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EY Greater China Consumer Products and Retail Sector Journal
April 2017
Eric Chia
PartnerGreater China Consumer Products Sector Co-Leader
Arnold Sun
Partner
Greater China Consumer Products Sector Co-Leader
Dear EY friends,
Hope you’ve all had a wonderful Chinese New Year. It has been a while – and welcome to the Spring Edition of the
Consumer Products and Retail (CPR) Journal from EY in Greater China. In this edition, we have pulled together
three viewpoints to share with you.
Since late 2016, more scrutiny on the outbound investment process has been introduced in an attempt to slow
down the “buying frenzies” for China-based companies. Although already a critical part of the global mergers and
acquisitions (M&As) market, Chinese companies, many of which are players in the CPR industry, in general have
insufficient relevant experience in conducting cross-border M&As compared to their peers from developed
countries. A strategically aligned M&As plan can secure these companies with a more protected overseas M&As
journey. EY’s viewpoint “Strategy leads the way in overseas mergers and acquisitions in CPR sector”, by Jerry
Bao and Vivien Shan, provides not only step-by-step plans to help China entrepreneurs do overseas acquisitions,
but also supplements the theory with real business world evidence.
In the New Year, there will also be some new additions to the CPR Journal – we are now welcoming article
submissions from our Assurance colleagues. The article “The new leases standard – Consumer Product and
Retail”, by Lai Ting Wong, explains the latest changes in the accounting for leases by lessees and their
implications for CPR entities’ finances and operations. The new standard, IFRS 16, is effective for annual periods
beginning on or after 1 January 2019.
Last but not least, with regards to large retail chains in China, Alvin Kong analyzes the opportunities, impacts and
risks arose from the value-added tax (VAT) reform in the article “Challenges and analysis for large-scale chain
retailers during the post VAT implementation”. Since the implementation of the reform on 1 May 2016, there
has been increasing pressure on leading retailers to improve capabilities in practicing VAT. This article compiles a
to-do checklist and provides a set of follow-up procedures to help large retailers to leverage opportunities and
manage risks simultaneously.
Enjoy reading.
2EY Greater China Consumer Products and Retail Sector Journal |
Strategy leads the way in overseas M&As in the CPR sectorJerry Bao
Partner/Principal, TS-Corp Finance Strategy
Vivien Shan
Senior Manager, TS-Corp Finance Strategy
Chinese companies’ overseas CPR M&As continue to increase
In 1978, China introduced the monumental ‘reform and
opening-up’ policy. Fast forward just three decades and we
see, not only, a radically different China but also an explosion
in the number and size of both inbound and outbound merger
and acquisition (M&As) activity. By 2015, Chinese outbound
M&As into other regions reached a staggering USD59b (an
18% increase year over year). In the first four months of 2016,
Chinese buyers eclipsed 2015 volumes with the
announcement of over USD96b worth of outbound activity
(JP Morgan, 2016). Benefitting from an increasing number of
Chinese companies determined to become global players,
strong state support and an increasing supply of deals,
Chinese outbound M&As activities are not only expected to
continue – they are likely to accelerate from here.
In the past, the primary focus of Chinese outbound
investment had been on the energy and resources sector.
Since 2010 we have been seeing a shift towards a new
strategic focus – global market share growth and core
capabilities development across the Industrial, Technology,
Media and Telecommunications(TMT) and Consumer Products
and Retail (CPR) sectors. Increasingly,we are seeing more and
more Chinese companies actively pursuing outbound M&As to
access advanced products and strong-globally renowned
brands to not only open doors to new global markets, but also
as a means of elevating their own brand images in the Chinese
domestic market – a direct response to the sophistication of
domestic consumer behaviors. Key examples of this trend
include: the Sanpower Group acquisition of the House of
Fraser (2014), and more recently, the Biostime acquisition of
Swisse (2015) and the Qingdao Haier acquisition of GE
Appliance (2016).
Prior to 2010, the CPR sector represented a mere 2% of all
Chinese outbound activities. More recently, this figure had
risen to 12% (See figure below). And this might just be the
beginning.
In the January 2016 Issue of CPR Journal, we identified five
major trends that will shape strategies of consumer
products over the next three to five years. Collectively,
these trends point towards one clear conclusion – the rise of
the increasingly sophisticated ‘Chinese consumer’. What this
means for Chinese companies is that marginal competitive
advantages in brand, product quality or pricing will have an
increasingly amplified effect on corporate financial
performance. Technological advances have enabled
information and the consumer ‘voice’ to become
increasingly structured and available – serving as both risk
and opportunity for modern corporations. Outbound M&As
is often chosen as the preferred strategy for these Chinese
companies to rapidly acquire the necessary scale, brand
and/or core capabilities.
