HKFRS and IFRS Seminar - Nelson CPA

Microsoft PowerPoint - LN-20060306-(Presented)HKFRS and IFRS Seminar 6 March 2006
Nelson Lam Nelson Lam CFA FCCA FCPA(Practising) MBA MSc BBA CPA(US) ACA
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Today’s Agenda
Summary of ConvergenceSummary of Convergence
Selected Major Changes HKAS 17 Leases HKAS 40 Investment Property HKAS 21 Effects of Changes in Foreign
Exchange Rates HKAS 39 Financial Instruments HKFRS 2 Share-based Payments HKFRS 3 Business Combinations
Selected Major Changes HKAS 17 Leases HKAS 40 Investment Property HKAS 21 Effects of Changes in Foreign
Exchange Rates HKAS 39 Financial Instruments HKFRS 2 Share-based Payments HKFRS 3 Business Combinations
Real Cases and Examples Real Cases
and Examples
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investment properties - 2,799
For the 6 months ended (30 June) 2004 HK$’M
Turnover 562 Profit before tax 407
2005 HK$’M
695%695%
Some Cases First CaseCase
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Some Cases First
Once year on year changes in asset values of investment properties are included in the profit and loss account, using reported profit as a yardstick to measure a company’s performance would be simplistic and possibly misleading.
Robert Gazzi and Ming Tse (01.2002) From a Big 4 firm
Once year on year changes in asset values of investment properties are included in the profit and loss account, using reported profit as a yardstick to measure a company’s performance would be simplistic and possibly misleading.
Robert Gazzi and Ming Tse (01.2002) From a Big 4 firm
…… (Hysan) (volatile earning resulted) (to have more disclosure) …… (18.06.2004)
…… (Hysan) (volatile earning resulted) (to have more disclosure) …… (18.06.2004)
But …...
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HKAS 40 seems to be the “most well-received” HKAS if in term of the no. of companies that have early adopted it before the effective date (exclude those have fully adopted all new HKFRS/HKAS)
But …...
• The Bank of East Asia, Limited • CATIC International Holdings Limited • Cheung Kong (Holdings) Limited • Gold Peak Industries (Holdings) Limited • Hanison Construction Holdings Limited • Hutchison Whampoa Limited • IDT International Limited • Junefield Department Store Group Limited • Omnicrop Limited • Pak Fah Yeow International Limited • Recruit Holdings Limited • South China Holdings Limited ……
• From large to small • From property developer to bank • From HK to PRC companies
Why?Why?Why?
Bank of East AsiaBank of East Asia (2004 Annual Report)
• Early adopted only one new HKAS, HKAS 40 ……
2003 2004 % HK$’M HK$’M
Reported profit before tax (after early adoption) 2,374 2,824 ↑19%
Eliminate the effect of early adoption - (175)
Adjusted profit before tax (before early adoption) by estimate 2,374 2,649 ↑12%
Is it?Is it?Is it?
investment properties 3,235 5,403
Turnover 4,544 Profit before tax 6,023
2005 HK$’M 6,955 8,752 45%45%
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• Full convergence to International Financial Reporting Standards (IFRSs) and International Accounting Standards (IASs) in HK in 2005 – Name change
• From Statements of Standard of Accounting Practice (SSAPs) • To Hong Kong Financial Reporting Standards (HKFRSs) and
Hong Kong Accounting Standards (HKASs) (same number, say IFRS 1 = HKFRS 1, IAS 12 = HKAS 12 ……)
– Standard contents change • Full alignment with IFRSs and IASs • Minor to major standard contents amendments • New standards
– Effective for the periods beginning on or after 1 January 2005 – Early application is encouraged (in most cases)
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Public Accountants and comprise: – Hong Kong Financial Reporting Standards; – Hong Kong Accounting Standards; and – Interpretations.
• HKASs (Hong Kong Accounting Standards) – Totally 31 sets A. 9 sets of HKAS renamed from SSAP B. 9 sets of HKAS amended due to IASB’s Improvement Project C. 8 sets of HKAS aligned with IAS D. 5 new sets of HKAS
• HKFRSs (Hong Kong Financial Reporting Standards) – Totally 7 sets E. 7 new sets of HKFRS (up to 2 March 2006)
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A. 9 sets of HKAS renamed from SSAP
HKAS 11 Construction contracts HKAS 12 Income taxes HKAS 14 Segment reporting HKAS 18 Revenue HKAS 19 Employee benefits HKAS 20 Accounting for Government Grants and
Disclosure of Government Assistance HKAS 34 Interim financial reporting HKAS 37 Provisions, Contingent Liabilities and
Contingent Assets HKAS 41 Agriculture
⇐ SSAP 23 ⇐ SSAP 12 ⇐ SSAP 26 ⇐ SSAP 18 ⇐ SSAP 34 ⇐ SSAP 35
⇐ SSAP 25 ⇐ SSAP 28
⇐ SSAP 36
• Only name changed • Nothing new from old SSAPs • Only name changed • Nothing new from old SSAPs
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B. 9 Sets of HKAS amended due to IASB’s Improvement Project
HKAS 1 Presentation of financial statements HKAS 2 Inventories HKAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors HKAS 10 Events after the Balance Sheet Date HKAS 16 Property, Plant and Equipment HKAS 21 The Effects of Changes in Foreign Exchange
Rates HKAS 27 Consolidated and Separate Financial Statements HKAS 28 Investments in Associates HKAS 33 Earnings Per Share
* HKAS 29 Financial Reporting in Hyperinflationary Economies (included in IASB’s Improvement Project but not yet issued in HK before, thus regarded as new in HK.)
• Refine some areas • Reduce some choices • Refine some areas • Reduce some choices
Numerous changesNumerous changes
Major changesMajor changes
Exemptions removedExemptions removed
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C. 8 Sets of HKAS Aligned with IAS
HKAS 7 Cash Flow Statements HKAS 17 Leases HKAS 23 Borrowing Costs HKAS 24 Related Party Disclosures HKAS 31 Interests in Joint Ventures HKAS 36 Impairment of Assets HKAS 38 Intangible Assets HKAS 40 Investment Property
• Eliminate the differences with IASs, but ……
• Some have significant impact to small to large companies in HK (some discussed last time)
• Eliminate the differences with IASs, but ……
• Some have significant impact to small to large companies in HK (some discussed last time)
Major change in HKMajor change in HK
HKAS 26 Accounting and Reporting by Retirement Benefit Plans
HKAS 29 Financial Reporting in Hyperinflationary Economies
HKAS 30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions (to be withdrawn)
HKAS 32 Financial Instruments: Presentation HKAS 39 Financial Instruments: Recognition and
Measurement
impact on small to large companies in HK
• New practices • Some have significant
impact on small to large companies in HK
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HKFRS 1 First-time Adoption of Hong Kong Financial Reporting Standards
HKFRS 2 Share-based Payment HKFRS 3 Business Combinations HKFRS 4 Insurance Contracts HKFRS 5 Non-current Assets Held for Sale and Discontinued
Operations HKFRS 6 Exploration for and Evaluation of Mineral Resources HKFRS 7 Financial Instruments: Disclosures
• All are new practices • Again …… some have
significant impact to small to large companies in HK
• All are new practices • Again …… some have
significant impact to small to large companies in HK
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disclosure requirements
and disclosure
• More and clearer presentation and disclosure
•• More and clearer More and clearer presentation and presentation and disclosuredisclosure
• Aim at enhancing the information for users’ decision making
•• Aim at enhancing Aim at enhancing the information the information for users’ for users’ decision makingdecision making
e.g. market value, value by appraisal ……
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For Rent
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HKAS 17 is largely the same as SSAP 14, but has just been amended to align with IAS 17 (in respect of land and buildings) by
Leases – Little Change?
