the International Accounting Standards Board introduces limitations in that respect.

2.2 Going concern

The consolidated financial statements of the PKO Bank Polski SA Group have been prepared on the basis that the Group will continue as a going concern for at least the period of 12 months from the issue date, i.e. since 16 March 2015. 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 continuing activity (of the PKO Bank Polski SA Group for 12 months following the issue date as a result of any intended or compulsory withdrawal or significant limitation in the activities of the PKO Bank Polski SA Group).

2.3 Basis of preparation of the financial statements

These financial statements have been prepared on a fair value basis in respect of financial assets and liabilities measured at fair value through profit and loss, including derivatives and financial assets available for sale, with the exception of those for which the fair value cannot be reliably estimated. Other financial assets and liabilities (including loans and advances) are measured at amortised cost impairment or at price impaired.

Non-current assets are stated at acquisition cost less accumulated depreciation and impairment allowances. Non-current assets (or groups of the above-mentioned assets) classified as held for sale are stated at the lower of their carrying amount and fair value less costs to sell. 

2.4 Basis of consolidation

2.4.1. Subsidiaries

Subsidiaries are entities (including entities which are not incorporated, such as general partnerships) 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. The definition of control provides that:

1)   an investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee,
2)   therefore, an investor controls an investee if and only if the investor has all of the following elements:

• power over the investee,
• the ability to use its power over the investee to affect the amount of the investor’s returns.
• exposure, or rights, to variable returns from its involvement with the investee, and

3)   to have power over an investee, an investor must have existing rights that give it the current ability to direct the relevant activities; for the purpose of assessing power, only substantive rights and rights that are not protective shall be considered,
4)   the determination as to whether an investor has power depends on the relevant activities, the way decisions about the relevant activities are made and the rights the investor and other parties have in relation to the investee.

The changes made to the definition of control did not affect the structure of the PKO Bank Polski SA Group compared with the previous financial periods. All entities classified as subsidiaries, according to the definition of control, are fully consolidated in the period from the date the parent company gains control over them until control has ceased.

The ‘full’ method of consolidation requires the adding up of all full amounts of the individual items of statement of financial position, income statement and other comprehensive income of the parent company and the subsidiaries, 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. inter-company receivables and payables, and any other settlements of a similar nature, between the consolidated entities,
2. revenue and costs arising from business transactions conducted between the consolidated entities,
3. gains or losses from business transactions conducted between consolidated entities, included in the carrying amount of the assets of the consolidated entities, except for losses indicating impairment,
4. dividends accrued or paid by the subsidiaries to the parent company and to 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 the additional notes and explanations.

IFRS 10 defines ‘an investment entity’ and introduces an exemption from the consolidation of subsidiaries for ‘investment entities’. 

An investment entity does not consolidate its subsidiaries. Instead, it measures its shares in subsidiaries at fair value through profit or loss. In order to classify a given entity as ‘an investment entity’ the following requirements must be met – i.e. an entity:

• obtains funds from one or more investors for the purpose of providing them with investment management services,
• gives a commitment to its investors that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both,
• measures and evaluates the performance of substantially all of its investments on a fair value basis.

The PKO Bank Polski SA Group does not meet the definition of ‘an investment entity’ and, consequently, the amendments made to the standards do not apply to the Group.

The parent company and consolidated subsidiaries reporting periods for the financial statements are co-terminous. Consolidation adjustments are made in order to eliminate any differences in the accounting policies applied by the Bank and its subsidiaries.

2.4.2. Acquisition method

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

As at the date of the acquisition, identifiable assets taken over, liabilities taken over and all non-controlling shares in the acquired entity are recognised separately from goodwill. 

Identifiable assets and liabilities acquired are initially designated at fair value as at the acquisition date. In each and every business combination, all non-controlling shares in the acquired entity are designated at fair value or on a pro rata basis in respect of the share of the non-controlling shares in the identifiable net assets of the target entity.

Goodwill is recognised as at the acquisition date and measured as the excess of the total of:

1. the consideration provided, designated at fair value as at the date of the acquisition,
2. value of all non-controlling shares in the acquired entity, measured in accordance with the above rules and
3. in the event of a business combination performed in stages, at fair value as at the date of acquiring interest in the capital of the acquired entity, which had been previously owned by the Bank, 

over the net amount of the value of identifiable assets and liabilities acquired, designated at fair value as at the acquisition date, determined as at the acquisition date.

If the net value, determined as at the acquisition date, of identifiable assets and liabilities acquired, designated at fair value as at the acquisition date is higher than the total of:

1. the consideration provided, designated at fair value as at the date of the acquisition,
2. value of all non-controlling shares in the acquired entity, measured in accordance with the above rules and
3. in the event of a business combination performed in stages, at fair value as at the date of acquiring interest in the capital of the acquired entity, which had been previously owned by the Bank,

the difference is recognised directly in the income statement.

2.4.3. Associates and joint ventures

Associates are entities (including entities which are not incorporated, such as general partnerships) on which the Group exerts significant influence but whose financial and operating policies 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 trade companies or other entities, which are partly controlled by parent company or a significant investor and other shareholders or partners on the basis of the Memorandum of Association, company’s agreement or an agreement concluded for a period longer than one year.

Investments in associates and joint ventures are accounted in accordance with the equity method and are initially stated at cost. The Group’s investment in associates and joint ventures includes goodwill determined as at the acquisition date, net of any potential accumulated impairment allowances. 

The Group’s share in the results of the associates and joint ventures from the date of purchase has been recorded in the income statement and its share in changes of other comprehensive income from the date of purchase has been recorded in other comprehensive income. The carrying amount of investments is adjusted by the total movements in particular equity items from the date of their purchase. When the Group’s share in the losses of an associate or joint ventures becomes equal or higher than the Group’s share in the associate or joint ventures, which covers potential unsecured receivables, the Group discontinues recognising further losses unless it has assumed the obligation or has made payments on behalf of the given associate or joint ventures.

Unrealised gains on transactions between the Group and its associates and joint ventures are eliminated in proportion to the Group’s share in the above-mentioned entities. Unrealised losses are also eliminated unless the transaction proves that the given asset transferred has been impaired. 

At each balance sheet date, the Group makes an assessment of whether there are any indicators of impairment in the value of investments in associates and joint ventures. If any such indicators exist, the Group estimates recovery value, i.e. the value in use of the investment or the fair value of the investment less costs to sale, depending on which of these values is higher. If carrying amount of the asset exceeds its recovery value, the Group recognises an impairment allowance in the income statement. The projection for the recovery value requires making assumptions, e.g. about future cash flows that the Group may receive from dividends or the cash inflows from a potential disposal of the investment, less costs of the disposal. The adoption of different assumptions with reference to the projected cash flows could affect the carrying amount of certain investments.

2.5 Foreign currencies

2.5.1. Functional and presentation currency

Items presented in the financial statements of the individual Group entities operating outside of Poland are measured in functional currency i.e. in the currency of the basic economic environment in which the given entity operates. The functional currency of the parent company and other entities included in these financial statements, except for 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, and the functional currency of entities operating in Sweden is Euro. 

Consolidated financial statements are presented in the Polish zloty, which is the functional and presentation currency of the Group.  

2.5.2. Transactions and balances denominated in foreign currencies

Foreign currency transactions are translated into the functional currency using exchange rates prevailing at the dates of the transactions. At each balance sheet date items are translated by the Group using the following principles:

1. monetary assets denominated in foreign currency using a closing rate i.e. the average rate announced by the National Bank of Poland prevailing as at the balance sheet date,
2. non-monetary assets measured at historical acquisition cost in foreign currency using exchange rate as of the date of the transaction,
3. non-monetary assets designated at fair value in foreign currency using exchange rates prevailing as at the date of the determination of fair value. 

