SME FRS and Other Updates 27 November 2014

Transcription

1 SME FRS and Other Updates 27 November 2014 LAM Chi Yuen Nelson 林智遠 MBA MSc BBA ACA ACS CFA CGMA CPA(US) CTA FCCA FCPA FCPA(Aust.) FHKIoD FTIHK MHKSI MSCA 2014 Nelson Consulting Limited 1 Effective for 2015 Dec. Year End Selected new interpretations and amendments to HKFRSs Amendments to HKAS 19 (2011) Employee Benefits Defined Benefit Plans: Employee Contributions Annual Improvements Cycle Annual Improvements Cycle SME FRF and SME FRS (Revised 2014) (pursuant to the New Companies Ordinance (Cap. 622) effective from 3 Mar. 2014) Effective for periods beginning on/after 1 Jul Jul (or other) 1 Jul (or other) 3 Mar (early application not allowed) 2014 Nelson Consulting Limited Updated to HKICPA Update No. 160 of 16 October

2 Effective after 2016 Dec. Year End Selected new interpretations and amendments to HKFRSs Amendments to HKFRS 11: Accounting for Acquisitions of Interests in Joint Operations Amendments to HKAS 16 and HKAS 38: Clarification of Acceptable Methods of Depreciation and Amortisation Amendments to HKAS 16 and HKAS 41: Agriculture: Bearer Plants Amendments to HKAS 27 Equity Method in Separate Financial Statements Amendments to HKFRS 10 and HKAS 28 Sale or Contribution of Assets between an Investor and its Associate or Joint Venture Annual Improvements to HKFRSs Cycle HKFRS 14 Regulatory Deferral Accounts HKFRS 15 Revenue from Contracts with Customers HKFRS 9 (2014) Financial Instruments Effective for periods beginning on/after 1 Jan Jan Jan Jan Jan Jan.2016 (or other) 1 Jan Jan Jan Nelson Consulting Limited Updated to HKICPA Update No. 160 of 16 October Today s Agenda SME FRF and FRS and Relevant Requirements in Co. Ordinance HKFRS 15 Revenue from Contracts with Customers HKFRS 9 Financial Instruments 2014 Nelson Consulting Limited 4 2

3 SME FRF and FRS and Co. Ord. (Cap. 622) 2014 Nelson Consulting Limited 5 Scope HK Incorporated Entity The new HK Companies Ordinance (Cap. 622) ( new CO ) becomes effective on 3 March 2014, contains an optional reporting exemption for certain private companies and companies limited by guarantee which satisfy the conditions set out in section 359 of the new CO. The Small and Medium sized Entity Financial Reporting Framework and Financial Reporting Standard which are effective for annual periods beginning on or after 3 March 2014 (the SME FRF and FRS (2014) ) are the accounting standards issued by the HKICPA that are to be followed in accordance with section 380(4) by those HK incorporated companies which are entitled to, and decide to, take advantage of this reporting exemption in the new CO (SME FRF para. 1) 2014 Nelson Consulting Limited 6 3

4 Scope Non HK Incorporated In accordance with para. 23 of the SME FRF (2014), an entity which is not a company incorporated under either the new CO or the predecessor CO (Cap. 32), subject to any specific requirements imposed by the law of the entity s place of incorporation and subject to its constitution, qualifies for reporting under the SME FRF when the entity meets the same requirements that a HK incorporated entity is required to meet under section 359 of the new CO (SME FRF para. 2) 2014 Nelson Consulting Limited 7 Scope Effective Date Consistent with section 358 of the new CO, this revised SME FRF becomes effective for a Qualifying Entity s financial statements that cover a period beginning on or after 3 March 2014, the commencement date of the new CO Earlier application of this revised SME FRF is not permitted (SME FRF para. 53) 2014 Nelson Consulting Limited 8 4

5 Key Changes from Old SME-FRF and FRS 1. A summary of the criteria for "qualifying entities" with cross-references to the new CO included SME-FRF (2014) Para New specific disclosure requirements to cover the first year that a company transitions from a different GAAP to SME-FRS SME-FRF (2014) Para New guidance on the concept of realized profits and losses SME-FRF (2014) Para New sections to cover business combinations, consolidated financial statements, joint arrangements and associates SME-FRS (2014) Section New guidance on presenting a cash flow statement (optional) SME-FRS (2014) Section Nelson Consulting Limited Adapted from HKICPA s Summary of Main Changes 9 Key Changes from Old SME-FRF and FRS 6. Additional disclosure requirements in the Income Taxes section for disclosure of applicable tax rates and unused tax losses SME-FRS (2014) Section New guidance on determining the "reporting currency (same as functional currency) SME-FRS (2014) Section The definition of "related party" aligned with the definition in full HKFRS SME-FRS (2014) Definitions 9. The definitions of "active market" & "fair value" updated to be consistent with HKFRS 13 SME-FRS (2014) Definitions 10.New guidance on determining whether an entity is acting as an agent or principal SME-FRS (2014) Appendix 1 11.Additional guidance on the non-exempted disclosure requirements in the new CO and certain other provisions SME-FRS (2014) Appendix Nelson Consulting Limited Adapted from HKICPA s Summary of Main Changes 10 5

6 1. Criteria for Qualifying Entities Follows the new CO with some further explanations on Reporting Exemption for easy reference Meeting the size tests in the first year that the new CO applies In accordance with sub section (2) of each of sections 361 to 366 of the new CO (as applicable), the entity will qualify for the reporting exemption for the first financial year beginning on or after 3 March 2014 if it meets the relevant size tests: (a) in that first financial year; and/or (b) in the immediately preceding financial year. If the entity qualifies in the first financial year in accordance with the above, it will continue to qualify until it is disqualified in accordance with sub section (4) (as set out in para. 32 of SME FRS). (SME FRF para. 30) 2014 Nelson Consulting Limited Criteria for Qualifying Entities Meeting the size tests in all subsequent financial years In accordance with sub section (3) of each of ss. 361 to 366 of the new CO (as applicable), an entity which was previously disqualified on the grounds of its size will need to meet the size tests for two consecutive reporting periods, before it will qualify for the reporting exemption in the third reporting period, regardless of its size in that period (SME FRF para. 31) Previously disqualified Meet the size test Can use reporting exemption Nelson Consulting Limited 12 6

7 1. Criteria for Qualifying Entities Meeting the size tests in all subsequent financial years In accordance with sub section (4) of each of ss. 361 to 363, or sub section (5) of each of ss. 364 to 366, of the new CO (as applicable), where an entity has previously qualified for the reporting exemption in terms of its size, Previously qualified the entity will continue to qualify for the reporting exemption even when it no longer meets the relevant size tests, unless the entity has failed the size tests for two consecutive reporting periods it will then fail to qualify for the reporting exemption in the third reporting period, regardless of its size in that period. (SME FRF para. 32) Meet the size test Can use reporting exemption Nelson Consulting Limited Criteria for Qualifying Entities An exception to this two year grace period for losing entitlement is where a new company enters the group. In this case, in accordance with sub section (4) of each of sections 364 to 366 of the new CO (as applicable), if the new subsidiary is such that the group fails the size tests in that year, the group will no longer be eligible for the reporting exemption in the year in which the new company enters the group (SME FRF para. 33) 2014 Nelson Consulting Limited 14 7

8 1. Criteria for Qualifying Entities Company A. A private co. is a small private co., or A private co. is the holding co. of a group of small private companies B. An eligible private co., or An eligible private co. is the holding co. of a group of eligible private companies C. A "small guarantee co., or A guarantee co. is the holding co. of a "group of small guarantee companies" D. Option similar to s. 141D of Cap. 32 S. 359(1)(b) Qualifying Conditions Size test, meeting any 2 of the following: i. Revenue less than $100M, ii. Assets less than $100M, iii. Employee less than 100 Size test, meeting any 2 of the following: i. Revenue less than $200M, ii. Assets less than $200M, iii. Employee less than % members approval without any member objection Size test, revenue less than $25M 2014 Nelson Consulting Limited Criteria for Qualifying Entities Size tests for group of small guarantee companies, small private companies, and eligible private companies each company in the group must meet the size tests; and the aggregate amounts for the group in total must meet the size tests (SME FRF para. 35, 37 ad 39) 2014 Nelson Consulting Limited 16 8

9 1. Criteria for Qualifying Entities Shareholder Approval In accordance with section 360 of the new CO, the shareholder approval requirements for the larger eligible category of private companies or groups are as follows: a) to gain exemption as a larger eligible private company at least 75% of all the members must pass a resolution at a general meeting that the company is to fall within the reporting exemption for the financial year, with none objecting; and b) to gain exemption for a group of larger eligible private companies all the companies in the group individually, as well as the parent of the group, must have obtained the necessary shareholder approval except for those subsidiaries within the group that fall within the small private company category 2014 Nelson Consulting Limited Criteria for Qualifying Entities Shareholder Approval The 75% vote is calculated as a percentage of the entire shareholding of a company, not simply as a percentage of the shareholders who attend the general meeting. The resolution is defeated if any member objects either at the meeting or at any time by giving notice in writing to the company, provided that the written notice is given at least 6 months before the end of the financial year to which the objection relates. (SME FRF para. 42) For s. 359(1)(b) (i.e. new version of s.141d) exemption, in order to qualify it, The company obtain 100% approval from their shareholders each year This approval must be in writing and can only be given for one year at a time (SME FRF para. 43) 2014 Nelson Consulting Limited 18 9