2. Introducing several new paragraphs 1. Deleting one sentence, and
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Properties in HK are leasehold interest in land
• Not freehold land → Not a “purchase” but a “lease” • In the past, SSAP 14 had an exemption:
– deemed all the risks and rewards incident to ownership of the “leasehold property” were transferred
– therefore, such interest was accounted for as a “purchase” in accordance with
• SSAP 13 Accounting for investment properties or • SSAP 17 Property, plant and equipment, as appropriate • instead of SSAP 14
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Separate measurement
Separate measurement
Land onlyLand only
Land and Building
Land and Building
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Leases – Separate Measurement
• As before, lease classification is made – at the inception of the lease – leases of land and buildings are classified as operating or finance
leases in the same way as leases of other assets
Building only
Building only
Lease of landLease of land
• Land normally has an indefinite economic life • If title of leasehold land is not expected to pass to the lessee
⇒ Lessee normally does not receive substantially all of the risks and rewards incidental to the ownership
⇒ In which case the lease of land will be an operating lease • payment acquiring such leasehold represents
prepaid lease payments • amortised over the lease term in accordance with
the pattern of benefits provided
Leasehold land without title pass
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Yes
LandLand
No
BuildingBuilding
If a lease contains land and buildings elements
2 elements are considered separately for lease classification
If title of both elements is expected to pass to the lessee
Both elements are classified as finance lease
Lease of landLease of land
If title of land or both elements is NOT expected to pass to the lessee
The land element alone is normally classified as an operating lease The building element is considered separately
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Lease of land and buildingsLease of land and buildings • To classify and account for a lease of land and buildings
• the minimum lease payments (including any lump-sum upfront payments) are allocated between the land and the buildings elements
• in proportion to the relative fair values of the leasehold interests in the land element and buildings element of the lease at the inception of the lease
• If the lease payments cannot be allocated reliably between the 2 elements • the entire lease is classified as a finance lease • unless it is clear that both elements are operating leases,
in which case the entire lease is classified as an operating lease • For a lease of land and building if the land is immaterial
• The lease may be treated as a single unit and classified as finance or operating leases
Building only
Building only
Yes
LandLand
No
BuildingBuilding
Can land and building be reliably separated?
No
No
Yes
Minimum lease payment allocated in proportion to the relative fair values of land and building elements
Minimum lease payment allocated in proportion to the relative fair values of land and building elements
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Entity A
• paid a land premium to lease a land from the HKSAR government for 50 years
• paid a land premium to lease a land from the HKSAR government for 50 years
• then, constructed a building on the land for own use
• then, constructed a building on the land for own use
10 years later, Entity B “acquired” the interest of the land and building from Entity A for own use
Assuming Entity B “acquired” the property at HK$20 million and at that time
A similar land has a fair value of $12M Construction cost of a similar building is $4M
• HK$ 20M to be separated in proportion to the relative fair values of the land and building element at the inception of the lease, i.e. by HK$ 12M to HK$ 4M
• Then, the separate measurement will result in: Land = HK$15M ($20M ×$12M / $16M) Building = HK$ 5M ($20M × $ 4M / $16M)
• HK$ 20M to be separated in proportion to the relative fair values of the land and building element at the inception of the lease, i.e. by HK$ 12M to HK$ 4M
• Then, the separate measurement will result in: Land = HK$15M ($20M ×$12M / $16M) Building = HK$ 5M ($20M × $ 4M / $16M)
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“The early adoption of HKAS 17 has resulted in a change in accounting policy relating to leasehold land.”
“Leasehold land and buildings were previously carried at valuation less accumulated depreciation.”
“In accordance with the provisions of HKAS 17, a lease of land and building should be split into a lease of land and a lease of building in proportion to the relative fair values of the leasehold interests in the land element and the building element of the lease at the inception of the lease.”
“The lease premium for land is stated at cost and amortised over the period of the lease whereas the leasehold building is stated at valuation less accumulated depreciation.”
2004 Annual Report, HKEX
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“The early adoption of HKAS 17 has resulted in a change in accounting policy relating to leasehold land.”
“Leasehold land and buildings were previously carried at valuation less accumulated depreciation.”
“In accordance with the provisions of HKAS 17, a lease of land and building should be split into a lease of land and a lease of building in proportion to the relative fair values of the leasehold interests in the land element and the building element of the lease at the inception of the lease.”
“The lease premium for land is stated at cost and amortised over the period of the lease whereas the leasehold building is stated at valuation less accumulated depreciation.”
2004 Annual Report, HKEX
Effect of adopting HKAS 17 Leases Increase/(Decrease) Balance sheet as at 31 December 2004 HK$’000 Fixed assets (170,100) Lease premium for land 95,218 Deferred tax liabilities (19,139) Revaluation reserves (73,815) Retained earnings 18,072
Income statement for the year 2004 Increase in premises expenses 548 Decrease in depreciation (1,749) Increase in taxation 128
Effect of adopting HKAS 17 Leases Increase/(Decrease) Balance sheet as at 31 December 2004 HK$’000 Fixed assets (170,100) Lease premium for land 95,218 Deferred tax liabilities (19,139) Revaluation reserves (73,815) Retained earnings 18,072
Income statement for the year 2004 Increase in premises expenses 548 Decrease in depreciation (1,749) Increase in taxation 128
From valuation to cost (for land) • Non-current assets reduced by
HK$ 75 million
From valuation to cost (for land) • Non-current assets reduced by
HK$ 75 million
• Amended and clearer definition on an investment property
SSAP 13 An investment property is an interest in land and/or buildings: a) in respect of which construction work and development have
been completed; and b) which is held for its investment potential, any rental income
being negotiated at arm’s length HKAS 40
Investment property is property (land or a building – or part of a building – or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: a) use in the production or supply of goods or
services or for administrative purposes; or b) sale in the ordinary course of business
Definitions – Revised
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• Amended and clearer definition on an investment property
Definitions – Revised
How’s about property held by the lessee under an operating lease?
Examples of investment property under HKAS 40 include: • Property leased out under operating leases • Property held for long-term capital appreciation • Property held for a currently undetermined future use • Vacant property to be leased out under operating leases
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Definitions – To Operating Leases
• A property interest – that is held by a lessee under an operating lease
may be classified and accounted for as investment property if, and only if • the property would otherwise meet the definition of an
investment property and • the lessee uses the Fair Value Model
• This classification alternative is available on a property-by-property basis
• However, once this classification alternative is selected for one such property interest held under an operating lease, all properties classified as investment property shall be accounted for using the Fair Value Model
An entity has a choice
How’s about property held by the lessee under an operating lease?
Simple?Simple?
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Definitions - Owner-Occupied Property
• Introduce a new term, owner-occupied property – Defined as a property held (by the owner or by the lessee under a
finance lease) for use in the production or supply of goods or services or for administrative purposes
– In substance, a property under HKAS 16 – Being one of the examples that is NOT an investment property
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Refer back to HKAS 16 for definition of property, plant and equipment • Property, plant and equipment are tangible items that:
a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and
b) are expected to be used during more than one period.