Despite the strategic importance of outbound M&As, we
have found that about 70% of M&As deals across all
industries in the 10 years to 2015 were not successful in
realizing their expected value. In pursuing overseas M&As,
Chinese companies have sometimes lacked a sufficient
rationale and execution plan in line with their visions. For
example, some enterprises were eager to expand and began
M&As activities in areas they were not familiar with. Some
entered a deal without a reasonable assessment of their
own resources and abilities and found themselves short of
the necessary core resources and execution power to
complete the overseas deals. Some did not have an orderly
execution plan and so their ‘going overseas’ strategies were
not given the required support.
To address these challenges and successfully complete an
overseas M&As deal, we believe that Chinese CPR
companies should formulate an M&As strategy in line with
their overall strategy and one that's proved to be effective.
They should have a plan before they make a move.
4EY Greater China Consumer Products and Retail Sector Journal |
China outbound M&As by target sector
Plan before action – strategy leads the way in overseas M&As
An overseas M&As includes five major steps: formulation of an overseas investment strategy, screen and lock in an investment target, transaction and execution, post-M&As integration, and post-investment management and investment portfolio assessment.
A sound overseas M&As strategy should guide the company
when launching an overseas M&As, enhance its ability to
capture opportunities in the international economic
environment and respond to challenges, and help avoid
deviations from the established strategic line and failure as
a result.
To formulate an overseas M&As strategy, a company first
needs to review its vision and overall strategic objective –
to ascertain the objective of its overseas M&As activity.
Second, it must analyze the targeted region and industry,
and the investment in terms of market attraction and
investment feasibility. This is to identify the key region and
sector for its investment in light of the company's own
strategy and resource allocation. Third, the company
should look at the internal resources of the company and
assess the resources available for overseas M&As, and
analyze the potential synergies of an overseas M&As target.
Having formulated an overseas M&As strategy, the
company should also lay down a detailed execution
roadmap, build the supporting platform, and enhance its
own internal abilities to ensure they can support the
implementation of its overseas M&As strategy.
► Company vision and strategic objective
► An overseas investment strategy plan
The essay here discusses only the formulation of an overseas M&As strategy
Overseas investing strategy
1
Screen and lock in on an investment target
3
► Principles for screening
investing targets
► Long- and short-list of
investment targets
► Initial contacts with
investment targets
Transaction and execution
2
► Transaction documentation
► Detailed due diligence ► Risk analysis ► Valuation ► Deal negotiations ► Settlement
Post-acquisition integration
4
► Identify challenges to management integration
► Specify major areas of integration and methods
► Monitor and optimize integration plan
Post-investment management and investment portfolio assessment
5
► Identify key steps in assessing the investment portfolio
► Finalize execution methods for assessing investment portfolios
Case studies – the formulation of an effective overseas M&As strategy in CPR sector
As China’s middle class continues to expand and to create
more demand for a variety of consumables, overseas M&As
are needed as companies search for ways to maintain
revenue growth and profitability while expanding
production to fulfill increasing orders.
Therefore companies need to ascertain their development
objectives and direction through reviewing their vision and
strategy, armed with a full understanding of external
markets, competition, addressable customer base and its
internal resources.
Depending on companies’ business, market positioning in
the niche industry, and internal capabilities, there appear
to be three major strategic rationales for Chinese CPR
companies going overseas – to expand to become a truly
global company, to bring home and strengthen value
proposition in the domestic market, as well as to penetrate
into premium segments with more growth potential.
Rationale #1 – Becoming a global company
For a variety of reasons, Chinese companies are buying
foreign companies to enter international markets. Leading
Chinese companies are adopting outbound investment to
equip themselves with well-known global brands, overseas
distribution channels and a broader customer base.
Here is a good example of a company that embarked on a
series of overseas M&As to accelerate its globalization. A
Chinese household electrical appliances manufacturer
acquired a Japanese brand and its business operations in
2011 to enter into Japan and other countries including
Indonesia and Malaysia. Company revenue contributed by
the Japan market grew 450% in the next year. In 2012, the
company acquired a New Zealand-based appliances
company to enter into Australasian market, leading to an
over 70% annual growth for the acquired business in the
next three years.
In 2016, this company closed a landmark deal by acquiring
the home appliances division of a diversified technology
and financial services company. According to the
company’s Chairman, the US market is a core market for
growth and this transaction has allowed the company to
substantially enhance its global competitiveness.
The acquisitions of these recognized mainstream brands,
together with those valuable international resources, has
turned the company into a stronger global consumer brand
much faster.
5EY Greater China Consumer Products and Retail Sector Journal |
Rationale # 2 – Creating a stronger China story
Chinese CPR companies are not just acquiring overseas
businesses in order to go overseas. Quite often, these
M&As enable Chinese companies to be more competitive in
the domestic market with more product offerings, better
quality and a stronger position.