10 2. Transition from Different GAAP The transition from a different GAAP (for example the transition from HKFRS) to the SME FRF and SME FRS is accounted for as follows: a) All items recognised previously under a different GAAP (for example, deferred tax liability) which do not meet the recognition criteria under the SME FRF and SME FRS are to be derecognised and dealt with as a change of accounting policy under section 2 of the SME FRS. b) All items not recognised previously under a different GAAP which meet the recognition criteria under the SME FRF and SME FRS3 are to be recognised in accordance with the relevant section of the SME FRS and dealt with as a change of accounting policy under section 2 of the SME FRS. c) All items recognised previously under a different GAAP, which meet the recognition criteria under the SME FRF and SME FRS, but which were previously measured on a basis inconsistent with the SME FRF and SME FRS (for example, unamortised goodwill) are to be re measured in accordance with the relevant section of the SME FRS and dealt with as a change of accounting policy under section 2 of the SME FRS (SME FRF para. 44) 2014 Nelson Consulting Limited Concept of Realized Profits and Losses New guidance on the concept of realized profits and losses Recognition of an item as income or expense in accordance with the SME FRS does not necessarily result in that item being realized within the meaning of s. 291 of the new CO. Consequently, a profit which is recognised for accounting purposes under the SME FRS may not necessarily be capable of distribution to shareholders by way of a dividend. The concept of realized profits and losses and their relationship to profits and losses as recognised under the SME FRS is dealt with in para. 46 to 52 of the SME FRF (SME FRF para.16) 2014 Nelson Consulting Limited 20 10

11 3. Concept of Realized Profits and Losses S. 297 of the new CO states that a company may only make a distribution out of profits available for distribution and that, for the purposes of this section, a company s profits available for distribution are its accumulated, realized profits, so far as not previously utilized by distribution or capitalization, less its accumulated, realized losses, so far as not previously written off in a reduction or reorganisation of capital. Such distributable profits are to be computed at the company level, irrespective of whether the company prepares consolidated financial statements (SME FRF para.46) 2014 Nelson Consulting Limited Concept of Realized Profits and Losses In accordance with HKICPA s Accounting Bulletin 4 Guidance on the Determination of Realised Profits and Losses in the Context of Distributions under the Hong Kong Companies Ordinance, a profit shall be treated as realised only when realised in the form of: a) cash; or b) other assets, the ultimate cash realisation of which can be assessed with reasonable certainty (SME FRF para.48) Most transactions recognised under the SME FRS in company level financial statements would satisfy this test (SME FRF para.49) However, if the sale was in exchange for an illiquid asset, such as a property, the profit could not be regarded as realized until the property itself was sold in a cash or near cash transaction, because the property would not be regarded as readily convertible to cash without a period of marketing (SME FRF para.50) 2014 Nelson Consulting Limited 22 11

12 3. Concept of Realized Profits and Losses With respect to realized losses, in general, where amounts are charged against profit or loss (and hence recorded in co. level retained earnings), the charge should be regarded as being realized irrespective of whether it arose on re measurement of the carrying value of an asset or liability, or the charge has crystallised, for example on settlement of a law suit Adjustments should not therefore be made to add back any expenses or other charges when computing profits available for distribution for the purposes of s. 291 of the new CO (SME FRF para.51) 2014 Nelson Consulting Limited Concept of Realized Profits and Losses Further guidance on the concept of realized profits and realized losses can be found in Accounting Bulletin 4and etc However, it should be noted that this guidance is primarily intended to address a wide variety of differences between recognition requirements under full HKFRSs and the concept of realized profits or losses (SME FRF para.52) Although the same principles for defining realized profits and losses will apply whether a company follows full HKFRSs or SME FRS in practice as the SME FRS does not permit upwards revaluation of assets and does not contain specific requirements relating to more complex financial instruments,» many of the differences identified in the Bulletin between recognised profits and losses and realized profits and losses will not be applicable to financial statements prepared in accordance with the SME FRS (SME FRF para. 52) 2014 Nelson Consulting Limited 24 12

13 4. New Sections New sections to cover business combinations, consolidated financial statements, joint arrangements and associates Section 18 Section 19 Section 20 Section 21 Business Combinations and Goodwill Consolidated and Company level Financial Statements Investments in Associates Interests in Joint Ventures and Other Forms of Joint Arrangements 2014 Nelson Consulting Limited Section 18 Business Combinations Section 18 is mainly based on HKFRS 3 (2004 version) but simplified and updated with some areas based on HKFRS 3 (2008 version) Apply in accounting for business combinations in a reporting entity s consolidated financial statements (SME FRS 18.1) Also apply in accounting for the acquisition of an unincorporated business in a reporting entity s company level financial statements (SME FRS 18.1) 2014 Nelson Consulting Limited 26 13

14 4. Section 18 Business Combinations Section 18 is mainly based on HKFRS 3 (2004 version) but simplified and updated with some areas based on HKFRS 3 (2008 version) Not required to be applied to business combinations involving entities or businesses under common control Common control combinations should be accounted for in accordance with one of the following methods: (a) (b) merger accounting in accordance with Accounting Guideline 5 Merger accounting for common control combinations; or at book values as stated in the financial statements of the acquired entity or in the consolidated financial statements of the previous parent (SME FRS 18.2) Different from current AG Nelson Consulting Limited Section 18 Business Combinations All business combinations should be accounted for by applying the purchase method (SME FRS 18.3) Applying the purchase method involves the following steps: (a) identifying an acquirer; (b) measuring the cost of the business combination; and (c) allocating, at the acquisition date, the cost of the business combination to the assets acquired and liabilities assumed (SME FRS 18.4) Different from current HKFRS Nelson Consulting Limited 28 14

15 4. Section 18 Business Combinations The acquirer should measure the cost of a business combination as the aggregate of the fair values, at the acquisition date, of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer, in exchange for control of the acquiree (SME FRS 18.8) Other costs attributable to effecting the business combination do not form part of the cost of a business combination should instead be recognised as expenses in the income statement in the periods in which the costs are incurred and the services are received (SME FRS 18.9) Same as current HKFRS Nelson Consulting Limited Section 18 Business Combinations The contingent consideration should include the estimated amount of that adjustment in the cost of the combination at the acquisition date if the adjustment is probable (ie more likely than not) and can be measured reliably (SME FRS 18.10) Different from current HKFRS Nelson Consulting Limited 30 15

16 4. Section 18 Business Combinations The acquirer should recognise separately the acquiree s identifiable assets and, liabilities at the acquisition date only if they satisfy the following criteria at that date: (a) in the case of an asset other than an intangible asset, it is probable that any associated future economic benefits will flow to the acquirer, and its fair value can be measured reliably; (b) in the case of a liability, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and its fair value can be measured reliably; and (c) in the case of an intangible asset, its fair value is readily apparent or otherwise can be measured reliably without undue cost or effort (SME FRS 18.13) Different from current HKFRS Nelson Consulting Limited Section 18 Business Combinations Intangible asset acquired in a business combination Section 4 also states that an intangible asset should be recognised if, and only if: a) in the case of an intangible asset acquired in a business combination, its fair value is readily apparent or otherwise can be measured reliably without undue cost; and b) in all other cases, it is probable that the future economic benefits that are attributable to the asset will flow to the entity and the cost of the asset can be measured reliably (SME FRS 4.2) 2014 Nelson Consulting Limited 32 16

17 4. Section 18 Business Combinations The acquirer should, at the acquisition date: (a) recognise goodwill acquired in a business combination as an asset; and (b) initially measure that goodwill at its cost, being the excess of the cost of the business combination over the acquirer s interest in the net fair value of the identifiable assets and liabilities recognised in accordance with para (SME FRS 18.18) After initial recognition, measure goodwill acquired in a business combination at cost less any accumulated amortisation and any accumulated impairment losses (SME FRS 18.19) A rebuttable presumption that the useful life of goodwill will not exceed 5 years from initial recognition (SME FRS 18.20) Different from current HKFRS 3 Impairment testing in Section Nelson Consulting Limited Section 18 Business Combinations Impairment of goodwill (new section) SME FRS Section 9 provides simplified guidance An impairment loss recognised for goodwill should not be reversed in a subsequent period (SME FRS 9.13) SME FRS Appendix provides guidance on impairment allocation Impairment of assets (amended slightly) An impairment loss should not be reversed unless its fair value is readily apparent or the asset s recoverable amount can otherwise be measured reliably without undue cost. For those assets (if any) which may satisfy this condition, at the end of each reporting period, an entity should assess whether there is any indication that an impairment loss recognised in prior periods for an asset may no longer exist or may have decreased and, if so, estimate the recoverable amount of that asset (SME FRS 9.5) 2014 Nelson Consulting Limited 34 17

18 4. Section 18 Business Combinations Foreign operation Any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation should be treated as assets and liabilities of the foreign operation should be expressed in the reporting currency of the foreign operation and should be translated at the closing rate (SME FRS 15.10) 2014 Nelson Consulting Limited Section 18 Business Combinations Previous business combination an entity that has not previously issued consolidated financial statements should apply Section either: (a) retrospectively to all past business combinations as a change in accounting policy in accordance with Section 2; or (b) as if all the past business combinations that occurred before the beginning of the comparative period had taken place at the beginning of the comparative period. The difference between the consideration transferred and the carrying amounts of assets and liabilities of the business acquired that meet the recognition criteria under the SME FRF and SME FRS at the beginning of the comparative period should be made against the opening balance of retained earnings. Any business combination for which the acquisition date falls between the beginning of the comparative period and the date of the first application of this Section should be accounted for in accordance with this Section. In the case where this option is used, this fact should be disclosed (SME FRS 18.27) 2014 Nelson Consulting Limited 36 18