Investment Property
Investment Property
Owner-occupied Property
Owner-occupied Property
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• One of the key indicators in determining the classification between investment property and owner-occupied property
Cash Flow
• held to earn rentals or for capital appreciation or both
• therefore, generates cash flows largely independently of the other assets held by an entity.
• the production or supply of goods or services (or the use of property for administrative purposes)
• generates cash flows that are attributable not only to property, but also to other assets used in the production or supply process
Investment Property
Investment Property
Owner-occupied property
Owner-occupied property
→ investment property
If owner-managed hotel was classified as investment property before 2005, it should be reclassified as • property, plant and equipment (HKAS 16) or • lease (HKAS 17)
• Significant impact on hotel group
Cash Flow Extent of Ancillary Services
• provided by an entity to the occupants of a property it holds is also considered
owner-occupied property e.g. a owner-managed hotel is not an
investment property
• Before 2005, its hotel properties are classified as investment properties, which are stated at annual professional valuations at the balance sheet date
• It announced on 17 Dec. 2004 that its hotel properties “will no longer be accounted for as investment properties” from 2005
• It will adopt the following accounting policies retroactively: 1. The underlying buildings and integral plant and machinery will be
stated at cost less accumulated depreciation and impairment 2. The underlying freehold land will be stated at cost less impairment 3. The underlying leasehold land will be stated at cost and subject to
annual operating lease rental charge (amortization of land cost)
ShangriShangri--La Asia Ltd.La Asia Ltd. (extracted from 2003 Annual Report and Announcement of 17 Dec. 2004)
• Owner-managed hotels cannot be classified as investment property
• They can be classified as property, plant and equipment (HKAS 16) and/or leases (HKAS 17)
CaseCase
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• 2004 Final Results Announcement of 31 Mar. 2005 further stated that, from 1 Jan. 2005: “Adoption of these new accounting policies will have the following significant consequences: a) The net book value of fixed assets, the overall provision for deferred
tax liabilities and the net asset value of the Group will be reduced b) The annual depreciation and lease rental charges will increase and
this will reduce the profit after tax attributable to the shareholders (“PAT”) and the earnings per share (“EPS”) of the Group.”
ShangriShangri--La Asia Ltd.La Asia Ltd.
Definitions - Owner-Occupied Property CaseCase
• Let’s do some estimates (based on 2004 results announcement)
ShangriShangri--La Asia Ltd.La Asia Ltd.
Asset base shrunk
Net assets 2,624 3,109 If revaluation reserves eliminated
(due to reclassification of hotel properties) (650) (805) Adjusted net assets (by estimate only) 1,974 2,304
CaseCase
Interim Report 2005 stated that:
Six months ended 30 June (HK$’000) 2005 2004 Note 3 to the interim report • Increase in depreciation arising from
reclassification of hotel properties and owner- occupied properties to PPE 73,245 50,767
Condensed consolidated income statement • Profit before tax (without fair value changes on
investment properties) 283,623 176,357
CaseCase
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Cost ModelCost Model
Fair Value ModelFair Value Model
• HKAS 40 implicitly implies that the choice can only be elected on the first-time adoption of HKAS 40
• The model chosen should be applied to all investment properties, except for some identified exceptions.
and
• However, even Cost Model is adopted, HKAS 40 still requires all entities to determine the fair value of investment property …… • For disclosure purpose, the fair value of the investment property has to
be disclosed in notes to the financial statement! • In determining the fair value of investment property for both cost model
and fair value model ⇒ an entity is only encouraged, but not required, to rely on a
professional valuer’s valuation
Fair Value ModelFair Value ModelAfter initial recognition, an entity that chooses → • shall measure all of its investment property at
fair value, except in the cases that 1. the fair value cannot be determined reliably, or 2. the cost model is chosen for the investment property backing liabilities
that pay a return linked directly to the fair value of, or returns from specific assets including that investment property
• When a property interest held by a lessee under an operating lease is classified as an investment property ⇒ the fair value model must be applied for all investment
properties • A gain or loss arising from a change in the fair value of
investment property shall be recognised in profit or loss for the period in which it arises
Depreciation? Tax Implication?
HKAS 40 • Uses fair value, instead of open market value
– but in substance, they are similar – not the same as SSAP 13, HKAS 40 only encourages, but not
requires, a profession valuation on a fair value
Measurement after Recognition
Fair Value ModelFair Value Model
• Fair value is defined as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction – Same definition used in other HKFRSs and HKASs – But HKAS 40 provides more explanations unique for a fair value of a property
• The fair value of investment property shall reflect market conditions at the balance sheet date
Depreciation? Tax Implication?
Not our concern this time! But be careful, good & bad …...
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For 6 months ended 2004 2005 % HK$’M HK$’M
Turnover 3,987 4,385 ↑10%
Profit before tax 1,395 3,099 ↑120%
73% of 04 profit 33% of 05 profit 73% of 04 profit 33% of 05 profit
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Interim Report 2005 clearly stated that:Interim Report 2005 clearly stated that:
CaseCase
• The directors consider it inappropriate for the company to adopt two particular aspects of the new/revised IFRSs as these would result in the financial statements, in the view of the directors, either: • not reflecting the commercial substance of the business or • being subject to significant potential short-term volatility, as
explained below …….
Measurement after Recognition CaseCase
• IAS 40 “Investment property” requires an assessment of the fair value of investment properties.
• The group intends to follow the same accounting treatment as adopted in 2004, which is to value such investment properties on an annual basis.
• Accordingly, the investment properties were not revalued at 30 June 2005, since the directors consider that such change of practice could introduce a significant element of short- term volatility into the income statement in respect of assets which are being held on a long-term basis by the group ……
• It is not practicable to estimate the financial effect of this non-compliance as no interim valuation of the properties has been conducted.
Interim Report 2005 clearly stated that:Interim Report 2005 clearly stated that:
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Approach in HKAS 21 1. In preparing financial statements, each entity
determines its functional currency.
2. The entity translates foreign currency items or transactions into its functional currency and reports the effects of such translation.
3. The results and financial position of any individual entity (say subsidiary, associate or branches) within the reporting entity (say parent) whose functional currency differs from the presentation currency of the reporting entity are translated.
4. If the entity’s presentation currency differs from its functional currency, its results and financial position are also translated into the presentation currency.
Determine Functional Currency
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What is Foreign Currency?
• Foreign currency is a currency other than the functional currency of the entity.
• Functional currency is the currency of the primary economic environment in which the entity operates.
• Presentation currency is the currency in which the financial statements are presented.
1. In preparing financial statements, each entity determines its functional currency.
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Indicators to Determine
• Primary indicators a) the currency
i) that mainly influences sales prices for goods and services, and ii) of the country whose competitive forces and regulations mainly
determine the sales price of its goods and services. b) the currency that mainly influences labour, material and other costs of
providing goods or service. • Other indicators in determining functional currency
a) the currency in which funds from financing activities (ie issuing debt and equity instruments) are generated.
b) the currency in which receipts from operating activities are usually retained.
Functional currency is the currency of the primary economic environment in which the entity operates.
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• When the above indicators are mixed and the functional currency is not obvious – management uses its judgement to determine the functional currency that
most faithfully represents the economic effects of the underlying transactions, events and conditions.