Gains and losses on settlements of these transactions and the carrying amount of monetary and non-monetary assets and liabilities denominated in foreign currencies are recognised in the income statement.

2.6 Financial assets and liabilities

2.6.1. Classification

Financial assets are classified by the Group into the following categories: financial assets designated at fair value through profit and loss, financial assets available for sale, loans, advances and other receivables, financial assets held to maturity. Financial liabilities are classified as follows: financial liabilities designated at fair value through profit and loss and other financial liabilities. The classification of financial assets and liabilities is determined by the Group on initial recognition.

2.6.1.1. Financial assets and liabilities designated at fair value through profit and loss

Financial assets and liabilities designated at fair value through profit and loss are financial assets and liabilities that meet either of the following conditions:

1. they are classified as held for trading. Financial assets or financial liabilities are classified as held for trading if it is acquired or incurred principally for the purpose of selling or repurchasing it in the near term, is a part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-making. Derivatives are also classified as held for trading except for derivatives that are designated and effective hedging instruments, 
2. upon initial recognition they are classified as designated at fair value through profit and loss. The Group may use this designation only when: 

a) the designated financial asset or liability is a hybrid instrument which includes one or more embedded derivatives qualifying for separate recognition, and the embedded derivative financial instrument cannot significantly change the cash flows resulting from the host contract or its separation from the hybrid instrument is forbidden,
b) it eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as 'an accounting mismatch' that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different basis),
c) a group of financial assets, liabilities or both is managed and its performance is evaluated on a fair value basis, in accordance with the written risk management principles or investment strategy of the Group.

3)   The Group has a policy of financial assets and liabilities management according to which financial assets and liabilities classified as held for trading and financial assets and liabilities portfolio designated upon initial recognition at fair value through profit and loss are managed separately. 

2.6.1.2. Financial assets available for sale

Financial assets available for sale are non-derivative financial assets that are designated as available for sale or are not classified as financial assets: 

1. designated by the Group upon initial recognition at fair value through profit and loss,
2. held to maturity,
3. those that meet the definition of loans and advances.

2.6.1.3. Loans, advances and other receivables

Loans, advances and other receivables are non-derivative financial assets with fixed or determinable payments that are not quoted on an active market, other than:

1. financial assets that the Group intends to sell immediately or in the near term, which are classified as held for trading, and those that were upon initial recognition designated as at fair value through profit and loss,
2. financial assets that the Group designates upon initial recognition as available for sale,
3. financial assets for which the holder may not recover substantially all of its initial investment, other than because of credit deterioration, which are classified as available for sale.

2.6.1.4. Financial assets held to maturity

Financial assets held to maturity are non-derivative financial assets with fixed or determinable payments and fixed maturity that the Group has the positive intention and ability to hold to maturity other than:

1. those that the Group designates upon initial recognition at fair value through profit and loss,
2. those that the Group designates as available for sale, 
3. those that meet the definition of loans and advances.

2.6.1.5. Other financial liabilities

Other financial liabilities are financial liabilities other than designated at fair value through profit and loss which have the nature of a deposit, or a loan or an advance received.

2.6.1.6. Reclassification of financial assets

A financial asset classified as available for sale, which meets the definition of loans and advances, can be reclassified by the Group from the category of financial assets available for sale to the category of loans and advances, if the Group has the intention and ability to hold that financial asset in the foreseeable future or to maturity.

The Group does not reclassify financial instruments to or from the category of designated at fair value through profit and loss since they are held or issued. The Group can reclassify financial instruments classified as held for trading, other than derivative financial instruments and financial instruments designated upon initial recognition at fair value through profit or loss, to loans, advances and other receivables category, if they meet criteria described in the note 2.6.1.3.

2.6.2. Accounting for transactions

Financial assets and financial liabilities, including forward transactions giving rise to an obligation or a right to acquire or sell in the future a given number of specified financial instruments at a given price, are recognised in the books of account under trade date, irrespective of the settlement date provided in the contract. 

2.6.3. Derecognition of financial instruments from a statement of financial position

Financial assets are derecognised 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:

1. the contractual rights to receive the cash flows from the financial asset are transferred, or
2. 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 a case:

1. if all the risks and rewards of ownership of the financial asset are substantially transferred, then the Group derecognises the financial asset from the statement of financial position,
2. if all the risks and rewards of ownership of the financial asset are substantially retained by the Group, then the financial asset continues to be recognised in the statement of financial position,
3. if substantially all the risks and rewards of ownership of the financial asset are neither transferred nor retained by the Group, then a determination is made as to whether control of the financial asset has been retained.

If the Group has retained control, it continues to recognise 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 derecognised from the statement of financial position.

The Group removes a financial liability (or a part of a financial liability) from its statement of financial position when the obligation specified in the contract is discharged or cancelled or expires.

The Group derecognises loans when they have been extinguished, when they are expired, or when they are not recoverable. Loans, advances and other amounts due are written off against impairment allowances that were recognised for these accounts. In the case where no allowances were recognised against the account or the amount of the allowance is less than the amount of the loan, advance or other receivable, the loan, advance or receivable is written off after, 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 recognised to date.

2.6.4. Valuation 

When a financial asset or liability is initially recognised, it is measured at its fair value plus, in the case of a financial asset or liability not designated at fair value through profit and loss, transaction costs that are directly attributable to the acquisition or the issue of the financial asset or liability.

The fair value is the price that would be received for the sale of an asset item or paid for transfer a liability in a transaction carried out under regular conditions on the main (or most advantageous) market at the valuation date in the current market conditions (i.e. output price), regardless of whether this price is directly observable or estimated using another valuation technique.

Subsequent to the initial recognition financial instruments are valued as follows: 

2.6.4.1. Financial assets and liabilities designated at fair value through profit and loss

They are designated at fair value through profit and loss to the item net income from financial instruments at fair value through profit and loss.

2.6.4.2. Financial assets available for sale

They are designated at fair value, and gains and losses arising from changes in fair value (except for impairment allowances and currency translation differences) are recognised in other comprehensive income until the amount included in other comprehensive income is reclassified to the income statement when the asset is derecognised from the statement of financial position. Interest determined using effective interest rate from financial assets available for sale is presented in the net interest income.

2.6.4.3. Loans, advances and investments held to maturity

They are measured at amortised cost with the use of an effective interest rate with an allowance for impairment losses. In case of loans and advances for which it is not possible to reliably estimate the future cash flows and the effective interest rate, loans advances and investments held to maturity are measured at cost to pay.

2.6.4.4. Other financial liabilities including liabilities resulting from the issue of securities

They are measured at amortised cost. If the time schedule of cash flows from a financial liability cannot be determined, and thus the effective interest rate cannot be determined fairly, this liability is measured at cost to pay.

Debt instruments issued by the Group are recognised as financial liabilities and measured at amortised cost.

2.6.5. Derivative instruments

2.6.5.1. Recognition and measurement

Derivative financial instruments are recognised at fair value from the trade date. A derivative instrument becomes an asset if its fair value is positive and it becomes a liability if its fair value is negative. In the valuation of these instruments assumptions about the contractor’s credit risk and the Bank’s own credit risk are taken into account.

When the estimated fair value is lower or higher than the fair value as of the preceding balance sheet date (for transactions concluded in the reporting period – initial fair value), the Group includes the difference, respectively, in the net income from financial instruments designated at fair value through profit and loss or in the net foreign exchange gains in correspondence with ‘Derivative financial instruments’. The above-mentioned recognition method applies to derivative instruments which do not qualify to the application of hedge accounting. The method of recording hedging derivatives is presented in the note 2.6.6.4.