Food safety issues have greatly influenced Chinese
consumer behavior. Middle class consumers prefer to pay a
premium for imported products with perceived better
quality. To address the unmet customer needs, a Chinese
leading dairy company formulated its overseas M&As
strategy to strengthen its industry chain, product portfolio
and brand image by constantly acquiring established
foreign brands in the past six years. The successful
acquisitions have provided strong competitive advantages
against its domestic rivals.
Rationale # 3 – Penetrating the premium segment with more growth potential
Another business motivation for Chinese companies’
ongoing overseas M&As is to enter a new and premium
segment. The transaction helps the company expand and
upgrade its competency by acquiring new capabilities,
specialized talents, valuable niche channels as well as a
strong footprint in a more promising market with higher
quality customer base.
A Shenzhen listed company specializing in corn oil
production, recently announced its 100% acquisition of a
Canada-based company that manufactures and sells
branded diet products primarily in the North American
market. This transaction will enable the Chinese company
to enter a much more profitable and fast growing nutrition
product markets from its existing relatively mature and low
margin corn oil business. It will also help the Canadian
company enter emerging and developing markets such as
China. After the purchase, the Chinese company will
develop products more receptive to Chinese consumers.
According to its Chairman, the company will strive to build
itself into a top brand in the high-end health food industry,
and will make use of its domestic business network to bring
premium products into the China market.
Conclusion
Based on our experience in assisting Chinese companies in
going overseas, Chinese companies sometimes have
insufficient relevant experience in conducting cross-border
M&As compared to peers from developed countries. If
Chinese companies are able to formulate a solid plan
before taking actions and have strategy-led M&As, their
overseas M&As journey will be more assured and protected.
These companies will steer clear of hidden reefs, in seeking
safe passage around the world.
6EY Greater China Consumer Products and Retail Sector Journal |
Overview
Consumer products and retail entities will
need to change certain lease accounting
practices when implementing IFRS 16
Leases, the new leases standard issued by
the International Accounting Standards
Board (IASB) on 13 January 2016. IFRS 16
significantly changes the accounting for
leases by lessees and could have far-
reaching implications for consumer
products and retail entities’ finances and
operations. The requirement for lessees to
recognise right-of-use assets and lease
liabilities for most leases may have a
significant effect on these entities balance
sheet metrics, given the number of leases
they typically have.
8EY Greater China Consumer Products and Retail Sector Journal |
Lessor accounting is remained substantially the same as the
current accounting, requiring lessors to classify their leases
into two types: finance and operating leases. Lease
classification determines how and when a lessor recognises
lease revenue and what leased asset a lessor account for.
IFRS 16 requires lessees to recognise most leases on their
balance sheets as lease liabilities with corresponding right-
of-use assets. Lessees apply a single model for most leases.
Generally, the profit or loss recognition pattern will change
to interest and depreciation expense and is recognised
separately in the statement of profit or loss (similar to
today’s finance lease accounting). However, lessees can
make accounting policy elections to apply accounting similar
to IAS 17’s operating lease accounting to ‘short-term’ leases
and leases of ‘low-value’ assets.
For consumer products and retail lessees, this means
recognising assets and liabilities for most leases of stores
and distribution centres that they may currently account for
as operating leases. Recognising assets and liabilities could
have significant financial reporting and business implications.
Recognising a lease obligation for most leases may affect
certain key metrics, and the effect may be significant for
entities that lease a large number of stores and/or stores in
high-rent locations. Implementing the standard could also
require an entity to develop new processes and controls to
track and account for leases, including: (1) identifying a
lease; (2) initially and subsequently measuring lease-related
assets and liabilities; (3) identifying and allocating
consideration to the lease and non-lease components; and (4)
collecting and aggregating information necessary for
disclosure.
The new standard will be effective for annual periods
beginning on or after 1 January 2019. Early adoption will be
permitted, provided the new revenue standard, IFRS 15
Revenue from Contracts with Customers, has been applied
or is applied at the same date as IFRS 16. Lessees must
apply IFRS 16 using either a full retrospective or a modified
retrospective approach.
Illustrative examples relevant to consumer products and
retail entities are provided in IFRS 16.
1. Key Considerations
1.1 Definition of a lease
A lease is a contract (i.e., an agreement between two or
more parties that creates enforceable rights and obligations)
or part of a contract, that conveys the right to use an asset
(the underlying asset) for a period of time in exchange for
consideration. To be a lease, a contract must convey the
right to control the use of an identified asset.