• An entity’s functional currency reflects the underlying transactions, events and conditions that are relevant to it – once determined, the functional currency is not changed unless there is a
change in those underlying transactions, events and conditions. • If the functional currency is the currency of a hyperinflationary economy, the
entity’s financial statements are restated in accordance with HKAS 29 – An entity cannot avoid restatement in accordance with HKAS 29 by, for
example, adopting as its functional currency a currency other than the functional currency determined in accordance with HKAS 21 (such as the functional currency of its parent).
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• In its 2005 Interim Report, full set of HKFRS was adopted: – The functional currency of each of the consolidated entities has
been re-evaluated based on the guidance to the revised HKAS 21. • Accounting policy on functional and presentation currency:
– Items included in the financial statements of each of the Group entities are measured using the currency of the primary economic environment in which the entity operates (“the functional currency”).
– The consolidated financial statements are presented in HK dollars, which is the Company’s functional and presentation currency.
CaseCase
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• If Entity A, a HK incorporated company, reports its financial statements in HK$.
• However, its head office is located in HK but only serves for accounting purpose.
• All the other operation, trading and finance souring are located in UK and all the transactions are denominated in UK GBP.
• Which currency is the foreign currency of Entity A under HK SSAP 11 and HKAS 21?
ExampleExample
• Under HK SSAP 11 • The reporting currency is HK$ • The foreign currency is UK GBP
• Under HKAS 21 • The function currency is UK GBP • The foreign currency is HK$
• Under HK SSAP 11 • The reporting currency is HK$ • The foreign currency is UK GBP
• Under HKAS 21 • The function currency is UK GBP • The foreign currency is HK$
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But I am sure, you may not forget ……
Pacific Century Insurance Holdings Ltd.
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Hang Hang Seng Seng BankBank (2004 Annual Report)
• On 1 January 2005, the Group has reclassified most of its Held-to-Maturity debt securities as Available-for-Sale securities.
• The change in fair value will cause volatility to the shareholders' equity.
Why reclassified most?Why reclassified most?
Why volatility to equity?Why volatility to equity?
CaseCase
MeasurementMeasurement
DerecognitionDerecognition
• Extended the scope to all contract to buy and sell of non-financial items that meet the scope.
• All financial instruments, including derivatives, are recognised in the balance sheet (on balance sheet).
• Except for strict conditions are fulfilled, all financial assets are measured at fair value
• Detailed derecognition rules are set out.
Definitions Definitions • Financial instruments, including derivatives,
are clearly defined.
Scope
Scope Scope • Extended the scope to all contract to buy and
sell of non-financial items that meet the scope.
How to capture all derivative contracts? How to capture all
derivative contracts?
Under HKAS 39, contracts to buy or sell a non- financial item can be mainly divided into 2 types: 1. that can be settled
• net in cash or another financial instrument, or
• by exchanging financial instruments
2. that were entered into and continue to be held • for the purpose of the receipt or delivery of a
non-financial item • in accordance with the entity’s expected
purchase, sale or usage requirements
Derivative contracts • as if financial instruments • within scope
Derivative contracts • as if financial instruments • within scope
Usual executory contracts • NOT within scope Usual executory contracts • NOT within scope
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are clearly defined.
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A financial instrument is any contract that gives rise to 1. a financial asset of one entity, and 2. a financial liability or equity instrument
of another equity
A financial instrument is any contract that gives rise to 1. a financial asset of one entity, and 2. a financial liability or equity instrument
of another equity
Financial liability or
⇒ is a financial instrument or other contract within the scope of HKAS 39 with all 3 of the following characteristics: a) its value changes in response to the change in a
specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable (sometimes called the ‘underlying’);
b) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
c) it is settled at a future date.
Value change based on an underlying
Value change based on an underlying
Little or no initial net investment
Little or no initial net investment
Settled at a future date Settled at
a future date
Settled at a future date Settled at
a future date
Equity prices (equity of another entity)Equity Swap
Credit rating, credit index or credit priceCredit Swap
Total fair value of the reference asset and interest ratesTotal Return Swap
Interest ratesPurchased or Written Treasury Bond Option
Equity pricesEquity Forward
Interest ratesInterest Rate Swap
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• All financial instruments, including derivatives, are recognised in the balance sheet (on balance sheet).
Scope
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• An entity shall recognise financial instruments on its balance sheet when and only when the entity becomes a party to the contractual provisions of the instruments
Implies trade date accounting for all cases Only a regular way purchase or sale (e.g. purchase of derivatives is not a regular way of purchase) can be accounted for by • either trade date accounting or settlement date accounting
Initial Recognition
Financial asset
Financial asset
Financial liability
Financial liability
• Thus, an entity recognise all of its contractual rights and obligations under derivatives in its balance sheet as assets and liabilities respectively, examples: – Committing to a purchase of equity securities – Committing to write a derivative option
• Thus, an entity recognise all of its contractual rights and obligations under derivatives in its balance sheet as assets and liabilities respectively, examples: – Committing to a purchase of equity securities – Committing to write a derivative option
Initial Recognition
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• When a financial asset or financial liability is recognised initially, an entity shall measure the financial asset or a financial liability – at its fair value – plus transaction costs (except for those
classified at fair value through profit or loss)
Initial Recognition & Measurement
Financial instrument Financial
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Fair value at Initial Recognition – Low Interest Loan • Entity A grants a 3-year loan of $50,000 to an important new customer • The interest rate on the loan is 4%, while the current market lending
rates for similar loans to customers with a similar credit risk profile is 6% • Entity A believes that the future business to be generated with this new
customer will lead to a profitable lending relationship.
• On initial recognition, Entity A should recognise the carrying amount of the loan at the fair value of the payments that it will receive from the customer.
• Discounting the interest and principal repayments using the market rate of 6%, Entity A will recognise an originated loan of $47,328.
• The difference of $2,672 is expensed immediately as the expectation about future lending relationships does not qualify for recognition as an intangible asset.
• On initial recognition, Entity A should recognise the carrying amount of the loan at the fair value of the payments that it will receive from the customer.
• Discounting the interest and principal repayments using the market rate of 6%, Entity A will recognise an originated loan of $47,328.
• The difference of $2,672 is expensed immediately as the expectation about future lending relationships does not qualify for recognition as an intangible asset.
Initial Recognition & Measurement ExampleExample
financial assets are measured at fair value
4-category classification will affect the subsequent measurement of financial assets (but not the initial measurement).
4-category classification will affect the subsequent measurement of financial assets (but not the initial measurement).
Scope
36
FA at FV through P/L
HTM investments
HTM investments
© 2005-06 Nelson 72
A financial asset that meets either of the following 2 conditions.
a) It is classified as held for trading, if: i) it is acquired/incurred principally for the purpose
of selling or repurchasing it in the near term; ii) there is evidence of a recent actual pattern of short-
term profit-taking on it; or iii) a derivative
(except for a designated and effective hedging instrument)
b) Upon initial recognition it is designated by the entity as at fair value through profit or loss, except for investments in equity instruments that • do not have a quoted market price in
an active market, and • whose fair value cannot be reliably measured.