The result of the ultimate settlement of derivative instruments transactions is reflected in the result from financial instruments designated at fair value through profit and loss or in the net foreign exchange gains. 

The notional amounts of the underlying derivative instruments are presented in off-balance sheet items from the date of the transaction until maturity.

2.6.5.2. Embedded derivative instruments

An embedded derivative is a component of a hybrid (combined) instrument that also includes a non-derivative host contract (both of a financial or non-financial nature), with the effect that some of the cash flows of the combined instrument vary in a way similar to the cash flow of a stand-alone derivative. 

An embedded derivative causes some or all of the cash flows required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, or other variable, provided that the non-financial variable is not specific to a party to the contract.

An assessment of whether a given contract contains an embedded derivative instrument is made at the date of entering into a contract. 

A reassessment can only be made when there is a change in the terms of the contract that significantly modifies the cash flows required under the contract.

Derivative instruments separated from host contracts and recognised separately in the account books are designated at fair value. Valuation is presented in the statement of financial position under ‘Derivative Financial Instruments’. Changes in the valuation at fair value of derivative instruments are recorded in the income statement under the ‘Net income from financial instruments measured at fair value’ or ‘Net foreign exchange gains’.

Derivative instrument is recognised separately, if all of the following conditions are met:

1. the hybrid (combined) instrument is not designated at fair value through profit and loss,
2. the economic characteristics and risks related to the embedded instrument are not closely related to the economic characteristics of the host contract and related risks,
3. a separate instrument with the same characteristics as the embedded derivative instrument would meet the definition of a derivative. 

In case of contracts which are not financial instruments and which include an instrument that fulfils the above conditions, embedded derivatives are recorded in the income statement under the position ‘Net income from financial instruments measured at fair value through profit and loss’ or ‘Net foreign exchange gains’. 

2.6.6. Hedge accounting

2.6.6.1. Hedge accounting criteria

The Group applies hedge accounting when all the terms and conditions below, specified in IAS 39, have been met:

1. upon setting up the hedge, a hedge relationship, the purpose of risk management by the entity, and the hedging strategy were officially established. The documentation includes the identification of the hedging instrument, the hedged item or transaction, the nature of the hedged risk and the manner in which the entity will assess the effectiveness of the hedging instrument in compensating the threat of changes in fair value of the hedged item or the cash flows related to the hedged risk,
2. a hedge is expected to be highly effective in compensating changes to the fair value or cash flows resulting from the hedged risk in accordance with the initially documented risk management strategy relating to the specific hedge relationship,
3. in respect of cash flow hedges, the planned hedged transaction must be highly probable and must be exposed to changes in cash flows which may, as a result, have an impact on the income statement, 
4. the effectiveness of a hedge may be reliably assessed, i.e. the fair value or cash flows related to the hedged item and resulting from the hedged risk, and the fair value of the hedging instrument, may be reliably measured,
5. the hedge is assessed on a current basis and its high effectiveness in all reporting periods for which the hedge had been established is determined.

2.6.6.2. Discontinuing hedge accounting

The Group discontinues hedge accounting when:

1. a hedge instrument expires, is sold, released or exercised (replacing one hedge instrument with another or extending the validity of a given hedge instrument is not considered to be expiration or release if the replacement or extension of period to maturity is part of the documented hedging strategy adopted by the entity). In such an instance accumulated gains or losses related to the hedging instrument which were recognised directly in other comprehensive income over the period in which the hedge was effective are recognised in a separate item in other comprehensive income until the planned transaction is effected,
2. the hedge ceases to meet the hedge accounting criteria. In such an instance accumulated gains or losses related to the hedging instrument which were recognised directly in other comprehensive income over the period in which the hedge was effective are recognised in a separate item in other comprehensive income until the planned transaction is effected,
3. the planned transaction is no longer considered probable, therefore, all the accumulated gains or losses related to the hedging instrument which were recognised directly in other comprehensive income over the period in which the hedge was effective, are recognised in the income statement,
4. the Group invalidates a hedge relationship.

2.6.6.3. Fair value hedge

As at 31 December 2014 and 2013 respectively, the Group did not apply fair value hedge accounting. 

2.6.6.4. Cash flow hedges

A cash flow hedge is a hedge against the threat of cash flow volatility which can be attributed to a specific type of risk related to a recorded asset or a liability (such as the whole or a portion of future interest payments on variable interest rate debt) or a highly probable planned transaction, and which could affect the income statement.

Changes in the fair value of a derivative financial instrument designated as a cash flow hedge are recognised directly in other comprehensive income in respect of the portion constituting the effective portion of the hedge. The ineffective portion of a hedge is recognised in the income statement in ‘Net income from financial instruments designated at fair value’.

Amounts transferred directly to other comprehensive income are transferred to the income statement in the same period or periods in which the hedged planned transaction affects the income statement.

The effectiveness tests comprise the valuation of hedging transactions, net of interest accrued and currency translation differences on the nominal value of the hedging transactions (in case of CIRS transactions). They are recognised in the income statement, in ‘Net interest income’ and ‘Net foreign exchange gains’ respectively.

2.6.7. Offsetting financial instruments

The Group offsets financial assets and liabilities, and presents them in the consolidated statement of financial position on a net basis, when there is a legally enforceable right to offset of the recognised amounts and the intention to settle them on a net basis or simultaneous realisation of particular asset and liability settlement.

2.7 Transactions with a commitment to sell or buy back

Sell-buy back and buy-sell back transactions are sale or purchase operations of a security with a commitment to buy or sell back the security at an agreed date and price.

Sell-buy back securities transactions are recognised at the date of the transaction under amounts due to other banks or amounts due to customers in respect of deposits, depending on the counterparty of transaction. 

Buy-sell back securities are recognised under amounts due from banks or loans and advances to customers, depending on the counterparty of transaction.

Sell-buy back, buy-sell back transactions are measured at amortised cost, whereas securities which are an element of a sell-buy back transaction are not derecognised from the statement of financial position and are measured at the terms and conditions specified for particular securities portfolios. The difference between the sale price and the repurchase price is recognised as interest expense/income, as appropriate, and it is settled over the term of the contract using the effective interest rate.

2.8 Impairment of financial assets

2.8.1. Assets measured at amortised cost

At each balance sheet date for credit and loan, the Group assesses whether there is objective evidence that a given financial asset or a group of financial assets is impaired. If such evidence exists, the Group determines the amounts of impairment losses. An impairment loss is incurred when there is objective evidence of impairment due to one or more events that occurred after the initial recognition of the asset (‘a loss event’), and the loss has a reliably measurable impact on the expected future cash flows from the financial asset or group of financial assets.

Objective evidence that a financial asset or group of assets is impaired includes information that comes to the attention of the Group particularly about the following events:

1. significant financial difficulties of the issuer or the debtor,
2. breach of a contract by the issuer or the debtor, such as a default or a delinquency in contracted payments of interest or principal,
3. granting of a concession by the lender to the issuer or the borrower, for economic or legal reasons relating to the borrower's financial difficulty, that the lender would not otherwise consider (detailed description for forbearance practices is presented in the note 53.3 ‘Forbearance practices’),
4. high probability of bankruptcy or reorganisation of the issuer or the debtor,
5. evidence that there is a measurable reduction in the estimated future cash flows from a group of financial assets, including collectability of these cash flows. 

Credit exposures, in respect of which no objective evidence of individual impairment was identified, or in spite of their occurrence no impairment loss was recognised, are assessed for impairment as a group of exposures with the same characteristics.

Loan receivables are classified by the Group on the basis of the amount of exposure.