1.1.1 Identified asset
An identified asset can be either implicitly or explicitly
specified in a contract and can be a physically distinct
portion of a larger asset (e.g., a store located in a shopping
centre). Even if an asset is specified, a customer does not
have the right to use an identified asset if, at inception of
the contract, a supplier has the substantive right to
substitute the asset throughout the period of use. A
substitution right is substantive if the supplier has the
practical ability to substitute alternative assets throughout
the period of use and the supplier would benefit
economically from exercising its right to substitute the asset.
If the customer cannot readily determine whether the
supplier has a substantive substitution right, the customer
presumes that any substitution right is not substantive.
Consumer products and retail entities enter into a variety of
supply arrangements that will need to be evaluated to
determine whether they involve the use of an identified
asset. For example, some contract manufacturing
arrangements require the use of an explicitly or implicitly
specified asset (e.g., an entire facility) or involve the use of a
portion of a larger asset (e.g., a production line within a
facility). Even if the arrangement specifies an asset, retail
entities will also need to carefully evaluate whether the
supplier has substantive substitution rights to determine if
there is an identified asset that may be a lease.
9EY Greater China Consumer Products and Retail Sector Journal |
1.1.2 Right to control the use of the identified asset
A contract conveys the right to control the use of an
identified asset for a period of time if, throughout the period
of use, the customer has both of the following:
► The right to obtain substantially all of the economic
benefits from the use of the identified asset
► The right to direct the use of the identified asset
A customer has the right to direct the use of an identified
asset throughout the period of use when either:
(a) The customer has the right to direct how and for what
purpose the asset is used throughout the period of use
Or
(b) The relevant decisions about how and for what purpose
the asset is used are predetermined and the customer either:
i. Has the right to operate the asset, or direct others to
operate the asset in a manner that it determines, throughout
the period of use, without the supplier having the right to
change the operating instructions
Or
ii. Designed the asset, or specific aspects of the asset, in a
way that predetermines how and for what purpose the asset
will be used throughout the period of use
When evaluating whether a customer has the right to direct
how and for what purpose the asset is used throughout the
period of use, the focus is on whether the customer has the
decision-making rights that will most affect the economic
benefits that will be derived from the use of the asset. The
decision-making rights that are most relevant are likely to
depend on the nature of the asset and the terms and
conditions of the contract. The standard also says that if the
customer has the right to control the use of an identified
asset for only a portion of the term of the contract, the
contract contains a lease for that portion of the term.
Appendix A includes a flowchart that may assist entities in
making the assessment of whether a contract is, or contains,
a lease.
1.2 Identifying and separating components of a contract and allocating contract consideration
For contracts that contain the rights to use multiple assets
(e.g., a warehouse and equipment, multiple pieces of
equipment), the right to use each asset is considered a
separate lease component if both of the following conditions
are met: (1) the lessee can benefit from the use of the
underlying asset either on its own or together with other
resources that are readily available to the lessee; and (2) the
underlying asset is neither highly dependent on, nor highly
interrelated with, the other underlying assets in the contract.
For example, the lease contract for a warehouse and an
adjacent land parcel to be used for future development by
the lessee will generally be considered to contain two lease
components because the lessee could benefit from the
warehouse without development of the adjacent land parcel.
Many contracts contain a lease coupled with an agreement
to purchase or sell other goods or services (non-lease
components). For these contracts, the non-lease
components are identified and accounted for separately
from the lease component, in accordance with other
standards. For example, the non-lease components may be
accounted for as executory arrangements by lessees
(customers) or as contracts subject to IFRS 15 by lessors
(suppliers).
IFRS 16 provides a practical expedient that permits lessees
to make an accounting policy election, by class of underlying
asset, to account for each separate lease component of a
contract and any associated non-lease components as a
single lease component. Lessees that do not make an
accounting policy election to use this practical expedient are
required to allocate the consideration in the contract to the
lease and non-lease components on a relative stand-alone
price basis. Lessees are required to use observable stand-
alone prices (i.e., prices at which a customer would purchase
a component of a contract separately) when available. If
observable stand-alone prices are not readily available,
lessees estimate stand-alone prices, maximizing the use of
observable information.
10EY Greater China Consumer Products and Retail Sector Journal |
Lessors do not have a practical expedient to account for
lease and non-lease components as a single lease
component. Lessors are required to apply IFRS 15 to
allocate the consideration in a contract between the lease
and non-lease components generally on a relative stand-
alone selling price basis. The stand-alone selling price is the
price at which an entity would sell a promised good or
service separately to a customer. When stand-alone selling
prices are not directly observable, the lessor must estimate
the stand-alone selling price. IFRS 15 also provides suitable
methods for estimating the stand-alone selling price.
Retailers’ store leases frequently include payments for
maintenance activities including common area maintenance
(CAM) (e.g., cleaning the reception area of a building,
removing snow from a car park for employees and
customers) and other goods or services transferred to the
lessee (e.g., providing utilities or trash removal). Under IFRS
16, payments for these activities are considered non-lease
components because they provide the lessee with a service.