An entity has NO choice
Definition – for Financial Assets at Fair Value through P/LFA at FV through P/L
Measurement – Classification
© 2005-06 Nelson 73
• Those non-derivative financial assets that are designated as available for sale, or
• Those not classified into other categories • Implies
⇒ Except for those held for trading, all the remaining financial assets can be designated as AFS financial assets
⇒ Loans and receivables and HTM investments can also be initially designated as AFS financial assets
AFS financial assets
through P/L Definition – for Available-for-sale financial assets
In initial recognition, an entity has a choice not to classify any financial assets as • HTM investments or • Loans and receivables
© 2005-06 Nelson 74
HTM investments
HTM investments
All financial assets would be stated at fair value (to be discussed later)
But ……But ……
• Non-derivative financial assets with fixed or determinable payments and fixed maturity
• That the entity has the positive intention and ability to hold to maturity, other than – those initially designated as FA at FV through P/L – those designated as AFS financial assets – those that meet the definition of loans and receivables
Measurement – Classification FA at FV
through P/L Definition
• A debt instrument with a variable interest rate can satisfy the criteria for a HTM investment.
• Equity instruments cannot be HTM investments either – because they have an indefinite life (such as ordinary shares) or – because the amounts the holder may receive can vary in a manner that is
not predetermined (such as for share options, warrants and similar rights).
AFS financial assets for Held-to-Maturity Investments
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An entity shall not classify any financial assets as held to maturity – if the entity has,
• during the current financial year or • during the two preceding financial years, • sold or reclassified more than an insignificant amount of held-to-
maturity investments before maturity (more than insignificant in relation to the total amount of held-to- maturity investments)
Measurement – Classification
The sales or reclassifications are exempted from the above Tainting Rule if they: – are so close to maturity or the financial asset’s call date (for example, less than 3
months before maturity) that changes in the market rate of interest would not have a significant effect on the financial asset’s fair value;
– occur after the entity has collected substantially all of the financial asset’s original principal through scheduled payments or prepayments; or
– are attributable to an isolated event that is beyond the entity's control, is non- recurring and could not have been reasonably anticipated by the entity.
The sales or reclassifications are exempted from the above Tainting Rule if they: – are so close to maturity or the financial asset’s call date (for example, less than 3
months before maturity) that changes in the market rate of interest would not have a significant effect on the financial asset’s fair value;
– occur after the entity has collected substantially all of the financial asset’s original principal through scheduled payments or prepayments; or
– are attributable to an isolated event that is beyond the entity's control, is non- recurring and could not have been reasonably anticipated by the entity.
HTM investments
HTM investments
39
© 2005-06 Nelson 77
Measurement – Classification ExampleExample
Sale of HTM investments • Entity A sells 1,000 bonds from its HTM portfolio with 5,000 bonds on
interim date of 2003 before the bonds will be matured in 2007. • Since Entity A wants to realise the appreciation in market price of the
bonds.
• The disposed bonds would be over an insignificant amount of the whole portfolio and it is not an exemption from Tainting Rule.
• The sale of part of the HTM portfolio “taints” that the entire portfolio and all remaining investments in the HTM category must be reclassified.
• Entity A will be prohibited from classifying any assets as HTM investments for 2 full financial years, until the year of 2006.
• The disposed bonds would be over an insignificant amount of the whole portfolio and it is not an exemption from Tainting Rule.
• The sale of part of the HTM portfolio “taints” that the entire portfolio and all remaining investments in the HTM category must be reclassified.
• Entity A will be prohibited from classifying any assets as HTM investments for 2 full financial years, until the year of 2006.
HTM investments
HTM investments
© 2005-06 Nelson 78
• On 1 January 2005, the Group has reclassified most of its Held-to-Maturity debt securities as Available-for-Sale securities.
• The change in fair value will cause volatility to the shareholders' equity.
It explained why!It explained why!
CaseCase
40
Loans and receivables Loans and receivables
• Non-derivative financial assets with fixed or determinable payments that are not quoted in an active market, other than – those the entity intends to sell immediately or in the near term (which shall
be classified as held for trading) – those initially designated as FA at FV through P/L – those initially designated as AFS financial assets – those for which the holder may not recover substantially all of its the initial
investment, other than because of credit deterioration, which shall be classified as AFS financial assets
• An interest acquired in a pool of assets that are not loans or receivables is not a loan or receivable (for example, an interest in a mutual fund or a similar fund).
• Examples include: loan assets, trade receivables, rental deposits, deposits held by banks ……
Definition
through P/L HTM
investments AFS financial
derivative)?
Upon initial recognition, designated at FA at FV
through P/L?
HTM investments
HTM investments
Has positive intention and ability to hold to maturity and fulfils
tainting rule?
No
May recover substantially all
Subsequent Measurement
at Fair Value
at Fair Value
at Amortised Cost
at Amortised Cost
Except for investments in equity instruments that • do not have a quoted market price in an active
market, and • whose fair value cannot be reliably measuredat Cost
Loans and receivables Loans and receivables
HTM investments
HTM investments
Loans and receivables at amortised cost
Loans and receivables at amortised cost
Upon initial recognition, designated at FA at FV
through P/L?
No
Has positive intention and ability to hold to maturity and fulfils
tainting rule? Yes
May recover substantially all
A Financial Asset
Yes
No
No
Yes
To be discussed later
Has a quote at active market or fair value can be reliably measured?
AFS financial assets at
cost
Yes
No Has a quote at active market or fair value can be reliably measured?
Yes
No
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© 2005-06 Nelson 83
• Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
Active market exists – A financial instrument is regarded as quoted in an active market if quoted
prices are readily and regularly available from an exchange and similar entities.
– The existence of published price quotations in an active market is the best evidence of fair value and when they exist they should be used to measure the financial asset (or financial liability) • For an asset held (or liability to be issued) Current bid price • For an asset to be acquired (liability held) Current ask price • If the current bid and asking prices not available Price of most
recent transaction
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• Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
No active market – An entity establishes fair value by using a valuation technique – To establish what the transaction price would have been on the
measurement date in an arm’s length exchange motivated by normal business considerations
– Valuation techniques include • Using recent arm’s length market transactions between knowledgeable,
willing parties • Discounted cash flow analysis • Option pricing models
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© 2005-06 Nelson 85
• In its 2005 Interim Report, full set of HKFRS was adopted and the report set out that:
– The fair values of quoted investments are based on current bid prices.
– If the market for a financial asset is not active (and for unlisted securities), the Group establishes fair value by using valuation techniques. These include • the use of recent arm’s length transactions, • reference to other instruments that are substantially the same, • discounted cash flow analysis, and • option pricing models refined to reflect the issuer’s specific
circumstances.
CaseCase
At each balance sheet date • assess whether there is any
objective evidence that a financial asset (or group of financial assets) is impaired.
• Conditions must be fulfilled in recognising impairment loss.
at Fair Value
at Fair Value
at Amortised Cost
at Amortised Cost
HTM investments
HTM investments
Measurement – Impairment
• Implicitly, no impairment review is needed as gain or loss on change in fair value is recognised in profit or loss
Outside the scope of HKAS 36
at Fair Value
Loans and receivables
HTM investments
• 2 conditions to effect impairment loss 1. when a decline in its fair value has been
recognised directly in equity and 2. there is objective evidence that it is impaired
• Then, the cumulative loss recognised directly in equity shall be • removed from equity and • recognised in profit or loss even the asset has not been derecognised.
at Fair Value
• Impairment loss is measured as the difference between • the carrying amount of the financial asset, and • the present value of estimated future cash
flows discounted at the current market rate of return for a similar financial asset.
at Cost
• The amount of impairment loss is measured as the difference between – the asset’s carrying amount, and – the present value of estimated future
cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition)
• The carrying amount of the asset shall be reduced either – directly or – through use of an allowance account.
• The amount of the loss shall be recognised in profit or loss.