In individually significant credit exposures portfolio, each individual credit exposure is subjected to individual assessment of the evidence of impairment and the level of recognised loss. For individually insignificant exposures recognition and measurement of loss are made using portfolio risk parameters estimated with statistical methods. If loss is recognised for individual credit exposure, the adequate impairment allowance is made. If for individual credit exposure loss is not recognised, the exposure is classified to a portfolio of assets with similar characteristics which is assessed on a group basis and is a subject of impairment allowance set up for the certain group for incurred but not reported loss (IBNR allowance).

IBNR allowance is estimated using the portfolio parameters. These parameters are estimated for the group of exposures with the same characteristics, that meet certain evidences of loss at the group level (not reported at the individual level) – IBNR evidence.

IBNR evidences are in particular:

1. increase during the lending period, the risk of industry in which debtor (group of debtors) operates, reflected by the industry being qualified by the Bank as a high-risk industry,
2. delay in payment of principal or interests no longer than 90 days,
3. unrecognised deterioration of the economic and financial situation of the debtor in the assessment of risk associated with its financing (in spite of keeping the existing procedures for monitoring the situation and updating the assessment),
4. receiving information about potential credit extortion.

The amount of the impairment allowance and IBNR allowance is the difference between the carrying amount of the asset and the present value of the estimated future cash flows (excluding future credit losses that have not been incurred), discounted using the effective interest rate as of the date when objective evidence of the impairment of financial asset was identified.

The calculation of the present value of estimated cash flows relating to financial assets for which collateral is held takes into account cash flows arising from the realisation of the collateral, less costs to acquire and sell. 

When determining the impairment allowance on an individual basis, future cash flows are estimated taking into account the nature of the case and possible scenarios for exposure management.

In determining impairment allowances for exposures not assessed on an individual basis, portfolio parameters are used:

1. recovery rates assessed for the group of exposures with certain characteristics,
2. probability of reporting loss on the individual level (in relation to exposures from IBNR portfolio).

Future cash flows of a group of financial assets assessed for impairment on a collective basis are estimated on the basis of cash flows generated from contracts and historical recovery parameters generated from assets with similar risk characteristics.

Historical recovery parameters are adjusted on the basis of data from current observations, so as to take into account the impact of current conditions and exclude factors that were relevant in the past but which currently do not occur. In subsequent period, if the amount of impairment loss is reduced because of an event subsequent to the impairment being recognised (e.g. improvement in debtor's credit rating), the impairment loss that was previously recognised is reversed by making an appropriate adjustment to impairment allowances. The amount of the reversal is recorded in the income statement.

The Group plans that the adopted methodology used for estimating impairment allowances will be developed in line with the further accumulations of acquiring impairment data from the existing and implemented applications and information systems. As a consequence, new data obtained by the Group could influence the level of impairment allowances in the future. 

The methodology and assumptions used in the estimates are reviewed on a regular basis to minimise the differences between the estimated and actual loss amounts. 

2.8.2. Assets available for sale

At each balance sheet date, the Group makes an assessment, whether there is objective evidence that a given financial asset classified to financial assets available for sale is impaired. If such evidence exists, the Group determines the amounts of impairment allowances.

Objective evidence that a financial asset or group of assets available for sale is impaired includes the following events: 

1. significant financial difficulties of the issuer,
2. breach of a contract by the issuer, such as lack of contracted payments of interest or principal or late payments,
3. granting of a concession by the lender to the issuer, for economic or legal reasons relating to the borrower's financial difficulty, that the lender would not otherwise consider (detailed description for forbearance practices is presented in the note 53.3 ‘Forbearance practices’),
4. deterioration of the issuer’s financial condition in the period of maintaining the exposure,
5. high probability of bankruptcy or other financial reorganisation of the issuer,
6. increase in risk of a certain industry in the period of maintaining a significant exposure, in which the borrower operates, reflected by the industry being qualified by the Bank as elevated risk industry.

The Group firstly assesses if impairment on an individual basis for significant receivables exists.

If there is objective evidence of impairment on financial assets classified as debt securities available for sale not issued by the State Treasury, an impairment allowance is calculated as the difference between the asset’s carrying amount and the present fair value estimated as value of future cash flows discounted using the market interest rates based on yield curves for Treasury bonds moved by risk margins.

Impairment of a financial asset classified as available for sale is recognised in the income statement, which results in the necessity to transfer the effects of accumulated losses from other comprehensive income to the income statement. 

In subsequent periods, if the fair value of debt securities increases, and the increase may be objectively related to an event subsequent to the impairment being recognised in the income statement, the impairment loss is reversed and the amount of the reversal is recorded in the income statement. 

Impairment losses recognised against equity instruments are not reversed through profit and loss.

2.9 Leasing

The Group is a party to lease agreements, based on which it conveys in return for payment to use and take profits (the lessor) from tangible assets during a fixed period (the rights).

The Group is also a party to lease agreements, based on which it receives tangible fixed assets for an agreed period of time (the lessee). 

The classification of lease agreements by the Group is based on the extent to which risks and rewards incidental to ownership of an asset lie with the lessor or the lessee.

2.9.1. The Group as a lessor

As regards finance lease agreements, the Group, as a lessor, has receivables of the present value of contractual lease payments, increased by a possible unguaranteed residual value assigned to the lessor, fixed at the date of the lease agreement. These receivables are disclosed under ‘Loans and advances to customers’. Finance lease payments are apportioned between the interest income and the reduction of balance of receivables in a way that provide fixed interest rate from an outstanding debt. 

As regards operating lease agreements, initial direct costs that are incremental and directly attributable to negotiating and arranging a lease, are added to the carrying value of the leased asset during the period fixed in the lease agreement, on the same basis as in the case of contracts for hire. Conditional lease payments constitute income when they are due. Lease payments due from agreements, which do not meet the finance lease criteria (operating lease agreements) constitute income in the income statement and are recognised on a straight-line basis during the lease term. 

2.9.2. The Group as a lessee

Lease payments under an operating lease and subsequent instalments are recognised as an expense in the income statement and are recognised on a straight-line basis over the lease term. 

2.10 Tangible fixed assets and intangible assets

2.10.1. Intangible assets

Intangible assets are identifiable non-monetary assets which do not have a physical form. 

As a result of a settlement of the transaction in accordance with IFRS 3, two components of intangible assets that are recognised separately from goodwill, i.e. customer relationships and value in force, representing the present value of future profits from concluded insurance contracts, were identified. These components of intangible assets are amortised by declining balance method based on the rate of economic benefits consumption arising from their use. In addition, they are subject to impairment test on the annual basis, as at 31 December.

2.10.2. Goodwill

Goodwill arising on acquisition of a business entity is initially recognised at the value determined according to the Note 2.4.2. 

Following the initial recognition, goodwill is stated at the initial value less any cumulative impairment allowances. 

Goodwill arising on acquisition of subsidiaries is recognised under ‘Intangible assets’ and goodwill arising on acquisition of associates and joint ventures is recognised under ‘Investments in associates and joint ventures’.

The test for goodwill impairment is carried out at least at the end of each year. Impairment is calculated by estimating the recoverable amount of the cash-generating unit to which the given goodwill relates. If the recoverable amount of the cash-generating unit is lower than its carrying amount, an impairment allowance is recognised. 

2.10.3. Software

Acquired computer software licenses are capitalised in the amount of costs incurred on the purchase and preparation of the software for use, taking into consideration accumulated amortisation and impairment allowances. 

Further expenditure related to the maintenance of the computer software is recognised in costs when incurred.

2.10.4. Other intangible assets

Other intangible assets acquired by the Group are recognised at acquisition cost or production cost, less accumulated amortisation and impairment allowances.