19 4. Section 19 Consolidated F.S. Section 19 is mainly based on HKAS 27, not HKFRS 10 A subsidiary is an entity that is controlled by the parent. Control (of an entity) is defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities (SME FRS 19.4 and Definitions) Control is presumed to exist when the parent owns, directly or indirectly through subsidiaries, more than half of the voting power of an entity that presumption should be overcome if it can be clearly demonstrated that such ownership does not constitute control (SME FRS 19.5) Different from current HKFRS Nelson Consulting Limited Section 19 Consolidated F.S. An entity which is a parent at the end of the financial year is required to present consolidated financial statements in accordance with the SME FRS except when: (a) it is a wholly owned subsidiary of another entity; or (b) it meets all of the following conditions: i) it is a partially owned subsidiary of another entity; ii) at least 6 months before the end of the financial year, the directors notify the members in writing of the directors' intention not to prepare consolidated financial statements for the financial year, and the notification does not relate to any other financial year; and iii) as at a date falling 3 months before the end of the fin. year, no member has responded to the notification by giving the directors a written request for the preparation of consol. fin. statements for the financial year; or (c) all of its subsidiaries qualify for exclusion from consolid. in accordance with paragraph 19.2 (SME FRS 19.1) Different from current HKFRS 10 but same as s. 379(3) 2014 Nelson Consulting Limited 38 19

20 4. Section 19 Consolidated F.S. If a parent is exempt from preparing consolidated financial statements and does not prepare such financial statements, it should prepare company level financial statements. Company level financial statements are those in which investments in subsidiaries, associates and joint ventures are accounted for using the cost model set out in Section 6. If consolidated financial statements are presented they should include all subsidiaries of the parent, exceptthat one or more subsidiaries may be excluded from consolidation when: (a) their exclusion measured on an aggregate basis is not material to the group as a whole; or (b) their inclusion would involve expense and delay out of proportion to the value to members of the company (SME FRS 19.2) 2014 Nelson Consulting Limited Section 19 Consolidated F.S. A parent may not exclude a subsidiary from consolidation on the grounds of expense and delay out of proportion to the value to members of the company unless the members of the company have been informed in writing about, and do not object to, this exclusion. In order to satisfy this condition: (a) the notification to the members of the company must: (i) state which financial year that the notification relates to (and the notification must not relate to more than one financial year); (ii) specify the subsidiary or subsidiaries proposed to be excluded; and (iii) state the directors reasons for believing that the inclusion of the subsidiary or subsidiaries in the consolidated financial statements may involve expense and delay out of proportion to the value to the shareholders; 2014 Nelson Consulting Limited 40 20

21 4. Section 19 Consolidated F.S. In order to satisfy this condition: (b) in the case of an entity which needs to obtain shareholder approval in accordance with para. 41 to 43 of SME FRF in order to qualify for the reporting exemption, the notification to the members of the co. proposing to exclude one or more subsidiaries from consolidation must be included as part of the notice to obtain the necessary shareholder approvals required to qualify for the reporting exemption and must be subject to the same approval and objection processes as apply to that approval; (c) in all other cases the notification must be sent to the members before the date of approval of the financial statements and must allow the members of the co. a period of no less than one month to raise objections, unless all the members of the co. confirm that such a period is not necessary; and (d) within the time frame allowed in accordance with (b) or (c) no member has indicated to the co. that they disagree with the directors assertion that the inclusion of the subsidiary or subsidiaries would involve expense and delay out of proportion to the value to members of the co. (SME FRS 19.3) 2014 Nelson Consulting Limited Section 19 Consolidated F.S. Consolidation procedures follows HKAS 27, except that On disposal of subsidiary the gain or loss, includes the cumulative amount of any exchange differences that relate to the subsidiary recognised in equity in accordance with Section 15, except when undue cost or effort is needed to arrive at such cumulative amount of exchange difference and disclosure is made in the financial statements for such exclusion on a transaction by transaction basis (SME FRS 19.11) If an entity ceases to be a subsidiary but the investor (former parent) continues to hold some equity shares, the carrying amount of any investment retained in the former subsidiary at the date that the entity ceases to be a subsidiary should be regarded as the cost on initial measurement of an investment (SME FRS 19.12) 2014 Nelson Consulting Limited 42 21

22 4. Section 19 Consolidated F.S. Parent s Company Level Statement of Financial Position In accordance with s. 380(3)(a) and Part 1 of Sch. 4 to the new CO, if a parent company presents consolidated financial statements, it must also include in the notes to the consolidated financial statements: a) a note which contains the parent company s company level statement of financial position in the format in which that statement would have been prepared if the parent company had not been required to prepare consolidated financial statements; and b) a note which discloses the movement in the parent company s reserves. Further notes to the parent company s company level statement of financial position are not required (SME FRS 1.23) 2014 Nelson Consulting Limited Section 20 Associates Section 20 specifies: A reporting entity should make an accounting policy choice between the benchmark treatment and the allowed alternative treatment and apply the policy consistently in accordance with para (SME FRS 20.3) Benchmark Allowed Alternative Cost model, irrespective of company level or consolidated financial statements Equity method for consolidated financial statements; and Cost model for all other cases 2014 Nelson Consulting Limited 44 22

23 4. Section 21 Joint Ventures & Other JA Section 21 states A joint venture Joint Venture is a contractual arrangement whereby two or more parties undertake an economic activity through an entity that is separate from the parties and subject to joint control (SME FRS 21.2) does not include other forms of joint arrangements, Other Joint Arrangements such as an arrangement to use the assets and other resources of the venturers or the joint ownership by the venturers of one or more assets contributed to, or acquired for the purpose of, the joint arrangement, as these do not involve the establishment of an entity that is separate from the venturers themselves (SME FRS 21.3) 2014 Nelson Consulting Limited Section 21 Joint Ventures & Other JA A reporting entity should make an accounting policy choice between the benchmark treatment and the allowed alternative treatment and Joint Venture apply the policy consistently in accordance with paragraphs (SME FRS 21.4) Benchmark Allowed Alternative Cost model, irrespective of company level or consolidated financial statements Equity method for consolidated financial statements; and Cost model for all other cases 2014 Nelson Consulting Limited 46 23

24 4. Section 21 Joint Ventures & Other JA In respect of its interests in these other forms of joint arrangements, a venturer should recognise in its financial statements: (a) its assets and its share of any jointly controlled assets, classified according to the nature of the assets; (b) any liabilities that it has incurred and its share of any liabilities Other Joint incurred jointly with the other Arrangements venturers in relation to the joint arrangement; (c) any income from the sale or use of its share of the output of the joint arrangement, together with its share of any expenses incurred by the joint arrangement; and (d) any expenses that it has incurred in respect of its interest in the joint arrangement (SME FRS 21.3) Similar to current HKFRS Nelson Consulting Limited Cash Flow Statement New guidance on presenting a cash flow statement (optional) In accordance with section 1.1 of the SME FRS, an entity which prepares and presents its financial statements in accordance with the SME FRS is not required to include a cash flow statement in those financial statements However, if an entity voluntarily includes a cash flow statement in those financial statements, then this cash flow statement should be prepared in accordance with the requirements of section 22 of the SME FRS (SME FRS 22.1) 2014 Nelson Consulting Limited 48 24

25 6. Additional Disclosure for Income Taxes Additional disclosure requirements in the Income Taxes Section An entity should disclose: a) the accounting policy adopted for income taxes; and b) major components of tax expense (income); c) the applicable tax rates and jurisdictions in which the tax expense arose; and d) the amount of unused tax losses available to be carried forward against future taxable profits and the expiry dates of those losses (SME FRS 14.9) New New 2014 Nelson Consulting Limited Determining Reporting Currency New guidance on determining the reporting currency Consistent with the definition and guidance in HKAS 21 about functional currency, SME FRS defines: An entity s reporting currency is the currency of the primary economic environment in which the entity operates. SME FRS 15.1 requires: Each entity should identify its reporting currency. SME FRS Section 15 provides other guidance similar to HKAS Nelson Consulting Limited 50 25

26 8. Definition of Related Party Definition of related party aligned with that of full HKFRS A related party is a person or entity that is related to the entity that is preparing its financial statements (the reporting entity ). a) A person or a close member of that person s family is related to a reporting entity if that person: i. has control or joint control over the reporting entity; ii. has significant influence over the reporting entity; or iii. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity. b) An entity is related to a reporting entity if any of the following conditions applies: i. The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others). ii. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member) Nelson Consulting Limited Definition of Related Party Definition of related party aligned with that of full HKFRS A related party is a person or entity that is related to the entity that is preparing its financial statements (the reporting entity ). b) An entity is related to a reporting entity if any of the following conditions applies: iii. Both entities are joint ventures of the same third party. iv. One entity is a joint venture of a third entity and the other entity is an associate of the third entity. v. The entity is a post employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity. vi. The entity is controlled or jointly controlled by a person identified in (a). vii. A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity) Nelson Consulting Limited 52 26

27 9. Active Market and Fair Value Definitions of active market and fair value updated to similar to HKFRS 13 An active market is a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm s length transaction Nelson Consulting Limited New Guidance on Revenue Appendix 1 B20 Determining whether an entity is acting as a principal or as an agent SME FRS Para states that: In an agency relationship, the gross inflows of economic benefits include amounts collected on behalf of the principal and which do not result in increases in equity for the entity. The amounts collected on behalf of the principal are not revenue. Instead, revenue is the amount of commission. Determining whether an entity is acting as a principal or as an agent requires judgement and consideration of all relevant facts and circumstances. An entity is acting as a principal when it has exposure to the significant risks and rewards associated with the sale of goods or the rendering of services Nelson Consulting Limited 54 27

28 10. New Guidance on Revenue Appendix 1 B20 Determining whether an entity is acting as a principal or as an agent Features that indicate that an entity is acting as a principal include: a) the entity has the primary responsibility for providing the goods or services to the customer or for fulfilling the order, for example by being responsible for the acceptability of the products or services ordered or purchased by the customer; b) the entity has inventory risk before or after the customer order, during shipping or on return; c) the entity has latitude in establishing prices, either directly or indirectly, for example by providing additional goods or services; and d) the entity bears the customer s credit risk for the amount receivable from the customer Nelson Consulting Limited New Guidance on Revenue Appendix 1 B20 Determining whether an entity is acting as a principal or as an agent An entity is acting as an agent when it does not have exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. One feature indicating that an entity is acting as an agent is that the amount the entity earns is predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed to the customer Nelson Consulting Limited 56 28