Impairment (if there is objective evidence)
at Fair Value
at Fair Value
at Amortised Cost
at Amortised Cost
HTM investments
HTM investments
Sequence of Impairment Assessment • First assesses whether objective evidence
of impairment exists – individually for financial assets that are
individually significant, and – individually or collectively for financial assets
that are not individually significant. • If an entity determines that no objective
evidence of impairment exists for an individually assessed financial asset, whether significant or not
– it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment.
• Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment.
Impairment (if there is objective evidence)
at Fair Value
at Fair Value
at Amortised Cost
at Amortised Cost
HTM investments
HTM investments
© 2005-06 Nelson 90
Measurement – Impairment ExampleExample
Impairment Based on Ageing Analysis • Entity A calculates impairment in the unsecured portion of loans and
receivables on the basis of a provision matrix – that specifies fixed provision rates for the number of days a loan has been
classified as non-performing as follows: • 0% if less than 90 days • 20% if 90-180 days • 50% if 181-365 days, and • 100% if more than 365 days
• Can the results be considered to be appropriate for the purpose of calculating the impairment loss on loans and receivables?
Not necessarily. • HKAS 39 requires impairment or bad debt losses to be calculated as
the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the financial instrument’s original effective interest rate.
Not necessarily. • HKAS 39 requires impairment or bad debt losses to be calculated as
the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the financial instrument’s original effective interest rate.
46
© 2005-06 Nelson 91
Measurement – Impairment ExampleExample
Impairment on Portfolio Basis • If one loan in Entity A is impaired but the fair value of another loan in
Entity A is above its amortised cost. • Does HKAS 39 allow non-recognition of the impairment of the first loan?
No. • If an entity knows that an individual financial asset carried at amortised cost
is impaired, HKAS 39 requires that the impairment of that asset should be recognised.
• HKAS 39 states: “the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate”.
• Measurement of impairment on a portfolio basis under HKAS 39 may be applied to groups of small balance items and to financial assets that are individually assessed and found not to be impaired when there is indication of impairment in a group of similar assets and impairment cannot be identified with an individual asset in that group.
No. • If an entity knows that an individual financial asset carried at amortised cost
is impaired, HKAS 39 requires that the impairment of that asset should be recognised.
• HKAS 39 states: “the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate”.
• Measurement of impairment on a portfolio basis under HKAS 39 may be applied to groups of small balance items and to financial assets that are individually assessed and found not to be impaired when there is indication of impairment in a group of similar assets and impairment cannot be identified with an individual asset in that group.
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• The current accounting policy on provisions for bad and doubtful debts is set out in note 3(c) above.
• Note 3(c) states that: – It is the Group’s policy to make provisions for bad and doubtful debts
promptly where required and on a prudent and consistent basis. – There are two basic types of provisions, specific and general, each of
which is considered in terms of the charge and the amount outstanding.
Provisions for bad and doubtful debts
CaseCase
47
• On adoption of HKAS 39, – Impairment provisions for advances assessed individually are calculated
using a discounted cash flow analysis for the impaired advances. – Collective assessment of impairment for individually insignificant items
or items where no impairment has been identified on an individual basis is made using formula-based approaches or statistical methods.
– Impairment provisions for advances will be presented as individually assessed and collectively assessed instead of specific provisions and general provisions.
– There will be no significant change in the net charge for provisions to profit and loss account.
Provisions for bad and doubtful debts
CaseCase
HTM investments
HTM investments
at Amortised Cost
at Amortised Cost
To AFS at Fair Value
To AFS
Reversal
N/A
Related objectively to an event
Related objectively to an event
48
Derecognition
Definitions
Scope
Financial asset
Financial asset
An entity shall derecognise a financial asset when, and only when:
a) the contractual rights to the cash flows from
the financial asset expire; or
b) it transfers the financial asset, and
the transfer qualifies for derecognition
General principles • If passing both Further Tests ⇒ derecognise the asset • If not passing Asset Transfer Test ⇒ not derecognise the asset • If passing the Asset Transfer Test, but
not passing Risk and Reward test ⇒ consider the entity’s control over the asset, and extent of continuing involvement
General principles • If passing both Further Tests ⇒ derecognise the asset • If not passing Asset Transfer Test ⇒ not derecognise the asset • If passing the Asset Transfer Test, but
not passing Risk and Reward test ⇒ consider the entity’s control over the asset, and extent of continuing involvement
Derecognition of Financial Assets
Further Test 2: Risk and Reward Test
49
Has the entity transferred substantially all risks and rewards [Para. 20(a)]Has the entity transferred substantially all risks and rewards [Para. 20(a)]
Has the entity retained substantially all risks and rewards? [Para. 20(b)]Has the entity retained substantially all risks and rewards? [Para. 20(b)]
Derecognise the asset
Yes
No Has the entity retained control of the asset? [Para. 20(c)]Has the entity retained control of the asset? [Para. 20(c)]
No
No
Yes
Consolidate all subsidiaries (including any SPE) [Para. 15]Consolidate all subsidiaries (including any SPE) [Para. 15]
Determine whether the derecognition principles below are applied to a part or all of an asset (or group of similar assets) [Para. 16]
Determine whether the derecognition principles below are applied to a part or all of an asset (or group of similar assets) [Para. 16]
Has the entity transferred its rights to receive the cash flows from the asset? [Para. 18(a)]
Has the entity transferred its rights to receive the cash flows from the asset? [Para. 18(a)]
Have the rights to the cash flows from the asset expired? [Para. 17(a)]Have the rights to the cash flows from the asset expired? [Para. 17(a)]
Has the entity assumed an obligation to pay the cash flows from the asset that meets the conditions in paragraph 19? [Para. 18(b)]
Has the entity assumed an obligation to pay the cash flows from the asset that meets the conditions in paragraph 19? [Para. 18(b)]
Yes
No
No
No
Yes
Continue to recognise the asset to the extent of the entity’s continuing involvement
Continue to recognise the asset to the extent of the entity’s continuing involvement
Yes
Has the entity retained substantially all risks and rewards? [Para. 20(b)]Has the entity retained substantially all risks and rewards? [Para. 20(b)] Continue to recognise the asset
Continue to recognise the asset
Yes
• If a transfer does not result in derecognition because the entity has retained substantially all the risks and rewards of ownership of the transferred asset, the entity shall – continue to recognise the transferred asset in
its entirety – recognise a financial liability for the
consideration received – in subsequent periods, recognise
• any income on the transferred asset and • any expense incurred on the financial liability.
Recognise (create) a financial liability
Recognise (create) a financial liability
Consideration received
For SMEs/SMPs ⇒ say Discounted Bills, Factored Trade Receivables For larger entities ⇒ say Strip and Total return swap
Let’s analyse a bill discounted to bank ⇒ At present, most entities derecognise bill receivable discounted to
bank and disclose it as contingent liability ⇒ Is it appropriate under new derecognition criteria?
Let’s analyse a bill discounted to bank ⇒ At present, most entities derecognise bill receivable discounted to
bank and disclose it as contingent liability ⇒ Is it appropriate under new derecognition criteria?