2.10.5. Development costs

Research and development costs are included in intangible assets in connection with future economic benefits and meeting specific terms and conditions, i.e. if there is a possibility and intention to complete and use the internally generated intangible asset, there are appropriate technical and financial resources to finish the development and to use the asset and it is possible to measure reliably the expenditure attributable to the intangible asset during its development which can be directly associated to the creation of the intangible asset.

2.10.6. Tangible fixed assets

Tangible fixed assets are stated at the end of the reporting period at acquisition cost or production cost, less accumulated depreciation and impairment allowances. 

Properties accounted for investment properties are valued according to accounting principles applied to tangible fixed assets.

2.10.7. Capital expenditure accrued

Carrying amount of tangible fixed assets and intangible assets is increased by additional expenditures incurred during their maintenance, when:

1. probability exists that the Group will achieve future economic benefits which can be assigned to the particular tangible fixed asset or intangible asset (higher than initially assessed, measured e.g. by useful life, improvement of service quality, maintenance costs), 
2. acquisition price or production cost of tangible fixed assets and intangible assets can be reliably estimated.  

2.10.8. Depreciation/amortisation

Depreciation/amortisation is charged on all non-current assets, whose value decreases due to usage or passage of time, using the straight-line method over the estimated useful life of the given asset. The adopted depreciation/amortisation method and useful lives are reviewed at least on an annual basis.

Depreciation of tangible fixed assets, investment properties and amortisation of intangible assets begins on the first day of the month following the month in which the asset has been brought into use, and ends no later than at the time when: 

1. the amount of depreciation or amortisation charges becomes equal to the initial cost of the asset, or 
2. the asset is designated for liquidation, or
3. the asset is sold, or
4. the asset is found to be missing, or
5. it is found - as a result of verification - that the expected residual value of the asset exceeds its (net) carrying amount.

For non-financial non-current assets it is assumed that the residual value is nil, unless there is an obligation of a third party to buy back the asset, or if there is an active market which will continue to exist at the end of the asset's period of use and when it is possible to determine the value of the asset on this market.

Depreciation/amortisation periods for basic groups of tangible fixed assets, investment properties and intangible assets applied by the Group:

Costs relating to acquisition or construction of buildings are allocated to significant parts of the building (components), when such components have different useful lives or when each of the components generates benefits for the Group in a different manner. Each component of the building is depreciated separately.

Intangible assets with indefinite useful lives, which are subject to an annual impairment test in accordance with Note 2.10.9., are not amortised.

2.10.9. Impairment allowances of non-financial non-current assets

At each balance sheet date, the Group makes an assessment of whether there are any indicators of impairment of any of non-financial non-current assets (or cash-generating units). If any indicator exists and annually, in case of intangible assets which are not subject to amortisation and goodwill, the Group estimates the recoverable amount being the higher of the fair value less costs to sell and the value in use of a non-current asset (or a cash generating unit), if the carrying amount of an asset exceeds its recoverable amount, the Group recognises an impairment loss in the income statement. The projection for the above-mentioned values requires making assumptions, e.g. about future expected cash flows that the Group may receive from the continued use or disposal of the non-current asset (or a cash-generating unit). The adoption of different assumptions with reference to the projected cash flows could affect the carrying amount of certain non-current assets. 

If there are indications for impairment for common assets, which do not generate cash inflows irrespective of other assets or asset groups, and the recoverable amount of a single asset included in common assets cannot be determined, the Group determines the recoverable amount at the level of the cash generating unit to which the asset belongs.

An impairment allowance is recognised if the book value of an asset or its cash generating unit exceeds its recoverable amount. Impairment losses are recognised in the income statement.

Impairment allowances in respect of cash generating units first and foremost reduce the goodwill relating to those cash generating units (groups of units), and then they reduce proportionally the book value of other assets in the unit (group of units).

An impairment allowance in respect of goodwill cannot be reversed. In respect of other assets, the impairment allowance may be reversed if there was a change in the estimates used to determine the recoverable amounts. An impairment allowance may be reversed only to the level at which the book value of an asset does not exceed the book value – less depreciation/amortisation – which would be determined should the impairment allowances not have been recorded.

2.11 Other items in the statement of financial position

2.11.1. Non-current assets held for sale and discontinued operations

Non-current assets held for sale include assets which carrying amount is to be recovered as a result of sale and not due to continued use. Such assets only include assets available for immediate sale in the current condition, when such sale is highly probable, i.e. the entity has determined to sell the asset, started to seek actively for a buyer and finish the sale process. In addition, such assets are offered for sale at a price which is reasonable with respect to their current fair value and it is expected that the sale will be recognised as completed within one year from the date of classification of the asset into this category.

Non-current assets held for sale are stated at the lower of their carrying amount or fair value less costs to sell. Impairment allowances for non-current assets held for sale are recognised in the income statement for the period, in which these allowances are made. These assets are not depreciated.

Discontinued operations are an element of the Group’s business which has been sold or which is qualified as held for sale, and which also constitutes an important separate area of the operations or its geographical area, or is a subsidiary acquired solely with the intention of resale. 

Operations may be classified as discontinued only when the operations are sold or when they meet the criteria of operations held for sale, whichever occurs earlier. A group for sale which is to be retired may also qualify as discontinued operations. 

In case of non-current assets, for which qualification criteria for the group of non-current assets held for sale are no longer fulfilled, the Group makes reclassification from non-current assets held for sale to the proper category of assets. Non-current assets withdrawn from assets held for sale are valued at lower of two values:

1. carrying amount before the moment of qualification to non-current assets held for sale, less depreciation, which would have been included if the asset (or group of assets to be sold) would not have been qualified as held for sale,
2. recoverable amount for the day of decision of sales abandonment. 

2.11.2. Inventories

Inventories are valued at the lower of two values: the purchase price/cost of production and net realisable value.

Net realisable value is the estimated selling price in the ordinary course of business less costs of completion and the estimated costs necessary to make the sale.

The value of inventories disbursement is determined by specific identification of individual purchase prices or production costs of components, which relate to realisation of specific projects.

2.11.3. Accruals and deferred income

This item mainly comprise fee and commission income recognised using the straight-line method and other income received in advance, which will be recognised in the income statement in future reporting periods. Accruals and deferred income are shown in the statement of financial position under ‘Other liabilities’.

Prepayments and deferred costs include particular kinds of expenses which will be recognised in the income statement in future reporting periods. Prepayments and deferred costs are shown in the statement of financial position under ‘Other assets’.

2.12 Provisions

Provisions are liabilities of uncertain timing or amount. They are accrued when the Group has a present obligation (legal or constructive) as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made.

If the effect of the time value of money is material, the amount of the provision is determined by discounting the forecast future cash flows to their present value, using the discount rate before tax which reflects the current market assessments of the time value of money and the potential risk related to a given obligation.

The Bank creates provisions for legal claims with counterparties, customers and external institutions (e.g. UOKiK) after confirming with legal adviser the probability of losing a court case, provisions for retirement benefits, provisions for loan commitments and guarantees granted and other provisions, in particular restructuring provision and provision for potential claims on impaired loans portfolios sold. A detailed description of the changes is described in the note 38 ‘Provisions’ and note 53.8 ‘Off-balance sheet provisions’.

Provisions for loan commitments and guarantees granted are recognised in accordance with IAS 37. In order to determine the expected value of exposure in the statement of financial position, which will arise as a result of off-balance sheet liability granted, a credit conversion factor (ccf) is used - estimated to portfolio of exposures with similar characteristics. Value calculated in such a way is then the basis for determining the amount of the provision, either by comparing it to the present value of expected future cash flows from the exposure in the statement of financial position, arising from commitments granted, determined on an individual basis, or using of portfolio parameters estimated using statistical methods (a portfolio and group basis).

