A closely related issue to determining fair value of financial instruments is the recognition of deferred day 1 profit or loss. We have entered into transactions, some of which will mature in the long-term, where we determine fair value using valuation models for which not all material inputs are market observable prices or rates. We initially recognize such a financial instrument at the transaction price, which is the best indicator of fair value, although the value obtained from the relevant valuation model may differ. Such a difference between the transaction price and the model value is commonly referred to as “day 1 P / L”. We do not immediately recognize that initial difference, usually a gain, in profit or loss because the applicable accounting literature prohibits immediate recognition of day 1 profit. The accounting literature does not, however, address its subsequent recognition prior to the time when fair value can be determined using market observable inputs or by reference to prices for similar instruments in active markets. It also does not address subsequent measurement of these instruments and recognition of subsequent fair value changes indicated by the model.

Our decisions regarding recognizing deferred day 1 profit p are made after careful consideration of facts and circumstances to ensure we do not prematurely release a portion of the deferred profit to income. For each transaction, we determine, individually, the appropriate method of recognizing the day 1 profit amount in the income statement. It may be amortized over the life of the transaction, or deferred until fair value can be determined using market observable inputs, or realized through settlement. In all instances, any unrecognized day 1 profit is immediately released to income if fair value of the financial instrument in question can be determined either by using market observable model inputs or by reference to a quoted price for the same product in an active market.

Changes in fair value after day 1 resulting from changes in observable parameters or otherwise indicated by the model are recognized immediately in the income statement independently of the release of deferred day 1 profits. See Note 26e) to the Financial Statements for quantitative information on deferred day 1 profit or loss.