29 11. Guidance on Non-Exempted Disclosure Appendix 1 Section D As explained in para. 21 of the SME FRF, unless specifically exempt from a particular requirement, the financial statements and directors report prepared by a qualifying entity are required to follow the same requirements in the new CO as apply to full financial statements and directors reports. These non exempt disclosure requirements which apply under the new CO are set out below: S. 383: Sch. 4 Part 1.1 Sch. 4 Part 1.2 Sch. 4 Part 1.3 Sch. 4 Part 1.4 S Nelson Consulting Limited Guidance on Non-Exempted Disclosure S. 383 The financial statements must contain the information prescribed by the Regulation about the following matters: (a) directors emoluments (b) directors retirement benefits (c) termination benefits paid to directors (d) loans, quasi loans and other dealings in favour of directors of the company or its holding company (e) material interests of directors in transactions, arrangements or contracts entered into by the company or another company in the same group (f) consideration provided to or receivable by a third party for making available the services of a director In this regard, reference should be made to the Companies (Disclosure of Information about Benefits of Directors) Regulation made under s. 451 & 452(2) for the purposes of s Nelson Consulting Limited 58 29

30 11. Guidance on Non-Exempted Disclosure Sch4 Part 1.1 The financial statements must disclose the aggregate amount of outstanding loans made under the authority of sections 280 and 281. Sch4 Part 1.2 If a company presents consolidated financial statements it must also include in the notes to the consolidated financial statements: a) a note which contains the parent company s company level statement of financial position in the format in which that statement would have been prepared if the parent company had not been required to prepare consolidated financial statements; and b) a note which discloses the movement in the parent company s reserves. Further notes to the parent company s company level statement of financial position are not required Nelson Consulting Limited Guidance on Non-Exempted Disclosure Sch4 Part 1.3 If at the end of the year the company is a subsidiary of another undertaking, it must disclosure particulars relating to that parent undertaking as set out in Sch. 4. Sch4 Part 1.4 The financial statements must state whether they have been prepared in accordance with the applicable accounting standards within the meaning of section 380 of the new CO and, if they have not been so prepared, must state the particulars of, and the reasons for, any material departure from those standards. (NB As stated in paragraph 20 of the SME FRF, the SME FRF and FRS are the applicable accounting standards for the purposes of section 380 for those companies which are entitled to and do take advantage of the reporting exemption) 2014 Nelson Consulting Limited 60 30

31 11. Guidance on Non-Exempted Disclosure S. 387 The statement of financial position must be approved by the directors and must be signed by 2 directors on the directors behalf (unless the company only has one director, in which case the sole director must sign the statement of financial position). The names of the director(s) who signed the statement of financial position must be stated on any statement of financial position laid before the company in general meeting, sent to a member under section 430 or otherwise, circulated, published or issued by the company Nelson Consulting Limited 61 HKFRS 15 Revenue from Contracts with Customers 2014 Nelson Consulting Limited 62 31

32 HKFRS 15 Issued in Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied HKFRS 15 establishes a comprehensive framework for determining whento recognise revenue and how much revenue to recognise. The core principle in that framework is that an entity recognises revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services Under HKFRS 15, an entity applies a 5 step approach in recognising revenue 2014 Nelson Consulting Limited 63 HKFRS 15 Issued in Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price Effective Date An entity shall apply HKFRS 15 for annual reporting periods beginning on or after 1 January Earlier application is permitted. If an entity applies HKFRS 15, it shall disclose that fact. 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited 64 32

33 HKFRS 15 Issued in Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied HKFRS 15 supersedes the following Standards: a. HKAS 11 Construction Contracts b. HKAS 18 Revenue c. HK(IFRIC) Int 13 Customer Loyalty Programmes d. HK(IFRIC) Int 15 Agreements for the Construction of Real Estate e. HK(IFRIC) Int 18 Transfers of Assets from Customers f. HK(SIC) Int 31 Revenue Barter Transactions Involving Advertising Services 2014 Nelson Consulting Limited 65 Contents in HKFRS 15 Issued in Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied A. Objective B. Scope C. Recognition Identifying the contract (Step 1) Identifying performance obligations (Step 2) Satisfaction of performance obligations (Step 5) D. Measurement Determining the transaction price (Step 4) Allocating the transaction price to performance obligations (Step 5) E. Contract costs (not to be discussed today) F. Presentation (not to be discussed today) G. Disclosure (not to be discussed today) 2014 Nelson Consulting Limited 66 33

34 Brief Summary of Changes Existing Practice IFRS 15 Using IAS 11 and 18, IFRIC Int. 13, Using IFRS 15, one standard only 15, and 18, and SIC 31 Inconsistent and diversified practices Risk and reward approach in satisfying recognition Limited guidance on multiple element arrangements, variable consideration, licences and etc. Single and unified 5 step revenue recognition model Control approach in satisfying the performance obligation More guidance on separating elements, allocating the transaction price, licences, and etc. New estimates and judgements required New set of disclosure requirements 2014 Nelson Consulting Limited 67 A. Objective The objective of HKFRS 15 is to establish the principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer (HKFRS 15.1) To meet the objective The core principle of HKFRS 15 is that an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. (HKFRS 15.2) When applying HKFRS 15, an entity shall consider the terms of the contract and all relevant facts and circumstances apply HKFRS 15, including the use of any practical expedients, consistently to contracts with similar characteristics and in similar circumstances. (HKFRS 15.3) 2014 Nelson Consulting Limited 68 34

35 A. Objective HKFRS 15 specifies the accounting for an individual contract with a customer However, as a practical expedient, an entity may apply HKFRS 15 to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying HKFRS 15 to the portfolio would not differ materially from applying HKFRS 15 to the individual contracts (or performance obligations) within that portfolio When accounting for a portfolio, an entity shall use estimates and assumptions that reflect the size and composition of the portfolio. (HKFRS 15.4) 2014 Nelson Consulting Limited 69 B. Scope An entity shall apply HKFRS 15 to all contracts with customers, except the following: lease contracts within the scope of HKAS 17 Leases; insurance contracts within the scope of HKFRS 4 Insurance Contracts; financial instruments and other contractual rights or obligations within the scope of HKFRS 9 Financial Instruments, (or HKAS 39 if HKFRS 9 not yet applied) HKFRS 10 Consolidated Financial Statements, HKFRS 11 Joint Arrangements, HKAS 27 Separate Financial Statements and HKAS 28 Investments in Associates and Joint Ventures; and non monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers For example, HKFRS 15 would not apply to a contract between two oil companies that agree to an exchange of oil to fulfil demand from their customers in different specified locations on a timely basis. (HKFRS15.5) 2014 Nelson Consulting Limited 70 35

36 C. Recognition and D. Measurement 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited 71 C. Recognition 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied Step 1: Identifying the Contract(s) Combination of contracts Contract modifications Step 2: Identifying Performance Obligations Promises in contracts with customers Distinct goods or services Step 5: Satisfaction of performance obligations Performance obligations satisfied over time Performance obligations satisfied at a point in time Measuring progress towards complete satisfaction of a performance obligation 2014 Nelson Consulting Limited 72 36

37 Step 1: Identify the Contract(s) 1. Identify the Contract with a Customer Step 1: Identifying the Contract(s) A contract is an agreement between two or more parties that creates enforceable rights and obligations. The requirements of HKFRS 15 apply to each contract that has been agreed upon with a customer and meets specified criteria. In some cases, HKFRS 15 requires an entity to combine contracts and account for them as one contract. HKFRS 15 also provides requirements for the accounting for contract modifications. (HKFRS 15.IN7) 2014 Nelson Consulting Limited 73 Step 1: Identify the Contract(s) An entity shall account for a contract with a customer that is within the scope of HKFRS 15 only when all of the following criteria (i.e. contract criteria) are met: a. the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; b. the entity can identify each party s rights regarding the goods or services to be transferred; c. the entity can identify the payment terms for the goods or services to be transferred; d. the contract has commercial substance (i.e. the risk, timing or amount of the entity s future cash flows is expected to change as a result of the contract); and 2014 Nelson Consulting Limited 74 37

38 Step 1: Identify the Contract(s) An entity shall account for a contract with a customer that is within the scope of HKFRS 15 only when all of the following criteria (i.e. contract criteria) are met: e. it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see HKFRS 15.52) (HKFRS 15.9) 2014 Nelson Consulting Limited 75 Step 1: Identify the Contract(s) 1. Identify the Contract with a Customer Combination of Contracts Contract Modification An entity shall combine two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met: a. the contracts are negotiated as a package with a single commercial objective; b. the amount of consideration to be paid in one contract depends on the price or performance of the other contract; or c. the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation in accordance with HKFRS (HKFRS 15.17) 2014 Nelson Consulting Limited 76 38

39 Step 1: Identify the Contract(s) 1. Identify the Contract with a Customer Combination of Contracts Contract Modification An entity shall account for a contract modification as a separate contract if both of the following conditions are present: a. the scope of the contract increases because of the addition of promised goods or services that are distinct (in accordance with HKFRS ); and b. the price of the contract increases by Separate Contract an amount of consideration that reflects the entity s stand alone selling prices of the additional promised goods or services and any appropriate adjustments to that price to reflect the circumstances of the particular contract. (HKFRS 15.20) 2014 Nelson Consulting Limited 77 Step 1: Identify the Contract(s) 1. Identify the Contract with a Customer Contract Modification If a contract modification is not accounted for as a separate contract in accordance with HKFRS (as set out in last slide), an entity shall account for the promised goods or services not yet transferred at the date of the contract modification (i.e. the remaining promised goods or services) in whichever of the following ways is applicable: a. as if it were a termination of the existing contract and the creation of a new contract if b. as if it were a part of the existing contract if c. a combination of (a) and (b) Separate Contract New Contract Part of Existing Contract 2014 Nelson Consulting Limited 78 39