All provisions are recognised in the income statement, except for actuarial gains and losses recognised in the other comprehensive income.

A detailed description of the adopted policies is presented in the note 2.8.1 ‘Impairment of financial assets’ - ‘Assets measured at amortised cost’ and note 53.8. ‘Off-balance sheet provisions’.

A detailed description of changes in provisions is presented in the note 38 ‘Provisions’.

2.13 Restructuring provision

A restructuring provision is set up when general criteria for recognising provisions are met as well as the detailed criteria related to the legal or constructive obligation to set up provisions for restructuring costs specified in IAS 37 are met. Precisely, the constructive obligation of restructuring and recognising provisions arises only when the Group has a detailed, official restructuring plan and has raised justified expectations of the parties to which the plan relates that it will carry out restructuring by starting to implement the plan or by announcing the key elements of the plan to the above-mentioned parties. 

A detailed restructuring plan specifies at least activities or part of the activities to which the plan relates, the basic locations covered by the plan, the place of employment, functions and estimated number of employees who are to be compensated due to their contract termination, the amount of expenditure which is to be incurred and the date when the plan will be implemented. 

The restructuring provision covers only such direct expenditures arising as a result of the restructuring which at the same time:

1. necessarily result from the restructuring, 
2. are not related to the Group’s on-going business operations. 

The restructuring provision does not cover future operating losses. 

2.14 Employee benefits

According to the Labour Code (Kodeks Pracy), employees of the Group are entitled to retirement or pension benefits upon retirement or pension. The Group periodically performs an actuarial valuation of provisions for future liabilities to employees.

The provision for retirement and pension benefits resulting from the Labour Code is created individually for each employee on the basis of an actuarial valuation performed periodically by an independent actuary. The basis for calculation of these provisions is internal regulations, and especially the Collective Labour Agreements being in force at the Group entities. Valuation of the employee benefit provisions is performed using actuarial techniques and assumptions. The calculation of the provision includes all retirement and pension benefits expected to be paid in the future. The provision was created on the basis of a list including all the necessary details of employees, in particular the length of their service, age and gender. The provisions calculated equate to discounted future payments, taking into account staff turnover, and relate to the period beginning on the balance sheet date. Gains or losses resulting from actuarial calculations are recognised in other comprehensive income.

The Group creates provisions for future liabilities arising from damages and severance payments made to those employees whose employment contracts are terminated for reasons independent of the employee and periodical settlements for the employee compensation costs incurred in the current period which will be paid out in future periods, including bonuses and from unused annual leave, taking into account all outstanding unused holiday days.

Employee benefits include also employee pension programme being a defined contribution plan recognised as an expense in position ‘Wages and salaries’ as well as variable remuneration components programme for persons holding managerial positions, part of which is recognised as a liability due to cash-settled share–based payments pursuant to IFRS 2 ‘Share –based payments’.

2.15 Contingent liabilities

As regards operating activities, the Group concludes transactions, which, at the time of their inception, are not recognised in the statement of financial position as assets or liabilities, however they give rise to contingent liabilities. In accordance with IAS 37 contingent liability is:

1. a possible obligation that arises from past events and whose existence will be confirmed only at the time of occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Group entities,
2. a present obligation resulting from past events, but not recognised in the statement of financial position, because it is not probable that an outflow of cash or other assets will be required to fulfil the obligation, or the amount of the obligation cannot be estimated reliably.

Except the possibility of an outflow of funds related to the fulfillment of the obligation is negligible, in respect of each type of contingent liabilities, the entity discloses a short description of the type of the contingent liability at the balance sheet date and, where practicable, discloses: 

a)estimated value of its financial effects, 
b)indications of the uncertainty as to the amount or date of funds outflow, and 
c)possibility of obtaining any reimbursement.

Detailed information is presented in the Note 40 ‘Contingent liabilities and off-balance sheet liabilities received’.

In accordance with IAS 37 upon initial recognition, a financial guarantee is stated at fair value. Following the initial recognition, the financial guarantee is measured at the higher of: 

1. the amount determined in accordance with IAS 37 ‘Provisions, contingent liabilities and contingent assets’ and 
2. the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 ‘Revenue’.

Principles of recognising provisions for off-balance sheet liabilities granted are described in the note 2.12 ‘Provisions’ and in the note 53.8 ‘Off-balance sheet provisions’.

2.16 Shareholders’ equity

Equity constitutes capital and reserves created in accordance with the legal regulations. The classification to particular components, discussed below, results from the Polish Commercial Companies’ Code, the Banking Law and the requirements of IAS 1.7, IAS 1.78.e, IAS 1.54.q-r and IAS 1.79.b. In accordance with IAS 1, equity also includes undistributed profits and accumulated losses from previous years, currency translation differences on translating foreign operations, the effective portions of cash flow hedges, actuarial gains and losses and net gains or losses on the valuation of financial instruments classified as available for sale including their related deferred tax values. Equity components of the subsidiaries, other than share capital, in a proportion equal to the interest in the subsidiary held by the parent company, are added to respective equity components of the parent company. The Group's equity includes only those parts of the equity of the subsidiaries which arose after the acquisition of shares by the parent company. In accordance with the legislations which are in force in Poland, only the equity of the parent company and the equity of specific subsidiaries, determined on the basis of stand-alone financial statements, are distributable. 

2.16.1. Share capital 

Share capital comprises solely the share capital of the parent company and is stated at nominal value in accordance with Memorandum of Association and entry to the Register of Entrepreneurs.

2.16.2. Reserve capital 

Reserve capital is created according to the Memorandum of Association of the Group entities, from the distribution of net profits and from share premium less issue costs and it is to cover the potential losses of Group entities.

2.16.3. Other comprehensive income

Other comprehensive income comprises the effects of valuation of financial assets available for sale and the amount of the related deferred tax, the effective part of cash flow hedging resulting from hedge accounting and the related deferred tax as well as actuarial gains and losses and the amount of the related deferred tax. Moreover, the item includes the share of the parent company in the revaluation reserve of associated entities and foreign exchange differences on translation to polish currency of the net result of the foreign operation as a rate constituting the arithmetical average of foreign exchange rates for the currency as at the day ending each of the months in the financial year published by the National Bank of Poland, and foreign exchange differences arising on the measurement of net assets in the foreign operation.

2.16.4. General risk fund

General banking risk fund in PKO Bank Polski SA is created from net profit write-down according to ‘The Banking Law’ dated 29 of August 1997 (Journal of Laws 2012, item 1376 with subsequent amendments), hereinafter referred to ‘The Banking Law’ and it is to cover unidentified risks of 

the Bank.

2.16.5. Other reserves

Other reserves are created from the appropriation of net profits. It is uniquely to cover the potential losses in the statement of financial position. 

2.16.6. Non-controlling interests

Non-controlling interests represent the part of capital in a subsidiary, which cannot be directly or indirectly assigned to the parent company.

2.17 Determination of a financial result

The Group recognises all significant expenses and income in accordance with the following policies: accrual basis, matching principle, policies for recognition and valuation of assets and liabilities, policies for recognition of impairment losses.

2.17.1. Interest income and expense

Interest income and expense comprise interest, including premiums and discounts in respect of financial instruments measured at amortised cost and instruments at fair value, with the exception of derivative financial instruments. Interest income in case of financial assets or group of similar financial assets for which an impairment allowance was recognised is calculated from present values of receivables (that is net of impairment allowance) by using current interest rate used for discounting future cash flows for the purposes of estimating losses due to impairment.