The contractual rights to receive the asset’s cash flows are transferred
The contractual rights to receive the asset’s cash flows are transferred
If the debtor is default on the payment, the entity has to repay the bank ⇒ risks are retained by the entity
If the debtor is default on the payment, the entity has to repay the bank ⇒ risks are retained by the entity
Continue to recognise the bill receivables, and recognise a financial liability
© 2005-06 Nelson 100
• In its 2005 Interim Report, full set of HKFRS was adopted and the report set out that: – the Group’s discounted bills with recourse,
• which were previously treated as contingent liabilities, • have been accounted for as collateralized bank
advances prospectively on or after 1 January 2005, • as the financial asset derecognition conditions as
stipulated in HKAS 39 have not been fulfilled.
CaseCase
Total advances recognised: HK$ 822M
Current liabilities of that date: 7,578M Net current assets of that date: 1,229M
Total advances recognised: HK$ 822M
Current liabilities of that date: 7,578M Net current assets of that date: 1,229M
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Legend ……
• Its 7-page announcement of 24.1.06 explained that: – “The adoption of, transition to and application of the
requirements of HKAS 39 were new to the Group’s accounting staff ……”
– “This inadvertent error resulted in material misstatements of the Group’s unaudited net profit ……”
– 9-month net profit should be HK$7 million, not previously reported HK$104 million …… overstated over 1,300%
• Puzzle is: – 60-page Interim Report with material misstatements has not
been amended and reissued – Only explained the error by 7-page announcement, but …… – Accounting professors from local university and several
experienced accountants still unable to understand what that 7-page announcement explained
CaseCase
A ShareShare--based payment transaction based payment transaction is
• A transaction in which the entity receives or acquires goods or services
– as consideration for equity instruments of the entity (including shares or share options), or
– by incurring liabilities to the supplier of those good or services for amounts that are based on the price of the entity’s shares or other equity instruments of the entity
→ e.g. Employee share option (ESO)
→ e.g. Share appreciation rights
RecognitionRecognition • In the past, no recognition ⇒ Now, all share-based payment
transactions shall be recognised
MeasurementMeasurement • Using Fair Value measurement basis
– To measure the goods or services received at the fair value of the goods or services received (unless that fair value cannot be estimated reliably)
– To measure by reference to the fair value of the equity instruments granted (if the entity cannot estimate reliably the fair value of the goods or services received)
What is Fair Value of equity instruments, say share options? • Market price, if available • If market price is not available, valuation model (say option
pricing model) can be used to estimate the Fair Value
© 2005-06 Nelson 106
Share-based Payment
a. For transactions with employees and others providing similar services: • To measure by reference to the fair value of the equity instruments
granted (as it is typically not possible to estimate reliably the fair value of employee services received)
• The fair value of the equity instruments granted is measured at grant date
b. For transactions with other: • There is a rebuttable presumption that the fair value of the goods or
services received can be estimated reliably. • The fair value is measured at the date obtaining the goods or services
a. For transactions with employees and others providing similar services: • To measure by reference to the fair value of the equity instruments
granted (as it is typically not possible to estimate reliably the fair value of employee services received)
• The fair value of the equity instruments granted is measured at grant date
b. For transactions with other: • There is a rebuttable presumption that the fair value of the goods or
services received can be estimated reliably. • The fair value is measured at the date obtaining the goods or services
e.g. Employee share option (ESO)
54
Share-based Payment
When the goods or services received or acquired in a share- based transaction do not qualify for recognition as assets, they shall be recognised as expenses
→ e.g. over the vesting period of the share options
© 2005-06 Nelson 108
Share-based Payment
Esprit Holdings LimitedEsprit Holdings Limited • Adopted HK GAAP to 30 June 2003 but begin to adopt all
the new/revised IFRS in 2004 Annual Report, but …… • Only one IFRS not early adopted, IFRS 2 ShareIFRS 2 Share--based based
PaymentPayment
Why?Why?Why? • Its 2005 Annual Report (of 13 Sep. 2005) still stated:
– Management is currently evaluating the most appropriate assumptions and the valuation method that it will use in valuing the Group’s share options and therefore the Board takes the view that • it would be inappropriate to state an estimated
value of such options and the potential financial impact to the Group until IFRS 2 becomes effective for the Group’s annual accounting periods commencing July 1, 2005.
CaseCase
55
Esprit Holdings LimitedEsprit Holdings Limited • However, in its 2006 Interim Report (of 22 Feb. 2006), it has
no choice but state …… – In prior years, no employee benefit cost or obligation was
recognized when employees (which term includes directors) were granted share options by the Group over shares in the Company. When the share options were exercised, equity was increased by the amount of the proceeds received.
– IFRS 2 requires the Group to: • measure the fair value of the share options at the date of
grant and • recognize the amount as an expense over the relevant
period of service (normally the vesting period of the options).
CaseCase A New Expense A New A New
ExpenseExpense
© 2005-06 Nelson 110
Share-based Payment CaseCase
– The effect of the adoption of IFRS 2 on the consolidated income statement for the period is as follows:
For the 6 months ended December 31 2005 2004 HK$’000 HK$’000
Decrease in profit and earnings per share Profit attributable to shareholders 70,400 32,121 Earnings per share
– basic and diluted (HK$ per share) 0.06 0.03
Esprit Holdings LimitedEsprit Holdings Limited • However, in its 2006 Interim Report (of 22 Feb. 2006), it has
no choice but state ……
ExpenseExpense
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Summary of Changes in HKFRS 3
• HSBC adopted UK GAAP previously and proposed to change to IFRS in 2005 • It assessed that the impact of those changes from IFRS 3 would be high • Its US SEC filing (Dec. 2004) further stated that:
– Goodwill recorded at 31 December 2003 …… will be the subject of impairment testing thereafter
– In the event of impairment, the absence of previous amortisation is likely to lead to larger impairment charges than would have been required under UK GAAP
– The cessation of goodwill amortisation will impact the income statement
Comments argued that amendments “introduce more volatility” but also agreed that it can lead to • Greater international applicability • Comparability and reliability • Transparency
CFA Institute Conference Proceedings (2005)
Comments argued that amendments “introduce more volatility” but also agreed that it can lead to • Greater international applicability • Comparability and reliability • Transparency
CFA Institute Conference Proceedings (2005)
CaseCase
57
Summary of Changes in HKFRS 3
Method of accounting Method of accounting
Purchase method in all cases (prohibit uniting of interest or merger)
Purchase method in all cases (prohibit uniting of interest or merger)
Application of method
Application of method
Goodwill (and intangible asset) Goodwill (and
intangible asset) No amortisation and impairment testing only No amortisation and impairment testing only
Reassess and then recognise as a gain in the income statement
Reassess and then recognise as a gain in the income statement
Negative goodwill
Negative goodwill
To specify • the financial reporting by an entity when it
undertakes a business combination
In particular, HKFRS 3 specifies that all business combinations should be accounted for by applying the purchase method
Therefore, the acquirer: a) recognises the acquiree’s identifiable assets,
liabilities and contingent liabilities at their fair values at the acquisition date, and
b) recognises goodwill, which is subsequently tested for impairment rather than amortised
To specify • the financial reporting by an entity when it
undertakes a business combination
In particular, HKFRS 3 specifies that all business combinations should be accounted for by applying the purchase method
Therefore, the acquirer: a) recognises the acquiree’s identifiable assets,
liabilities and contingent liabilities at their fair values at the acquisition date, and
b) recognises goodwill, which is subsequently tested for impairment rather than amortised
DisclosureDisclosure
ScopeScope
58
Scope of HKFRS 3
Entities shall apply HKFRS 3 when accounting for all business combinations, except for business combinations: a) in which separate entities or businesses are brought together to form a
joint venture b) involving entities or businesses under common control c) involving two or more mutual entities d) in which separate entities or businesses are brought together to form a
reporting entity by contract alone without the obtaining of an ownership interest (for example, to form a dual listed corporation)
Common ControlCommon Control
Mutual EntitiesMutual Entities
© 2005-06 Nelson 116
Method of Accounting
• All business combinations shall be accounted for by applying the purchase method.