In some leases, a lessee may also reimburse, or make certain
payments on behalf of, the lessor that relate to the leased
asset for activities and costs that do not transfer a good or
service to the lessee and would not be considered a non-
lease component (e.g., payments made for real estate taxes
that would be owed by the lessor regardless of whether it
leased the building and regardless of who the lessee is,
payments made for the insurance that protects the lessor’s
investment in the building and the lessor will receive the
proceeds from any claim). Under IFRS 16, such costs are not
separate components of the contract, but are considered to
be part of the total consideration that is allocated to the
separately identified components of the contract (i.e., the
lease and non-lease components).
For such payments that are allocated to the lease
component, entities will need to evaluate whether they are
fixed (or in-substance fixed) lease payments or variable lease
payments. Fixed lease payments are included in the initial
measurement of the lease asset and liability.
2. Lease classification
Lessors classify all leases in the same manner as under IAS
17, distinguishing between two types of leases: finance and
operating. Lessors are required to reassess lease
classification upon a modification that does not result in a
separate lease.
Lessees, however, apply a single accounting model for all
leases, with options not to recognise short-term leases and
leases of low-value assets on the balance sheet.
3. Lessee accounting
At the commencement date of a lease, a lessee recognises a
liability to make lease payments (i.e., the lease liability) and
an asset representing the right to use the underlying asset
during the lease term (i.e., the right-of-use asset).
Lessees measure the lease liability using the interest rate
implicit in the lease, if that rate is readily determinable. If
that rate cannot be readily determined, the lessee is
required to use its incremental borrowing rate. Lessees
measure the right-of-use asset at the amount of the lease
liability, adjusted for lease prepayments, lease incentives
received, the lessee’s initial direct costs (e.g., commissions)
and an estimate of restoration, removal and dismantling
costs.
Lessees are required to separately recognise the interest
expense on the lease liability and the depreciation expense
on the right-of-use asset. When the right-of-use asset is
depreciated on a straight-line basis, this will generally result
in a front-loaded expense recognition pattern, which is
consistent with the subsequent measurement of finance
leases under IAS 17.
IFRS 16 specifies the accounting for lease incentives (e.g.,
lessor reimbursement for a lessee’s real estate commissions)
when measuring a lease liability and right-of-use asset.
Lease incentives receivable from the lessor at the
commencement date are deducted from the right-of-use
asset. Lease incentives received at or before the
commencement date reduce the initial measurement of the
right-of-use asset. ‘Key money’, which is paid by an
incumbent tenant to an outgoing tenant to secure a prime
location, is not included in lease payments and, therefore,
not included in the lessee’s lease liability.
11EY Greater China Consumer Products and Retail Sector Journal |
3.1 Short-term leases recognition exemption
Lessees can make an accounting policy election, by class of
underlying asset to which the right of use relates, to apply
accounting similar to IAS 17’s operating lease accounting to
leases that, at the commencement date, have a lease term
of 12 months or less and do not include an option to
purchase the underlying asset (short-term leases). Short-
term leases are not recognised on the balance sheet and the
related lease expense is recognised on a straight-line basis
over the term of the lease or another systematic basis, if
that basis is more representative of the pattern of the
lessee’s benefit.
3.2 Leases of low-value assets recognition exemption
Lessees can also make an election, on a lease-by-lease basis,
to apply accounting similar to current operating lease
accounting to leases for which the underlying asset is of low
value (low-value assets) in the amount of USD5,000 or less,
must be able to benefit from the asset on its own or together
with other resources that are readily available to the lessee
and must not be highly dependent on, or highly interrelated
with, other assets.
4. Lessor accounting
Consumer products and retail entities may be lessors if they
sublease assets or have supply or contract manufacturing
arrangements with a customer that are determined to
contain a lease.
IFRS 16 requires lessors to account for operating leases
using an approach that is substantially unchanged from IAS
17. That is, lessors continue to recognise the underlying
asset and lease payments are recognised as income over the
lease term, either on a straight-line basis or another
systematic basis that is more representative of the pattern
in which the benefits from the use of the underlying asset is
diminished.
Under IFRS 16, lessors are required to account for finance
leases also using an approach that is substantially
unchanged from IAS 17. That is, lessors derecognise the
carrying amount of the underlying asset, recognise a lease
receivable and recognise, in profit or loss, any selling profit
or loss.
4.1 Subleases – intermediate lessor accounting
It is common for retail entities to sublease retail space to a
third party. Under IFRS 16, an intermediate lessor accounts
for the head lease based on lessee accounting. However, an
intermediate lessor considers the lease classification criteria
with reference to the remaining right-of-use asset rather
than the underlying asset (e.g., building subject to a lease)
arising from the head lease when classifying a sublease as
finance or operating.