Interest income/expense in respect of derivative financial instruments are recognised in ‘Net income from financial instruments measured at fair value’ or ‘Net foreign exchange gains (losses)’ (applied to CIRS), with the exception of derivative instruments classified as hedging instruments into hedge accounting, which have been presented in interest income. Interest income also includes deferred fee and commission received and paid accounted for using effective interest rate, which are part of the financial instrument. 

Interest income and interest expense are recognised on an accrual basis using the effective interest rate method.

The effective interest rate is the rate that discounts estimated future cash inflows and payments made through the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the asset or financial liability. Calculation of the effective interest rate includes all commissions paid and received by parties to an agreement, transaction costs and all other premiums and discounts constituting an integral part of the effective interest rate.

The effect of fair value measurement of financial assets of the acquired Nordea Group entities was also recognised in interest income.

2.17.2. Fee and commission income and expense

Fee and commission income is generally recognised on an accrual basis at the time when the related service is performed. Fee and commission income includes one-off amounts charged by the Group for services not related directly to creation of loans, advances and other receivables, as well as amounts charged by the Group for services performed over a period exceeding 3 months, which are recognised on a straight-line basis. Fee and commission income also includes deferred fee and commission recognised on a straight-line basis, received on loans and advances granted with unspecified schedule of future cash flows for which the effective interest rate cannot be determined.

2.17.2.1. Income and expense from sale of insurance products related to loans and advances

Due to the fact that the Group offers insurance products along with loans and advances and there is no possibility of purchasing from the Group the identical insurance product as to the legal form, conditions and economic content without purchasing a loan or an advance, fees received by the Group from sale of insurance products are treated as an integral part of the remuneration from the offered financial instruments.

Remuneration received and due to the Group from offering insurance products for the products directly associated with the financial instruments is settled using the effective interest rate method and recognised in interest income.

Remuneration received and due to the Group for performing intermediary services is recognised in commission income upon the sale of an insurance product or its renewal.

Distribution of remuneration for a commission and an interest part is made in the proportion of the fair value of a financial instrument and the fair value of intermediary service in relation to the sum of these two values. 

Costs directly related to the sale of insurance products are settled in a similar manner to the settlement of revenues, according to the principle of matching revenues and expenses, i.e. as part of the amortised cost of a financial instrument or on a one-off basis.

The Group makes a periodically estimation of the compensation amount that will be recoverable in the future due to the early termination of the insurance agreement and accordingly reduces the recognised interest or commission income.

2.17.3. Dividend income

Dividend income is recognised in the income statement of the Group at the date on which shareholders’ rights to receive the dividend have been established.

2.17.4. Net income from financial instruments measured at fair value 

Net income from financial instruments measured at fair value through profit and loss includes gains and losses arising from the disposal of financial instruments classified as financial assets/liabilities at fair value through profit and loss as well as the effect of their fair value measurement. This position includes also an ineffective portion related to cash flow hedges, as described in the note 2.6.6.4.

2.17.5. Gains less losses from investment securities

Gains less losses from investment securities include gains and losses arising from disposal of financial instruments classified as available for sale and held to maturity. 

2.17.6. Net foreign exchange gains (losses)

Net foreign exchange gains (losses) comprise foreign exchange gains and losses, both realised and unrealised, resulting from daily revaluation of assets and liabilities denominated in foreign currency using the National Bank of Poland average exchange rates at the balance sheet date, and from the fair value valuation of outstanding derivatives (FX forward, FX swap, CIRS and currency options).

The Group recognises in net foreign exchange gains (losses) both realised and unrealised foreign exchange gains and losses on fair value measurement of unrealised currency options. From an economic point of view, the method of presentation of net gains/losses on currency options applied allows the symmetrical recognition of net gains/losses on currency options and on spot and forward transactions concluded to hedge such options (transactions hedging the currency position generated as a result of changes in the market parameters affecting the currency option position).

The effects of changes in fair value and the result realised on the Gold Index option are also included in the net foreign exchange gains (losses) due to the fact that the Bank treats gold as one of the currencies, in line with the provisions of the Regulation (EU) No. 575/2013 of the European Parliament and of the Council as of 26 June 2013 on prudential requirements for credit institutions and investment firms. 

Monetary assets and liabilities presented by the Group in the statement of financial position and off-balance sheet items denominated in foreign currency are translated into Polish zloty using the National Bank of Poland average exchange rate prevailing for a given currency as at the balance sheet date. 

Impairment allowances on loans and advances and other receivables denominated in foreign currencies, which are created in Polish zloty, are updated in line with a change in the valuation of the foreign currency assets for which these impairment allowances are created. Realised and unrealised currency translation differences are recorded in the income statement.

2.17.7. Other operating income and expense

Other operating income and expense includes income and expense not related directly to banking activity. Other operating income mainly includes gains from sale of housing investments, sale or liquidation of non-current assets and assets possessed in exchange for debts, sale of subsidiary, recovered non-performing loans, legal damages, fines and penalties, income from lease/rental of properties. Other operating expense mainly includes losses from sale or liquidation of non-current assets, including assets possessed in exchange for debts, costs of debt collection and donations.

Other operating income and expense in relation to the Group entities include also income from sale of finished goods, goods for resale and raw materials, and the corresponding costs of their production.

Income from construction services (real estate development activities) is recognised on a completed contract basis, which involves recognition of all costs related to the housing investments that are incurred during the period of construction as work-in-progress. Payments received on account of a purchase of apartments are shown within deferred income. 

2.18 Income tax

The income tax expense is classified into current and deferred income tax. The current income tax is recognised in the income statement. Deferred income tax, depending on the source of the temporary differences, is recorded in the income statement or in the item ‘Other comprehensive income’ in the statement of comprehensive income.

2.18.1. Current income tax

Current income tax is calculated on the basis of gross accounting profit adjusted by non-taxable income, taxable income that does not constitute accounting income, non-tax deductible expenses and tax costs which are not accounting costs, in accordance with tax regulations. These items mainly include income and expenses relating to accrued interest receivable and payable, allowances on receivables and provisions for off-balance sheet liabilities.

While calculating corporate income tax base, regulations being in force within particular tax jurisdiction with regard to corporate income tax of the Group entities are taken into consideration. Simultaneously, the regulations of Decree of the Minister of Finance dated 7 May 2001 on extending the deadlines for paying corporate income tax and prepayments for corporate income tax for banks granting housing loans (Journal of Laws No. 43, item 482) are taken into consideration. According to the above-mentioned Decree, taxation of capitalised interest not paid by the borrower and not subject to temporary redemption by the State budget is deferred to the date of actual repayment or redemption of such interest. Therefore, the Group recognises the deferred income tax liability on income due to capitalised interest on housing loans, as described in the Decree.

2.18.2. Deferred income tax

The amount of deferred income tax is calculated as the difference between the tax base and book value of assets and liabilities for financial reporting purposes. The Group recognises deferred income tax assets and liabilities. An amount of deferred income tax is determined as a difference between carrying amounts and tax bases of assets and liabilities calculated with the use of appropriate tax rate. Deferred income tax assets and deferred income tax liabilities of the Group are presented in the statement of financial position respectively as assets or liabilities. The change in the balance of a deferred income tax liability or a deferred income tax asset is included in obligatory net profit expense (position: ‘Income tax expense’ in the income statement), except for the effects of valuation of financial assets and actuarial gains and losses recognised in other comprehensive income, where changes in the balance of a deferred income tax liability or deferred income tax asset are accounted for in correspondence with other comprehensive income. The calculation of deferred income tax takes into account the balance of the deferred income tax asset and deferred income tax liability at the beginning and at the end of the reporting period. 