• Uniting of interest (pooling of interest or merger) method is no longer allowed.
• Purchase method views a business combination from the perspective of the combining entity that is identified as the acquirer.
Method of accounting Method of accounting
Scope
59
Method of accounting
Application of the method
Application of the method (a) Identifying an acquirer(a) Identifying an acquirer
(b) Measuring the cost of the business combination(b) Measuring the cost of the business combination
(c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date
(d) Initial accounting determined provisionally(d) Initial accounting determined provisionally
In addition, how if …..
© 2005-06 Nelson 118
Application of the Method
At the acquisition date, the acquirer shall allocate the cost of a business combination by:
Cost of Business
Combination
• recognising the acquiree’s identifiable assets, liabilities and contingent liabilities that satisfy the recognition criteria at their fair values at that date – except for non-current assets (or disposal groups), that are
classified as held for sale in accordance with HKFRS 5, which shall be recognised at fair value less costs to sell
Identifiable assets,
liabilities and contingent liabilities
Also implies Subsidiary acquired for temporary purpose is also consolidated but, if conditions met, it is valued and presented in accordance with HKFRS 5
60
Any difference between a) the cost of the business combination and b) the acquirer’s interest in the net fair value of the identifiable
assets, liabilities and contingent liabilities so recognised • shall be accounted for as goodwill or negative goodwill
Cost of Business
1. Asset other than an intangible asset
2. Liability other than a contingent liability
• Probable that its future economic benefit will flow in • Its fair value can be measured reliably
• Probable that an outflow of resources with economic benefit will be required to settle the obligation
• Its fair value can be measured reliably
Aligned with HKAS 37Aligned with HKAS 37
Any special?Any special? 3. Contingent liability or intangible asset
• Its fair value can be measured reliably
LiabilitiesLiabilities
• Under HKFRS 3 – the acquirer recognises separately a contingent liability of the
acquiree as part of allocating the cost of a business combination only if • its fair value can be measured reliably.
– After their initial recognition, the acquirer shall measure contingent liabilities that are recognised separately under HKFRS 3 at the higher of: a) the amount that would be recognised in
accordance with HKAS 37, and b) the amount initially recognised less, when
appropriate, cumulative amortisation recognised in accordance with HKAS 18 Revenue.
Contingent liabilitiesContingent liabilities
© 2005-06 Nelson 122
Goodwill acquired in a business combination
• at the acquisition date – shall be recognised as an asset and – initially measured that goodwill at its cost
• after initial recognition – shall be measured at cost less any accumulated impairment losses – shall NOT be amortised – instead, shall be tested for impairment
• annually, • or more frequently if events or changes in
circumstances indicate that it might be impaired in accordance with HKAS 36
Goodwill
• In 2004, as a result of the adoption of IFRS 3, IAS 36 and IAS 38 (equivalent to HKFRS 3, HKAS 36 and HKAS 38) – Depreciation reduced (profit increased) by HK$ 106 million – Trademarks increased by HK$ 86 million (resulted from
IAS 38) – Goodwill arising on the acquisition of Red Earth fully
impaired with a loss of HK$ 15 million
Esprit Holdings LimitedEsprit Holdings Limited
CaseCase
• No such name as “negative goodwill” now
• If there is such excess, the acquirer shall: a) reassess
• the identification and measurement of the acquiree’s identifiable assets, liabilities and contingent liabilities and
• the measurement of the cost of the combination; and b) after that reassessment,
• recognise immediately in profit or loss any such excess remaining (negative goodwill)
• Now termed as “excess of the acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over the cost of a business combination”
• Now termed as “excess of the acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over the cost of a business combination”
For our discussion purpose, Negative Goodwill is still used For our discussion purpose, Negative Goodwill is still used
63
© 2005-06 Nelson 125
Extracted from its 2005 interim report: • The Group’s unaudited profit attributable to shareholders
for the half year amounted to HK$11,824 million, a 10% increase over the HK$10,758 million for the same period last year, which has been restated for the adoption of new HKFRS issued by the HKICPA.
• EPS amounted to HK$2.77, compared to HK$2.52 in the same period last year. • These results include a net profit on revaluation of investment properties of
HK$3,696 million (2004 – Nil) and profits on disposal of investments and others totalling HK$14,900 million (2004 – HK$15,059 million). This profit resulted from two major transactions completed in the first half of this year.
• Firstly, a profit of HK$9,400 million arose from the exercise by the Group of its right to re-purchase from the minority shareholders of 3 UK their 35% interest for £210 million, a substantial discount both to its net asset value and to the £2,100 million paid to the Group by the minority shareholders when they acquired these interests in 2000.
• Secondly, a profit of HK$5,500 million was realised from the disposal for cash of a 20% interest in HK International Terminals and a 10% interest in COSCO-HIT Terminals (HK).
Application of the Method CaseCase
Extracted from its 2005 interim report: • The Group’s unaudited profit attributable to shareholders
for the half year amounted to HK$11,824 million, a 10% increase over the HK$10,758 million for the same period last year, which has been restated for the adoption of new HKFRS issued by the HKICPA.
• EPS amounted to HK$2.77, compared to HK$2.52 in the same period last year. • These results include a net profit on revaluation of investment properties of
HK$3,696 million (2004 – Nil) and profits on disposal of investments and others totalling HK$14,900 million (2004 – HK$15,059 million). This profit resulted from two major transactions completed in the first half of this year.
• Firstly, a profit of HK$9,400 million arose from the exercise by the Group of its right to re-purchase from the minority shareholders of 3 UK their 35% interest for £210 million, a substantial discount both to its net asset value and to the £2,100 million paid to the Group by the minority shareholders when they acquired these interests in 2000.
• Secondly, a profit of HK$5,500 million was realised from the disposal for cash of a 20% interest in HK International Terminals and a 10% interest in COSCO-HIT Terminals (HK).
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6 month ended 30 June 2005
HK$ M Unaudited profit attributable to shareholders 11,824 Net profit on revaluation of investment properties (3,696) Profit on re-purchase from the minority shareholders
of 3 UK their 35% interest (9,400) Profit from disposal of interest in HK International
Terminals and interest in COSCO-HIT Terminals (HK) (5,500)
Loss if without the above “profitable” items (6,772)
What’s it?What’s it?Negative Goodwill Negative Goodwill
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Leases – Possible Impact
In the balance sheet • Prepaid lease payments reclassified and presented as
another non-current asset • Previous revaluation surplus on the land would be de-
recognised • Total assets would be reduced (if used revaluation
before), like HKEx
In the income statement • Depreciation would be affected
Remember its effect to leasehold property, like property “acquired” in HK …...
In the balance sheet • Prepaid lease payments reclassified and presented as
another non-current asset • Previous revaluation surplus on the land would be de-
recognised • Total assets would be reduced (if used revaluation
before), like HKEx
In the income statement • Depreciation would be affected
Remember its effect to leasehold property, like property “acquired” in HK …...
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In the balance sheet • Significant impact on those had owner-

Documents

HKFRS and IFRS Seminar - Nelson CPA