40 C. Recognition and D. Measurement 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited 79 Step 2: Identify Performance Obligations 2. Identify the Performance Obligations Performance obligations Step 2: Identifying the Performance Obligations in the Contract A contract includes promises to transfer goods or services to a customer. If those goods or services are distinct, the promises are performance obligations and are accounted for separately A good or service is distinct if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer and the entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. (HKFRS 15.IN7) 2014 Nelson Consulting Limited 80 40

41 Step 2: Identify Performance Obligations At contract inception, an entity shall assess the goods or services promised in a contract with a customer, and identify as a performance obligation each promise to transfer to the customer either: a. a good or service (or a bundle of goods or services) that is distinct; or b. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see HKFRS 15.23) (HKFRS 15.22) HKFRS 15 defines performance obligation as: Performance obligations A promise in a contract with a customer to transfer to the customer either: a. a good or service (or a bundle of goods or services) that is distinct; or b. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer Nelson Consulting Limited 81 Step 2: Identify Performance Obligations A good or service that is promised to a customer is distinct if both of the following criteria are met: a. the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and b. the entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract). (HKFRS 15.27) Performance obligations 2014 Nelson Consulting Limited 82 41

42 Step 2: Identify Performance Obligations If a promised good or service is not distinct, an entity shall combine that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. In some cases, that would result in the entity accounting for all the goods or services promised in a contract as a single performance obligation. (HKFRS 15.30) Performance obligations 2014 Nelson Consulting Limited 83 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Incidental Obligations and Sales Incentives (see more in Step 2) Some companies may not separately recognise revenue for the transfer to the customer of goods or services that some consider to be sales incentives or otherwise incidental or ancillary to the other promised goods or services in the contract. That practice results in a company recognising all of the transaction price as revenue even though it has remaining performance obligations to satisfy. This sometimes occurs in the automotive industry when a manufacturer sells a car along with an incentive such as maintenance that will be provided at a later date. A company will assess whether the promised goods or services arising from incidental obligations and sales incentives are goods or services that are distinct. If the goods or services are distinct, the company will recognise revenue when (or as) each distinct good or service is transferred to the customer Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May

43 C. Recognition and D. Measurement 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited 85 D. Measurement 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations Step 3: Determining the Transaction Prices Variable consideration The existence of a significant financing component in the contract Non cash consideration Consideration payable to a customer Step 4: Allocating the Transaction Price to Performance Obligations Allocation based on stand alone selling prices Allocation of a discount Allocation of variable consideration Changes in the transaction price 2014 Nelson Consulting Limited 86 43

44 Step 3: Determine Transaction Price 3. Determine the Transaction Price Step 3: Determining the Transaction Prices The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer can be a fixed amount of customer consideration, but it may sometimes include variable consideration or consideration in a form other than cash is also adjusted for the effects of the time value of money if the contract includes a significant financing component and for any consideration payable to the customer. (HKFRS 15.IN7) 2014 Nelson Consulting Limited 87 Step 3: Determine Transaction Price 3. Determine the Transaction Price Step 3: Determining the Transaction Prices If the consideration is variable, an entity estimates the amount of consideration to which it will be entitled in exchange for the promised goods or services. The estimated amount of variable consideration will be included in the transaction price only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved. (HKFRS 15.IN7) 2014 Nelson Consulting Limited 88 44

45 Step 3: Determine Transaction Price HKFRS 15 defines transaction price as: The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). To determine the transaction price, an entity shall consider the terms of the contract and its customary business practices. The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.(hkfrs 15.47) 2014 Nelson Consulting Limited 89 Step 3: Determine Transaction Price The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. When determining the transaction price, an entity shall consider the effects of all of the following: a. variable consideration (see HKFRS and 59); b. constraining estimates of variable consideration (see HKFRS ); c. the existence of a significant financing component in the contract (see HKFRS ); d. non cash consideration (see HKFRS ); and e. consideration payable to a customer (see HKFRS ). (HKFRS 15.48) Variable Consideration Constraining Estimates of Variable Con. Significant Financing Component Non cash Consideration Consideration Payable to Customer 2014 Nelson Consulting Limited 90 45

46 Step 3: Determine Transaction Price If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer. (HKFRS 15.50) Variable Consideration 2014 Nelson Consulting Limited 91 Step 3: Determine Transaction Price An entity shall estimate an amount of variable consideration by using either of the following methods, depending on which method the entity expects to better predict the amount of consideration to which it will be entitled: a. The expected value the expected value is the sum of probabilityweighted amounts in a range of possible consideration amounts. An expected value may be an appropriate estimate of the amount of variable consideration if an entity has a large no. of contracts with similar characteristics. Variable Consideration b. The most likely amount the most likely amount is the single most likely amount in a range of possible consideration amounts (i.e. the single most likely outcome of the contract). Expected Value Most Likely Amount The most likely amount may be an appropriate estimate of the amount of variable consideration if the contract has only two possible outcomes (e.g. an entity either achieves a performance bonus or does not). (HKFRS 15.53) 2014 Nelson Consulting Limited 92 46

47 Step 3: Determine Transaction Price An entity shall include in the transaction price some or all of an amount of variable consideration estimated in accordance with HKFRS only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved. (HKFRS 15.56) In assessing such highly probable circumstance, an entity shall consider both the likelihood and the magnitude of the revenue reversal. Constraining Estimates of Variable Con Nelson Consulting Limited 93 Step 3: Determine Transaction Price In determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of money if the timing of payments agreed to by the parties to the contract (either explicitly or implicitly) provides the customer or the entity with a significant benefit of financing the transfer of goods or services to the customer. In those circumstances, the contract contains a significant financing component. A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract, or implied by the payment terms agreed to by the parties to the contract. (HKFRS 15.60) Significant Financing Component 2014 Nelson Consulting Limited 94 47

48 Step 3: Determine Transaction Price As a practical expedient, an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. (HKFRS 15.63) Significant Financing Component 2014 Nelson Consulting Limited 95 Step 3: Determine Transaction Price When adjusting the promised amount of consideration for a significant financing component, an entity shall use the discount rate that would be reflected in a separate financing transaction between the entity and its customer at contract inception. That rate would reflect the credit characteristics of the party receiving financing in the contract, as well as any collateral or security provided by the customer or the entity, including assets transferred in the contract. An entity may be able to determine that rate by identifying the rate that discounts the nominal amount of the promised consideration to the price that the customer would pay in cash for the goods or services when (or as) they transfer to the customer. Significant Financing Component After contract inception, an entity shall not update the discount rate for changes in interest rates or other circumstances (such as a change in the assessment of the customer s credit risk). (HKFRS 15.64) 2014 Nelson Consulting Limited 96 48

49 Step 3: Determine Transaction Price An entity shall present the effects of financing (interest revenue or interest expense) separately from revenue from contracts with customers in the statement of comprehensive income. Interest revenue or interest expense is recognised only to the extent that a contract asset (or receivable) or a contract liability is recognised in accounting for a contract with a customer. (HKFRS 15.65) Significant Financing Component 2014 Nelson Consulting Limited 97 Step 3: Determine Transaction Price To determine the transaction price for contracts in which a customer promises consideration in a form other than cash, an entity shall measure the non cash consideration (or promise of noncash consideration) at fair value. (HKFRS 15.66) If an entity cannot reasonably estimate the fair value of the non cash consideration, the entity shall measure the consideration indirectly by reference to the stand alone selling price of the goods or services promised to the customer (or class of customer) in exchange for the consideration. (HKFRS 15.67) Non cash Consideration Fair Value 2014 Nelson Consulting Limited 98 49

50 Step 3: Determine Transaction Price An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service (as described in HKFRS ) that the customer transfers to the entity. If the consideration payable to a customer includes a variable amount, an entity shall estimate the transaction price (including assessing whether the estimate of variable consideration is constrained) in accordance with HKFRS (HKFRS 15.70) Consideration Payable to Customer 2014 Nelson Consulting Limited 99 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Estimates of Variable Consideration (see more in Step 3) Revenue requirements do not include detailed guidance for measuring the amount of revenue that should be recognised when the consideration is variable If the consideration promised by a customer is variable, a company will estimate it using either the expected value or the most likely amount, depending on which amount better predicts the amount of consideration to which the company will be entitled. Some or all of the estimated amount of variable consideration is included in the transaction price only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May

51 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Significant Financing Components (see more on Step 3) If a customer pays for goods or services in advance or in arrears, some companies may not consider the effects of any financing components in the contract when determining the amount of revenue to be recognised. A company is required to consider the effects of any significant financing components in the determination of the transaction price (and thus the amount of revenue recognised). This may affect long term contracts in which payment by the customer and performance by the company occur at significantly different times Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May C. Recognition and D. Measurement 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited

52 Step 4: Allocate Transaction Price to PO 4. Allocate Transaction Price to Performance Obligations Step 4: Allocating the Transaction Price to Performance Obligations An entity typically allocates the transaction price to each performance obligation on the basis of the relative stand alone selling prices of each distinct good or service promised in the contract. If a stand alone selling price is not observable, an entity estimates it. Sometimes, the transaction price includes a discount or a variable amount of consideration that relates entirely to a part of the contract. HKFRS 15 specify when an entity allocates the discount or variable consideration to one or more, but not all, performance obligations (or distinct goods or services) in the contract. (HKFRS 15.IN7) 2014 Nelson Consulting Limited 103 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) Allocation of a Discount Allocation of Variable Consideration The objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. (HKFRS 15.73) 4. Allocate Transaction Price to Performance Obligations 2014 Nelson Consulting Limited