IFRS 16 requires the intermediate lessor to measure right-
of-use assets arising from leased property in accordance
with IAS 40 Investment Property if a leased property meets
the definition of investment property, the sublease is
classified as an operating lease and the intermediate lessor
elects the fair value model in IAS 40 as an accounting policy.
This represents a change from the current scope of IAS 40.
Under existing requirements, this is an election that is
available on a property-by-property basis.
An intermediate lessor generally accounts for a head lease
(as a lessee) and a sublease (as a lessor) as two separate
lease contracts. However, when contracts are entered into
at or near the same time with the same counterparty or
related parties of the counterparty, an intermediate lessor is
required to consider the criteria for combining contracts (i.e.,
whether the contracts are negotiated as a package with a
single commercial objective, the consideration to be paid in
one contract depends on the price or performance of the
other contract or rights to use the underlying assets
conveyed in the contract form a single lease component). If
any criterion is met, the intermediate lessor accounts for the
head lease and sublease as a single combined transaction.
12EY Greater China Consumer Products and Retail Sector Journal |
5. Other considerations
5.1 Sale and leaseback transactions
Because lessees are required to recognise most leases on
the balance sheet, sale and leaseback transactions will no
longer provide lessees with a source of off-balance sheet
financing.
IFRS 16 requires seller-lessees and buyer-lessors to apply
the requirements in IFRS 15 to determine whether a sale has
occurred in a sale and leaseback transaction. If control of an
underlying asset passes to the buyer-lessor, the transaction
is accounted for as a sale (or purchase) and a lease by both
parties. If not, the transaction is accounted for as a financing
by both parties.
5.2 Variable lease payments
Variable lease payments that depend on an index or rate are
included in lease payments and are measured using the
prevailing index or rate at the measurement date (e.g., lease
commencement date for initial measurement). Variable
payments that do not depend on an index or rate, such as
those based on performance (e.g., a percentage of sales) or
usage of the underlying asset, are not included as lease
payments.
Variable payments that do not depend on an index or rate,
such as those based on performance or usage of the
underlying asset, are not included as lease payments which
is similar to today’s accounting. Lessees recognise an
expense in the period in which the event that triggers those
payments occurs. Although IFRS 16 does not specify the
lessor’s accounting for variable lease payments that do not
depend on an index or rate, given that the IASB decided to
substantially carry forward the lessor accounting model in
IAS 17, a lessor recognises such variable lease payments as
income in the period in which they are earned, consistent
with current accounting.
Under IFRS 16, lessees are required to remeasure the lease
liability under certain circumstances, including when there is
a change in future lease payments resulting from a change in
an index or rate used to determine those payments. The
lessee is required to remeasure the lease liability to reflect
those revised lease payments only when there is a change in
the cash flows (i.e., when the adjustment to the lease
payments takes effect). For example, if the contractual lease
payments change every two years and the change is linked
to a change in the Consumer Price Index (CPI) during the
two-year period, a lessee would reassess the lease liability
every two years when the contractual payments change, not
each time the CPI changes.
13EY Greater China Consumer Products and Retail Sector Journal |
Next steps
► Entities should perform a preliminary assessment
as soon as possible to determine how their lease
accounting will be affected. Two critical first steps
include: (1) identifying the sources and locations of
an entity’s lease data; and (2) accumulating the
data in a way that will facilitate the application of
IFRS 16. For entities with decentralised operations
(e.g., an entity that is geographically dispersed),
this could be a complex process, given the
possibility for differences in operational, economic
and legal environments
► Entities will need to make sure they have the
processes, including internal controls, and systems
in place to collect the necessary information to
implement IFRS 16 (including making the necessary
financial statement disclosures)
► Consumer products and retail entities should
consider how they might communicate changes to
their financial reporting to investors and other
stakeholders
Appendix A: Extract from IFRS 16 B31 – Flowchart of lease definition
Is there an identified asset?
Yes
Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use?
Does the customer, the supplier or neither party have the right to direct how and for what purpose the asset is used throughout the period of use?
Neither; how and for what purpose the asset will be used is predetermined
Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions?
Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions?
Yes
No
Thecontract
contains aleasec
Yes
No
No
No
SupplierCustomer
Yes
Thecontractdoes notcontain a
lease
14EY Greater China Consumer Products and Retail Sector Journal |
Challenges and analysis for large-scale chain retailers during the post VAT implementationAlvin Kong
Manager, Indirect Tax
The final round of VAT pilot reform has
started nationwide from 1 May 2016 and
expanded to cover the construction, real
estate, finance and life-style service
industries. A number of circulars and
announcements have been issued regarding
the VAT pilot, with the aim to reduce the tax
burden for all industries. Under such
circumstances, it is important for large-
scale chain retailers to improve their VAT
management in order to enjoy the benefits
brought by the VAT pilot. Our analysis
below focuses on how large-scale chain
retailers should deal with the opportunities
and challenges from VAT management, VAT
filing and risk control during the stage of
post VAT implementation.