The carrying amount of deferred income tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or a part of the deferred income tax asset to be utilised.

Deferred income tax assets and liabilities are measured using tax rates that are expected to apply in the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the balance sheet date.

For deferred income tax calculation the Group uses the 19% tax rate for entities operating on the territory of Poland, 18% tax rate for entities operating in Ukraine and 22% tax rate for entities operating in Sweden.

Deferred income tax assets are offset by the Group with deferred income tax liabilities only when the enforceable legal entitlement to offset current income tax receivables with current income tax liabilities exists and deferred income tax is related to the same taxpayer and the same tax authority.

2.19 Critical estimates and judgements

While preparing financial statements, the Group makes certain estimates and assumptions, which have a direct influence on both the financial statements presented and the notes to the financial statements.

The estimates and assumptions that are used by the Group in determining the value of its assets and liabilities as well as revenues and costs, are made based on historical data and other factors which are available and are considered to be proper in the given circumstances. 

Assumptions regarding the future and the data available are used for assessing carrying amounts of assets and liabilities which cannot be determined interchangeably using other sources. In making estimates the Group takes into consideration the reasons and sources of the uncertainties that are anticipated at the balance sheet date. Actual results may differ from estimates. 

Estimates and assumptions made by the Group are subject to periodic reviews. Adjustments to estimates are recognised in the periods in which the estimates were adjusted, provided that these adjustments affect only the given period. If the adjustments affect both the period in which the adjustment was made as well as future periods, they are recognised in the period in which the adjustments were made and in the future periods.

The most significant areas in which the Group performs critical estimates are presented below:

2.19.1. Impairment of loans and advances

An impairment loss is incurred when there is objective evidence of impairment due to events that occurred after the initial recognition of the asset (‘a loss event’) and when the loss event has a reliably measurable impact on the expected future cash flows from the financial asset or group of financial assets. Future cash flows are assessed by the Group on the basis of estimates based on historical parameters. 

The methodology and assumptions used in the estimates of impairment allowances are reviewed on a regular basis to minimise the differences between the estimated and actual loss amounts. 

The impact of an increase/decrease of cash flows for the Bank’s loans and advances portfolio assessed for impairment on the basis of individual analysis of future cash flows arising both from own payments and realisation of collaterals, i.e. the exposures for which an individual method is applied and the impact of an increase/decrease of the amount of portfolio parameters for the Bank’s loans and advances portfolio assessed on a portfolio and group basis is presented in the table below (in PLN million):

2.19.2. Valuation of derivatives and non-listed debt securities available for sale 

The fair value of non-option derivatives is determined using valuation models based on discounted cash flows expected to be received from the given financial instrument. Options are valued using option pricing models. The variables and assumptions used in a valuation include, where available, data derived from observable markets. 

The fair value of derivatives includes own credit risk as well as counterparty credit risk. In case of derivative instruments adjustment of the valuation of derivatives reflecting counterparty credit risk CVA (credit value adjustment) and adjustment of the valuation of derivatives reflecting own credit risk DVA (debit value adjustment) is calculated. The process of calculation of the CVA and DVA adjustments includes a selection of method determining the spread of a counterparty’s or the Bank’s credit risk (e.g. a market price method based on the constant price quotations of debt instruments issued by the counterparty, a method of spread implied from Credit Default Swap contracts), an estimation of the probability of default of the counterparty or the Bank and the recovery rate, the choice of a method for calculating CVA and DVA adjustments (the advanced method including a collateral or the simplified method) and calculation of the amount of CVA and DVA adjustments. As at 31 December 2014 the amount relating to CVA and DVA amounted to PLN 4 million.

The fair value of non-listed debt securities available for sale is determined using valuation models based on discounted cash flows expected to be received from the given financial instrument. In the valuation of non-listed debt securities available for sale, assumptions are also made about the counterparty's credit risk, which may have an impact on the pricing of the instruments. The credit risk of the securities, for which there is no reliable market price available, is included in the margin, for which the valuation methodology is consistent with the calculation of credit spreads to determine the CVA and DVA adjustments.

The valuation techniques used by the Bank for non-option derivative instruments are based on yield curves based on available market data (deposit rates on interbank market, IRS quotations). The Group conducted a simulation to assess the potential influence of changes of the yield curves on the transaction valuation. 

The tables below present the outcomes of estimated changes in valuation of non-option derivative instruments due to parallel movements of yield curves:

• for the whole portfolio of non-option derivative instruments (in PLN million):

• for derivative instruments that are designated to hedge accounting (in PLN million):

2.19.3. Calculation of provision for employee benefits 

The provision for retirement benefits is created on the basis of an actuarial valuation performed periodically by an external independent actuary. Valuation of the employee benefit provisions is performed using actuarial techniques and assumptions. 

The calculation of the provision includes retirement and pension benefits expected to be paid in the future. The Group performed a reassessment of its estimates as at 31 December 2014, on the basis of calculation conducted by an independent external actuary. The provisions calculated equate to discounted future payments, taking into account staff turnover, and relate to the period ending on the balance sheet date. An important factor affecting the amount of the provision is the adopted financial discount rate, which was adopted by the Bank at the level of 2.75%. In 2013 the adopted financial discount rate amounted to 4%.

A contribution of an increase/decrease in the financial discount rate and main actuarial assumptions by 1 pp. to a decrease/increase in the amount of the provision for retirement benefits as at 31 December 2014 is presented in the table below (in PLN million):

Gains and losses of the calculations conducted by an actuary are recognised in other comprehensive income.

The Group creates provisions for future liabilities arising from unused annual leave (taking into account all outstanding unused holiday days), from damages and severance payments made to those employees whose employment contracts are terminated for reasons independent of the employee, and for the employee compensation costs incurred in the current period which will be paid out in future periods, including bonuses.

2.19.4. Useful economic lives of tangible fixed assets, intangible assets and investment properties

In estimating useful economic lives of particular types of tangible fixed assets, intangible assets and investment properties, the following factors are considered:

1. expected physical wear and tear, estimated based on the average period of use recorded to date, reflecting the normal physical wear and tear rate, intensity of use etc.,
2. technical or market obsolescence,
3. legal and other limitations on the use of the asset,
4. expected use of the asset assessed based on the expected production capacity or volume, 
5. other factors affecting useful lives of such assets.

When the period of use of a given asset results from a contract term, the useful life of such an asset corresponds to the period defined in the contract. If the estimated useful life is shorter than the period defined in the contract, the estimated useful life is applied. 

In case of assets identified as a result of the transaction of acquisition of Nordea Bank Polska, i.e. customer relationships and value in force, depreciation is made using declining balance method over a period of 10 and 15 years respectively, based on the estimated rate of economic benefits consumption arising from their use.

The impact of change in useful economic lives of assets being subject to depreciation and classified as land and buildings on the change of financial result is presented in the table below (in PLN million):

2.20  Changes in accounting policies

The Group prepares its consolidated financial statements in accordance with the International Financial Reporting Standards as adopted by the European Union in the form of the Decrees of the European Union Commission ('the EU Commission').

1)   Amendments to published standards and interpretations which have come into force and have been applied by the Group since 1 January 2014

New standards and interpretations and amendments to existing standards and interpretations, which have been published and also have been approved by the European Union, but are not yet effective nor applied by the Group

2)   Applying for the first time to the financial statements of the Group for the year 2015

3)   Not yet adopted by the European Union 

In conclusion, the Management Board does not expect the adoption of the above-mentioned standards and interpretations to have a significant influence on the accounting policies applied by the Group with the exception of IFRS 9 (an influence of IFRS 9 on accounting principles applied by the Group have not been assessed yet). 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.