53 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) Allocation of a Discount Allocation of Variable Consideration 4. Allocate Transaction Price to Performance Obligations To meet the allocation objective, an entity shall allocate the transaction price to each performance obligation identified in the contract on a relative stand alone selling price basis in accordance with HKFRS , except as specified in HKFRS (for allocating discounts) and HKFRS (for allocating consideration that includes variable amounts). (HKFRS 15.74) 2014 Nelson Consulting Limited 105 Step 4: Allocate Transaction Price to PO HKFRS 15 defines stand alone selling price as: The price at which an entity would sell a promised good or service separately to a customer.. Based on Stand alone Selling Price (SASP) To allocate the transaction price to each performance obligation on a relative stand alone selling price basis, an entity shall determine the stand alone selling price at contract inception of the distinct good or service underlying each performance obligation in the contract and allocate the transaction price in proportion to those stand alone selling prices. (HKFRS 15.76) 2014 Nelson Consulting Limited

54 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) The best evidence of a stand alone selling price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. A contractually stated price or a list price for a good or service may be (but shall not be presumed to be) the stand alone selling price of that good or service. (HKFRS 15.77) 2014 Nelson Consulting Limited 107 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) If SASP is not directly observable, an entity shall estimate the SASP at an amount that would result in the allocation of the transaction price meeting the allocation objective in HKFRS When estimating SASP, an entity shall consider all information (including market conditions, entity specific factors and information about the customer or class of customer) that is reasonably available to the entity. In doing so, an entity shall maximise the use of observable inputs and apply estimation methods consistently in similar circumstances. (HKFRS 15.78) 2014 Nelson Consulting Limited

55 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) Suitable methods for estimating SASP of a good or service include (not limited to): a. Adjusted market assessment approach b. Expected cost plus a margin approach c. Residual approach d. Combination of the above 2014 Nelson Consulting Limited 109 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Contingent Revenue Cap (see more in Step 4) Some practices for allocating the transaction price limit the amount of consideration allocated to a satisfied performance obligation to the amount that is not contingent on the satisfaction of performance obligations in the future. That practice is commonly used to account for telecommunications contracts that bundle the sale of a mobile phone with the provision of network services for a specified period (often for one or two years). IFRS 15 does not permit the transaction price to be allocated to performance obligations on a basis that is consistent with the contingent revenue cap. Instead, IFRS 15 requires a company to allocate the transaction price which would be any amount that the customer pays on entering into the contract and the monthly payments for the network services to the mobile phone and the network services on the basis of the relative stand alone selling prices of each item Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May

56 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 No Observable Selling Price (see more in Step 4) For some contracts, revenue requirements preclude a company from recognising revenue on the transfer of a good or service to a customer if there is no observable evidence of the standalone selling prices of each of the goods or services promised in the contract. This often results in the deferral of revenue recognition because revenue could not be recognised when the first of the promised goods or services transfers to the customer. This regularly occurs in the software industry when observable prices are not available for upgrades and additional functionality for computer software. If observable prices of the promised goods or services are not available, a company would allocate the transaction price on the basis of estimated standalone selling prices of those goods or services. The company will recognise revenue as each distinct good or service is transferred to the customer Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May C. Recognition and D. Measurement 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited

57 Step 5: Satisfy Performance Obligations Step 5: Satisfaction of performance obligations A an entity recognises revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer which is when the customer obtains control of that good or service. The amount of revenue recognised is the amount allocated to the satisfied performance obligation. (HKFRS 15.IN7) 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited 113 Step 5: Satisfy Performance Obligations 5. Recognise Revenue When a Performance Obligation is Satisfied Step 5: Satisfaction of performance obligations A performance obligation may be satisfied at a point in time (typically for promises to transfer goods to a customer) or over time (typically for promises to transfer services to a customer). For performance obligations satisfied over time, an entity recognises revenue over time by selecting an appropriate method for measuring the entity s progress towards complete satisfaction of that performance obligation. (HKFRS 15.IN7) 2014 Nelson Consulting Limited

58 Step 5: Satisfy Performance Obligations An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset (HKFRS 15.31) 2014 Nelson Consulting Limited 115 Step 5: Satisfy Performance Obligations For each performance obligation identified in accordance with HKFRS , an entity shall determine at contract inception whether it satisfies the performance obligation over time (in accordance with HKFRS ) or satisfies the performance obligation at a point in time (in accordance with HKFRS 15.38). If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time. (HKFRS 15.32) Over Time At a Point in Time 2014 Nelson Consulting Limited

59 Step 5: Satisfy Performance Obligations Goods and services are assets, even if only momentarily, when they are received and used (as in the case of many services). Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. When evaluating whether a customer obtains control of an asset, an entity shall consider any agreement to repurchase the asset (see HKFRS 15.B64 B76). (HKFRS 15.33) Over Time At a Point in Time 2014 Nelson Consulting Limited 117 Step 5: Satisfy Performance Obligations An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met: Over Time a. the customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs (see HKFRS 15.B3 B4); b. the entity s performance creates or enhances an asset (e.g. work in progress) that the customer controls as the asset is created or enhanced (see HKFRS 15.B5); or c. the entity s performance does not create an asset with an alternative use to the entity (see HKFRS 15.36) and the entity has an enforceable right to payment for performance completed to date (see HKFRS 15.37). (HKFRS 15.35) 2014 Nelson Consulting Limited

60 Step 5: Satisfy Performance Obligations If a performance obligation is not satisfied over time in accordance with HKFRS , an entity satisfies the performance obligation at a point in time. To determine the point in time at which a customer obtains control of a promised asset and the entity satisfies a performance obligation, the entity shall consider the requirements for control in HKFRS (HKFRS 15.38) At a Point in Time 2014 Nelson Consulting Limited 119 Step 5: Satisfy Performance Obligations In addition, an entity shall consider indicators of the transfer of control, which include, but are not limited to, the following: a. The entity has a present right to payment for the asset b. The customer has legal title to the asset c. The entity has transferred physical possession of the asset d. The customer has the significant risks and rewards of ownership of the asset e. The customer has accepted the asset At a Point in Time 2014 Nelson Consulting Limited

61 Step 5: Satisfy Performance Obligations Measuring Progress Towards Complete Satisfaction of a Performance Obligation Measuring Progress For each performance obligation satisfied over time in accordance with HKFRS , an entity shall recognise revenue over time by Over Time measuring the progress towards complete satisfaction of that performance obligation. The objective when measuring progress is to depict an entity s performance in transferring control of goods or services promised to a customer (i.e. the satisfaction of an entity s performance obligation). (HKFRS 15.39) 2014 Nelson Consulting Limited 121 Step 5: Satisfy Performance Obligations Measuring Progress Towards Complete Satisfaction of a Performance Obligation An entity shall apply a single method of measuring progress for each performance obligation satisfied over time and the entity shall apply that method consistently to similar performance obligations and in similar circumstances. At the end of each reporting period, Measuring Progress Over Time an entity shall remeasure its progress towards complete satisfaction of a performance obligation satisfied over time. (HKFRS 15.40) 2014 Nelson Consulting Limited

62 Step 5: Satisfy Performance Obligations Methods for Measuring Progress Measuring Progress Appropriate methods of measuring progress include output methods and input methods (HKFRS 15.B14 B19 provide guidance) In determining the appropriate method for measuring Over Time progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer. (HKFRS 15.41) When applying a method for measuring progress, an entity shall exclude from the measure of progress any goods or services for which the entity does not transfer control to a customer. Conversely, an entity shall include in the measure of progress any goods or services for which the entity does transfer control to a customer when satisfying that performance obligation. (HKFRS 15.42) 2014 Nelson Consulting Limited 123 C. Recognition and D. Measurement 1. Identify the Contract with a Customer 2. Identify the Performance Obligations 3. Determine the Transaction Price 4. Allocate Transaction Price to Performance Obligations When (or as) a performance obligation is satisfied, an entity shall recognise as revenue the amount of the transaction price (which excludes estimates of variable consideration that are constrained in accordance with HKFRS ) that is allocated to that performance obligation. (HKFRS 15.46) 5. Recognise Revenue When a Performance Obligation is Satisfied 2014 Nelson Consulting Limited

63 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Timing of Revenue Recognition (see more in Step 5) Because of a lack of clear and comprehensive guidance, there is some diversity in practice in determining whether a company should recognise revenue for some goods or services at a point in time or over time. Some companies selling residential real estate in multi unit developments have difficulty determining whether the construction of such assets is a service that is provided over time (revenue is recognised over time) or a good that is transferred to the customer when construction is complete (revenue is recognised at that point in time) A company will be able to recognise revenue over time only if the criteria specified in IFRS 15 are met. In all other cases, a company will recognise revenue at the point in time when the customer obtains control of the promised good or service Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Licences The revenue recognition guidance on accounting for licences of intellectual property is broad. Different interpretations of that guidance has led to significant diversity in the accounting for licences. IFRS 15 provides application guidance on how to apply the revenue framework to different types of licences of intellectual property Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May

64 Existing Practice vs HKFRS 15 Existing Practice HKFRS 15 Disclosure Disclosure of information about revenue is inadequate and lacks cohesion with the disclosure of other items in the financial statements. For example, many investors have said that some companies present revenue in isolation, which means that investors cannot relate revenue to the company s financial position. IFRS 15 includes a comprehensive set of disclosure requirements that require a company to disclose qualitative and quantitative information about its contracts with customers to help investors understand the nature, amount, timing and uncertainty of revenue Nelson Consulting Limited Adapted from the IASB s Project Summary issued in May HKFRS 9 Financial Instruments 2014 Nelson Consulting Limited