16EY Greater China Consumer Products and Retail Sector Journal |
1. VAT opportunities for large-scale chain retailers
Most large-scale chain retailers have already became general
VAT payers before the final round of VAT pilot on 1 May
2016 and have been allowed for input VAT credit. After 1
May 2016, the scope of input VAT credit has been expanded
to include the input VAT incurred for renting immovable
property, the purchase of immovable property, decoration
services, renovation services, sales supporting services,
labor dispatch services, agency services, employee
accommodation, certain banking, insurance services and so
on. The expanded scope of input VAT credit is aiming for
leading a decrease on VAT payable and a relief on total tax
burden.
In addition, there are opportunities for large-scale chain
retailers to improve their business model during the post
VAT implementation. The traditional retailers could leverage
and benefit from VAT pilot by planning and separating sales
channels or service modules. For example, retailers could
consider to separate out the online and platform sales
channel from the traditional sales channel, or separate out
the sales supporting service and goods handling service from
the traditional sales service, with the purpose to achieve
maximum tax benefit under the current VAT system.
2. VAT challenges for large-scale chain retailers
After the VAT pilot, the traditional retail industry is facing
challenges raised from the evolving VAT system, the
complicated VAT related information and the VAT collection
and management requirements. Detailed analysis are listed
below:
Firstly, the traditional retail industry is having a higher a
compliance cost due to the continuously updated VAT rules
and regulations, as well as the inconsistent interpretations
from tax officials. In order to have a smooth transition
period, specific VAT requirements regarding the applicable
VAT rate, calculation method, VATable base and VAT invoice
issuance are designed differently based on the
characteristics of each industry, and local tax bureaus may
hold different opinions on the interpretation and
implementation at practical level. In this regard, the retail
industry should pay attention to the newly issued VAT rules
and practical requirements from their in charge tax bureau
to improve their level of VAT compliance.
17EY Greater China Consumer Products and Retail Sector Journal |
Secondly, certain VAT practice requirements have brought
challenges on the operation model for the retail industry. For
example, the Announcement of the State Administration of
Taxation [2016] No. 53 has stipulated the requirements
regarding the VAT treatment and invoice requirements on
prepaid cards. The retail industry, which has adopted the
prepaid cards method for market development purpose
would be impacted significantly by these tax requirements.
The VAT requirements on prepaid cards could also bring
potential risks for retail industry on issues like deemed sales,
uncertain VAT rate applicable, input VAT recovery and VAT
invoice issuance etc. Chain retailers should consider taking
actions to mitigate these potential risks while maintain their
commercial interests.
Thirdly, the chain retailers may need to undertake significant
work load for VAT adjustment requirements. The final round
of VAT pilot started from 1 May 2016, tax and accounting
treatment for the business operations could be inter-
temporal on a quarterly, half yearly or yearly basis. Some
VAT rules require trace-back adjustments and chain retailers
would need to make adjustments accordingly. The workload
for large-scale chain retailers could be resource intensive
due to the scale of operation, large number of branches,
varying finance processes and moderate level of VAT
automation.
Fourthly, the retail industry would be impacted by the
development of e-invoicing. The downstream enterprises
would raise requirements on e-invoicing management for
their internal finance and reimbursement system, internal
recognition and control management etc. To meet the needs
from their customers, large retail industry would face
challenges from the improvement of e-invoice issuance and
management, including the solution to duplication and
identification issues.
Last but not the least, large-scale chain retailers need to
deploy significant resources on VAT filing. According to
prevailing VAT rules, it might not be practical for large-scale
chain retailers to have consolidated VAT payments at
national or even regional (cross city or town) level. In this
regard, the VAT filing could represent significant work load
for large-scale chain retailers with multiple VAT registration.
Especially after the final round of VAT pilot, the VAT returns
have been modified by the tax authorities and have been
updated to include nine forms. The co-relations between
these data are complicated as they are decided by the tax
authorities for automated tax risk management purposes.
When the data entered into the form meet the risk
assessment criteria, the system would raise alert to bring
the potential VAT issues to the attention of the in charge tax
bureau. In light of the above, large-scale chain retailers
would need to have capable and available human and IT
resources to ensure the VAT returns would be filed correctly
and timely.