65 HKFRS 9 Issued in 2014 Effective Date An entity shall apply HKFRS 9 for annual periods beginning on or after 1 January Earlier application is permitted. If an entity elects to apply HKFRS 9 early, it must disclose that fact and apply all of the requirements in HKFRS 9at the same time (but see also paragraphs 7.1.2, and 7.3.2). It shall also, at the same time, apply the amendments in Appendix C. (para ) 2014 Nelson Consulting Limited 129 HKFRS 9 Issued in Objective 2. Scope 3. Recognition and Derecognition 4. Classification 5. Measurement 6. Hedge Accounting 7. Effective Date and Transition Transferred from HKAS 39 Debt instruments can now be measured at fair value through other comprehensive income Initial measurement of trade receivable New impairment requirements Changes mainly on hedge conditions 2014 Nelson Consulting Limited

66 HKFRS 9 Issued in Objective 2. Scope 3. Recognition and Derecognition 4. Classification 5. Measurement 6. Hedge Accounting 7. Effective Date and Transition 2014 Nelson Consulting Limited 131 Chapter 4.1 Classification of FA Unless para of HKFRS 9 (so called fair value option ) applies, an entity shall classify financial assets as subsequently measured at either amortised cost, fair value through other comprehensive income, or fair value through profit or loss on the basis of both: a) the entity s business model for managing the financial assets; and b) the contractual cash flow characteristics of the financial asset. (para ) Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss 2014 Nelson Consulting Limited

67 Chapter 4.1 Classification of FA Determine the category of a financial asset for subsequent measurement Previous Version Choose fair value option (designate at fair value through profit or loss)? Yes No Held within a business model to collect contractual cash flow? No Yes Contractual cash flows are solely principal and interest? Yes No Yes Entitle and elect to present fair value changes in other comprehensive income No Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss 2014 Nelson Consulting Limited 133 Chapter 4.1 Classification of FA Determine the category of a financial asset for subsequent measurement Choose fair value option (designate at fair value through profit or loss)? No Held within a business model to collect contractual cash flow? Yes Contractual cash flows are solely principal and interest? Yes Amortised Cost Yes No No Held within a business model to collect contractual cash flow and for sale? Yes Contractual cash flows are solely principal and interest? Yes Yes Fair Value Through Other Comprehensive income No No Entitle and elect to present fair value changes in other comprehensive income No Fair Value Through Profit or Loss 2014 Nelson Consulting Limited

68 Chapter 4.1 Classification of FA 2014 Nelson Consulting Limited Adapted from the IASB s Project Summary issued in July Chapter 4.1 Classification of FA A financial asset shall be measured at fair value through other comprehensive income if both of the following conditions are met: a. the financial asset is held within a business model whose objective is achieved by both Held within a business model to collect contractual cash flow and for sale? collecting contractual cash flows and selling financial assets, and b. the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Para. B4.1.1 B provide guidance on how to apply these conditions. (para A) Fair Value Through Other Comprehensive income 2014 Nelson Consulting Limited

69 Chapter 4.1 Classification of FA For the purpose of applying para (b) and 4.1.2A(b): a. principal is the fair value of the financial asset at initial recognition. Para. B4.1.7B provides additional guidance on the meaning of principal. b. interest consists of consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs, as well as a profit margin. (Para. B4.1.7A and B4.1.9A B4.1.9E provide additional guidance on the meaning of interest) (para ) Contractual cash flows are solely principal and interest? Contractual cash flows are solely principal and interest? Yes Yes Amortised Cost Fair Value Through Other Comprehensive income 2014 Nelson Consulting Limited 137 HKFRS 9 Issued in Objective 2. Scope 3. Recognition and Derecognition 4. Classification 5. Measurement 6. Hedge Accounting 7. Effective Date and Transition 2014 Nelson Consulting Limited

70 Chapter 5 Measurement Initial measurement Except for trade receivables within the scope of para , at initial recognition, an entity shall measure a financial asset or financial liability at its fair value Initial Measurement Fair Value + Transaction Cost plus or minus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. (para ) However, if the fair value of the financial asset or financial liability at initial recognition differs from the transaction price, an entity shall apply para. B5.1.2A. (para A) 2014 Nelson Consulting Limited 139 Chapter 5 Measurement Subsequent Measurement of Financial Assets After initial recognition, an entity shall measure a financial asset in accordance with para at: a. amortised cost; b. fair value through other comprehensive income; or c. fair value through profit or loss. (para ) Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss 2014 Nelson Consulting Limited

71 Chapter 5 Measurement Subsequent Measurement of Financial Assets An entity shall apply the impairment requirements in Section 5.5 to financial assets that are measured at amortised cost in accordance with para and to financial assets that are measured at fair value through other comprehensive income in accordance with para A. (para ) New Impairment Requirements Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss 2014 Nelson Consulting Limited 141 Chapter 5 Measurement Subsequent Measurement of Financial Assets An entity shall apply the hedge accounting requirements in para (and, if applicable, para of HKAS 39 for the fair value hedge accounting for a portfolio hedge of interest rate risk) to a financial asset that is designated as a hedged item. (para ) Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss 2014 Nelson Consulting Limited

72 Chapter 5 Measurement Amortised Cost Measurement on Financial Assets Interest revenue shall be calculated by using the effective interest method (see Appendix A and para. B5.4.1 B5.4.7). This shall be calculated by applying the effective interest rate to the gross carrying amount of a financial asset except for: a. purchased or originated credit impaired financial assets For those financial assets, the entity shall apply the creditadjusted effective interest rate to the amortised cost of the financial asset from initial recognition. b. financial assets that are not purchased or originated credit impaired financial assets but subsequently have become credit impaired financial assets For those financial assets, the entity shall apply the effective interest rate to the amortised cost of the financial asset in subsequent reporting periods. (para ) 2014 Nelson Consulting Limited 143 Yes Chapter 5 Measurement Is the financial instrument a purchased or originated creditimpaired financial asset? No Is the simplified approach for trade receivables, contract assets and lease receivables applicable? No Does the financial instrument have low credit risk at the reporting date? No Has there been a significant increase in credit risk since initial recognition? Yes Yes No Yes Is the low credit risk simplification applied? No Calculate a credit adjusted effective interest rate, and Always recognise a loss allowance for changes in lifetime expected credit losses Yes Recognise 12 month expected credit losses, and Calculate interest revenue on gross carrying amount Recognise lifetime expected credit losses No Is the financial instrument a credit impaired financial asset? Yes Calculate interest revenue on Calculate interest revenue on the gross carrying amount amortised cost 2014 Nelson Consulting Limited Adapted from the flowchart after IFRS 9.IE

73 Chapter 5 Measurement Amortised Cost Measurement on Financial Assets Write off An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write off constitutes a derecognition event (see para. B3.2.16(r)).. (para ) 2014 Nelson Consulting Limited 145 Chapter 5.5 Impairment Topics Covered 1. Recognition of Expected Credit Losses General approach Determining significant increases in credit risk Modified financial assets Purchased or originated creditimpaired financial assets 2. Simplified Approach for Trade Receivables, Contract Assets and Lease Receivables 3. Measurement of Expected Credit Losses 2014 Nelson Consulting Limited

74 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach An entity shall recognise a loss allowance for expected credit losses on a financial asset that is measured in accordance with para or 4.1.2A, a lease receivable, a contract asset or a loan commitment and a financial guarantee contract to which the impairment requirements apply in accordance with para. 2.1(g), 4.2.1(c) or 4.2.1(d). (para ) HKFRS 9defines expected credit losses as: The weighted average of credit losses with the respective risks of a default occurring as the weights Nelson Consulting Limited 147 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach HKFRS 9defines credit losses as: The difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. all cash shortfalls), discounted at the original effective interest rate (or credit adjusted effective interest rate for purchased or originated credit impaired financial assets) Nelson Consulting Limited

75 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach HKFRS 9 defines credit losses as: An entity shall estimate cash flows by considering all contractual terms of the financial instrument (for example, prepayment, extension, call and similar options) through the expected life of that financial instrument. The cash flows that are considered shall include cash flows from the sale of collateral held or other credit enhancements that are integral to the contractual terms. There is a presumption that the expected life of a financial instrument can be estimated reliably. However, in those rare cases when it is not possible to reliably estimate the expected life of a financial instrument, the entity shall use the remaining contractual term of the financial instrument Nelson Consulting Limited 149 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach HKFRS 9defines Lifetime expected credit losses as: The expected credit losses that result from all possible default events over the expected life of a financial instrument. 12 month expected credit losses as: The portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date Nelson Consulting Limited

76 Chapter 5.5 Impairment Initial recognition Credit risk increases significantly Credit impaired 2014 Nelson Consulting Limited Adapted from the IASB s Project Summary issued in July Chapter 5.5 Impairment Performing Underperforming Non Performing 2014 Nelson Consulting Limited Adapted from the IASB s Project Summary issued in July

77 Yes Chapter 5.5 Impairment Calculate a credit adjusted effective Is the financial instrument a purchased or originated creditimpaired financial asset? No Is the simplified approach for trade receivables, contract assets and lease receivables applicable? No Does the financial instrument have low credit risk at the reporting date? No Has there been a significant increase in credit risk since initial recognition? Yes Yes No Yes Is the low credit risk simplification applied? No interest rate, and Always recognise a loss allowance for changes in lifetime expected credit losses Yes Recognise 12 month expected credit losses, and Calculate interest revenue on gross carrying amount Recognise lifetime expected credit losses No Is the financial instrument a credit impaired financial asset? Yes Calculate interest revenue on Calculate interest revenue on the gross carrying amount amortised cost 2014 Nelson Consulting Limited Adapted from the flowchart after IFRS 9.IE Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach An entity shall apply the impairment requirements for the recognition and measurement of a loss allowance for financial assets that are measured at fair value through other comprehensive income in accordance with para A. However, the loss allowance shall be recognised in other comprehensive income and shall not reduce the carrying amount of the financial asset in the statement of financial position. (para ) Fair Value Through Other Comprehensive income 2014 Nelson Consulting Limited

78 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach Subject to para , at each reporting date, an entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition. (para ) The objective of the impairment requirements is to recognise lifetime expected credit losses for all financial instruments for which there have been significant increases in credit risk since initial recognition whether assessed on an individual or collective basis considering all reasonable and supportable information, including that which is forward looking. (para ) 2014 Nelson Consulting Limited 155 Yes Chapter 5.5 Impairment Is the financial instrument a purchased or originated creditimpaired financial asset? No Is the simplified approach for trade receivables, contract assets and lease receivables applicable? No Does the financial instrument have low credit risk at the reporting date? No Has there been a significant increase in credit risk since initial recognition? Yes Recognise lifetime expected credit losses No Is the financial instrument a credit impaired financial asset? Yes Calculate interest revenue on Calculate interest revenue on the gross carrying amount amortised cost 2014 Nelson Consulting Limited Adapted from the flowchart after IFRS 9.IE

79 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach Subject to para , if, at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, an entity shall measure the loss allowance for that financial instrument at an amount equal to 12 month expected credit losses. (para ) For loan commitments and financial guarantee contracts, the date that the entity becomes a party to the irrevocable commitment shall be considered to be the date of initial recognition for the purposes of applying the impairment requirements. (para ) 2014 Nelson Consulting Limited 157 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach If an entity has measured the loss allowance for a financial instrument at an amount equal to lifetime expected credit losses in the previous reporting period, but determines at the current reporting date that para is no longer met, the entity shall measure the loss allowance at an amount equal to 12 month expected credit losses at the current reporting date. (para.5.5.7) An entity shall recognise in profit or loss, as an impairment gain or loss, the amount of expected credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognised in accordance with HKFRS 9. (para ) 2014 Nelson Consulting Limited

80 Chapter 5.5 Impairment Is the financial instrument a purchased or originated creditimpaired financial asset? No Is the simplified approach for trade receivables, contract assets and lease receivables applicable? No Does the financial instrument have low credit risk at the reporting date? No Has there been a significant increase in credit risk since initial recognition? No Yes Is the low credit risk simplification applied? No Yes Recognise 12 month expected credit losses, and Calculate interest revenue on gross carrying amount 2014 Nelson Consulting Limited Adapted from the flowchart after IFRS 9.IE Chapter 5.5 Impairment Example Entity A originates a single 10 year amortising loan for $1 million. Taking into consideration the expectations for instruments with similar credit risk (using reasonable and supportable information that is available without undue cost or effort), the credit risk of the borrower, and the economic outlook for the next 12 months, Entity A estimates that the loan at initial recognition has a probability of default (PD) of 0.5 per cent over the next 12 months. Entity A also determines that changes in the 12 month PD are a reasonable approximation of the changes in the lifetime PD for determining whether there has been a significant increase in credit risk since initial recognition Nelson Consulting Limited

81 Chapter 5.5 Impairment Example At the reporting date (which is before payment on the loan is due), there has been no change in the 12 month PD and Entity A determines that there was no significant increase in credit risk since initial recognition. Entity A determines that 25 per cent of the gross carrying amount will be lost if the loan defaults (i.e. the LGD is 25 per cent). Entity A measures the loss allowance at an amount equal to 12 month expected credit losses using the 12 month PD of 0.5 per cent. Implicit in that calculation is the 99.5 per cent probability that there is no default. At the reporting date the loss allowance for the 12 month expected credit losses is $1,250 (0.5% 25% $1,000,000) Nelson Consulting Limited 161 Chapter 5.5 Impairment Recognition of Expected Credit Losses Determining Significant Increases in Credit Risk At each reporting date, an entity shall assess whether the credit risk on a financial instrument has increased significantly since initial recognition. When making the assessment, an entity shall use the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses Nelson Consulting Limited

82 Chapter 5.5 Impairment Recognition of Expected Credit Losses Determining Significant Increases in Credit Risk An entity may assume that the credit risk on a financial instrument has not increased significantly since initial recognition if the financial instrument is determined to have low credit risk at the reporting date (see para. B B5.5.24). (para ) 2014 Nelson Consulting Limited 163 Chapter 5.5 Impairment Recognition of Expected Credit Losses Modified Financial Assets If the contractual cash flows on a financial asset have been renegotiated or modified and the financial asset was not derecognised, an entity shall assess whether there has been a significant increase in the credit risk of the financial instrument in accordance with para by comparing: a. the risk of a default occurring at the reporting date (based on the modified contractual terms); and b. the risk of a default occurring at initial recognition (based on the original, unmodified contractual terms). (para ) 2014 Nelson Consulting Limited

83 Chapter 5.5 Impairment Recognition of Expected Credit Losses Purchased or Originated Credit Impaired Financial Assets Despite para and 5.5.5, at the reporting date, an entity shall only recognise the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance for purchased or originated credit impaired financial assets. (para ) At each reporting date, an entity shall recognise in profit or loss the amount of the change in lifetime expected credit losses as an impairment gain or loss. An entity shall recognise favourable changes in lifetime expected credit losses as an impairment gain, even if the lifetime expected credit losses are less than the amount of expected credit losses that were included in the estimated cash flows on initial recognition. (para ) 2014 Nelson Consulting Limited 165 Chapter 5.5 Impairment Calculate a credit adjusted effective Is the financial instrument a purchased or originated creditimpaired financial asset? Yes interest rate, and Always recognise a loss allowance for changes in lifetime expected credit losses 2014 Nelson Consulting Limited Adapted from the flowchart after IFRS 9.IE

84 Chapter 5.5 Impairment Simplified Approach for Trade Receivables, Contract Assets and Lease Receivables Despite para & 5.5.5, an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for: a. trade receivables or contract assets that result from transactions that are within the scope of HKFRS 15, and that: i. do not contain a significant financing component (or when the entity applies the practical expedient for contracts that are one year or less) in accordance with HKFRS 15; or ii. contain a significant financing component in accordance with HKFRS 15, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or contract assets but may be applied separately to trade receivables and contract assets Nelson Consulting Limited 167 Chapter 5.5 Impairment Simplified Approach for Trade Receivables, Contract Assets and Lease Receivables Despite para & 5.5.5, an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for: b. lease receivables that result from transactions that are within the scope of HKAS 17, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables. (para ) An entity may select its accounting policy for trade receivables, lease receivables and contract assets independently of each other. (para ) 2014 Nelson Consulting Limited

85 Yes Chapter 5.5 Impairment Is the financial instrument a purchased or originated creditimpaired financial asset? No Is the simplified approach for trade receivables, contract assets and lease receivables applicable? Recognise lifetime expected credit losses No Is the financial instrument a credit impaired financial asset? Yes Calculate interest revenue on Calculate interest revenue on the gross carrying amount amortised cost 2014 Nelson Consulting Limited Adapted from the flowchart after IFRS 9.IE Chapter 5.5 Impairment Measurement of Expected Credit Losses An entity shall measure expected credit losses of a financial instrument in a way that reflects: a. an unbiased and probability weighted amount that is determined by evaluating a range of possible outcomes; b. the time value of money; and c. reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions. (para ) 2014 Nelson Consulting Limited

86 Chapter 5.7 Gains and Losses A gain or loss on a financial asset or financial liability that is measured at fair value shall be recognised in profit or loss unless: a. it is part of a hedging relationship (see para and, if applicable, para of HKAS 39 for the fair value hedge accounting for a portfolio hedge of interest rate risk); b. it is an investment in an equity instrument and the entity has elected to present gains and losses on that investment in OCI in accordance with para ; c. it is a financial liability designated as at fair value through profit or loss and the entity is required to present the effects of changes in the liability s credit risk in other comprehensive income in accordance with para ; or d. it is a financial asset measured at fair value through OCI in accordance with para A and the entity is required to recognise some changes in fair value in OCI in accordance with para (para ) Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss 2014 Nelson Consulting Limited 171 Chapter 6 Hedge Accounting More principles based to align hedge accounting more closely with risk management Conditions for hedge accounting rewritten Hedge effectiveness assessment is forward looking only and no arbitrary bright line effectiveness range, Credit risk is not expected to dominate the value change in the hedge relationship No changes on 3 types of hedging accounting, fair value, cash flow and net investment hedge 2014 Nelson Consulting Limited

87 Hedging Hedge Accounting Conditions Hedging Instrument Hedging Relationship Hedged Item HKFRS 9 has a choice for an entity to use the hegding model in HKFRS 9 or HKAS 39 HKFRS 9 retains the mechanics of 3 types of hedge accounting Conditions for Hedge Accounting Fair Value Hedge A Hedging Relationship qualifies for Hedge Accounting if and only if all the Conditions for Hedge Accounting are met Cash Flow Hedge Hedge of Net Investment in a Foreign Operation 2014 Nelson Consulting Limited 173 Hedging Hedge Accounting Conditions HKFRS 9 revises the conditions Hedging relationship The hedging relationship consists only of eligible hedging instruments and eligible hedged items Formal documentation at inception Meets all hedge effectiveness requirements At the inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the entity s risk management objective and strategy for undertaking the hedge That documentation shall include identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the entity will assess whether the hedging relationship meets the hedge effectiveness requirements (including its analysis of the sources of hedge ineffectiveness and how it determines the hedge ratio) 2014 Nelson Consulting Limited