18EY Greater China Consumer Products and Retail Sector Journal |
3. Post VAT reform management of large-scale chain retailers
In view of comprehensive analysis of opportunities and
challenges faced by enterprises, we can find although large-
scale chain retailers are traditional VAT payers instead of
pilot VAT payers, significant changes are still happened
during VAT reform and noteworthy for chain retailers. From
a practical point of view, chain retailers should strengthen
internal control environment and improve VAT management
efficiency.
Firstly, enterprise should introduce periodic VAT health
check mechanism. With the roll-out of VAT reform, certain
regulators are carrying out investigations and inspections on
VAT reform implementation. In September 2016, SAT
announced Notification of Carrying out Special Inspection on
the Use of VAT Fapiao. The circular has set out the guidance
on undertaking targeted inspection on how VAT taxpayers
are using VAT fapiao (invoices), distribution of VAT fapiao
and cancellation of VAT fapiao. As an observation, the scope
and frequency of similar large and comprehensive inspection
are expanding and increasing. In this regard, undertaking
periodic VAT internal health check appears to be very
important. Effective health check can ensure VAT
compliance, mitigate VAT risks, discover VAT saving
opportunities, improve VAT compliance management
efficiency, assess VAT key control points, refine VAT
procedures and help taxpayers to have a clearer view on
how VAT is being managed across the different parts of their
organization. The final goal is to improve the compliance of
business activities, and build VAT risk control system.
Secondly, large-scale chain retailers should optimize their
business models. With the fast developing digital economy,
the traditional procurement arrangements, stock models,
sales channels, and delivery models for large-scale chain
retailers are facing significant impacts. Most large-scale
chain retails currently are considering the use of third party
internet platform to extend their reaches to the consumer
market. This revolution has caused chain reaction to
optimize the efficient on stock replenishment, sales and
delivery model. In view of multiple VAT rates under current
VAT system, and the existence of preferential treatment on
certain lifestyle service sector, large-scale chain retailers
should optimize business model (e.g. build effective supply
chain managing platform, financial service center, delivering
center and sales platform), and arrange effective operation
model, to increase overall tax efficiency.
Thirdly, large-scale chain retailers should consider investing
on information-based tax platform aiming to improve their
tax accuracy and efficiency. With the development of
technology, information-based tax platform has been
changed dramatically. Digitized VAT sensitive data can help
reveal features of which businesses can rely on to improve
the accuracy of VAT compliance by reducing the chance of
making errors. The following approaches are samples of
digitalizing VAT data:
19EY Greater China Consumer Products and Retail Sector Journal |
► Electronic Fapiao
China has launched electronic fapiao pilot program from
May 2012. Until now, the pilot program has become
more mature. Currently, the SAT is accelerating the
progress of upgrading electronic fapiao. Associated data
pairing/matching measures have been released
continuously. From chain retailers practices point of view,
electronic fapiao has obvious advantages from costs and
operating efficiency perspectives. With the maturing of
electronic fapiao measures and full roll-out of VAT
reform implementation, it is observed that chain retailers
have adopted/ in the process of adopting electronic
fapiao as the cost and difficulties on issuing paper
fapaios have found to be increasing.
► Digitization of VAT Filing
Tax filing is one of the most essential components of VAT
management and can sometimes represent hurdles for
chain retailers. Tax filing often involves data pulled from
various internal IT system and if the data extractions and
handling are not being done automatically, it would be a
labor intensive process and the potential human error
could hinder the accuracy of the VAT filing. The first step
of automation on VAT management is often digitizing the
VAT sensitive data and there are readily available tools in
the market which can assist tax personnel with the VAT
return filing tasks.
Many digitized VAT return filing tools can realize
automated VAT data handling to a large extent which
involves data extraction, data population, reconciliation,
risk recognition and other VAT management functions.
An added benefits for adopting automation is that,
resources could be freed up to handle other value adding
matters within the company.
Fourthly, large-scale chain retailers should collect
requests of VAT associated policies and regulations. With
the implementation of VAT legislation, tax authorities are
refining/clarifying certain tax policies and regulations.
For example, on the VAT policy for consolidated VAT
filing for large-scale chain retailers head offices and
branches, due to certain requirements set by local tax
authorities in view of local financial interests, some
large-scale chain retailers head offices and branches are
having practical difficulties in utilizing consolidated VAT
filing.
On 2 November 2016, the General Office of the State
Council issued the Opinions of the General Office of the
State Council on Promoting the Innovative
Transformation of Physical Retail (Guo Ban Fa [2016] No.
78) and the circular has explicitly specified “enforce
associated policies and regulations on Enterprise Income
Tax and VAT consolidated filing of head offices and
branches”. Large-scale chain retailers should take
advantage of this principle set by the State Council and
this can be achieved by proposing reasonable and
practicable approaches (based on actual situations and
business model) on VAT consolidated filings.
20EY Greater China Consumer Products and Retail Sector Journal |
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APAC no. 03004519ED None.
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