Module A Financial Reporting

Transcription

1 DECEMBER 2014 AND JUNE 2015 SUPPLEMENT Qualification Programme Module A Financial Reporting

2 Published by BPP Learning Media Ltd. The copyright in this publication is jointly owned by BPP Learning Media Ltd and HKICPA. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means or stored in any retrieval system, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the copyright owners. HKICPA and BPP Learning Media Ltd 2014 ii

3 Changes at a glance Changes at a glance Amended on Learning Pack and Flashcards Chapter Name Supplement Page Part A: Identified Errata Learning Pack 1 Legal environment 1 Part B: Technical Updates Learning Pack 1 Legal environment 2 2 Financial reporting framework 2 3 Small company reporting 5 5 Property, plant and equipment 8 6 Investment property 8 8 Intangible assets and impairment of assets 9 9 Leases Provisions, contingent liabilities and contingent assets Construction contracts Share-based payment Revenue Employee benefits Financial instruments Related party disclosures Earnings per share Operating segments Principles of consolidation Consolidation of foreign operations 25 Flashcards 2 Financial reporting framework 29 3 Small company reporting 29 8 Intangible assets and impairment of assets Financial instruments Related party disclosures Operating segments 30 iii

4 Financial Reporting Reminder of the examination cut-off rule HKICPA operates a cut-off rule whereby students will only be examined on standards and legislation that had been released on or before 31 May each year. The same examinable contents applies to the December session of 2014 and the June session of Examinable contents are applicable to both module and final examinations. In determining what is examinable, reference must be made to both the release date of the pronouncements (or the enactment date of the legislation) and their corresponding effective date. Legislation and the Institute's pronouncements that meet the following conditions will be examined: Condition 1: Have been released/enacted six months prior to the reference date of 1 December 2014 (cut-off being 31 May 2014) AND Condition 2: Have been effective/will be effective on or before the 13th month from the reference date i.e. 1 January Examinable standards You will find a list of the standards that are examinable in your examination session by logging onto the HKICPA online QP Learning Centre. iv

5 Introduction Introduction This Supplement has been produced for those candidates preparing for the December 2014 and June 2015 examination sessions of the HKICPA Qualification Programme. It is designed to be used in conjunction with the fourth edition of the Learning Pack, and it will bring you fully up to date for developments that have occurred in the period since publication of the Learning Pack and 31 May 2014, the cut-off date for examinable standards and legislation for the December 2014 and June 2015 examinations. The Supplement comprises a technical update on developments that will be examinable in December 2014 and June 2015 examination sessions that are not currently covered in the Learning Pack. The topics covered are listed on the contents page, and again are covered in chapter order. In each case the text in the Supplement explains how the Learning Pack is affected by the change, for example whether the new material should be read in addition to the current material in the Learning Pack, or whether the new material should be regarded as a replacement. Good luck with your studies! v

6 vi Financial Reporting

7 December 2014 and June 2015 Supplement Part A: Identified Errata Learning Pack Chapter 1 Section 1.3 Page 10 Section Page 13 Section Page 16 Section Page 17 Legal environment The following typos should be corrected: Second line of (c) in middle of page: 'director' should be 'directors' Third bullet of (b) at foot of page: 'educing' should be 'reducing' Second line of (c) at foot of page: a closing bracket should be inserted after 'reporting' (i.e. those that do not qualify for simplified reporting) The following typo should be corrected: Third bullet of (c) at top of page: 'roper' should 'proper' The following typo should be corrected: First line of second paragraph: 'Land Office' should be 'Lands Office' The following typo should be corrected: First line of section 3.4.1: 'Where new auditors are to be appointed ' 1

8 Financial Reporting Part B: Technical Update Learning Pack Chapter 1 Section 1.2 Page 7 Section Page 12 Legal environment Replace the first paragraph of the section with the following: Companies are established under the provisions of the Companies Ordinance (Chapter 32 of the Law of Hong Kong). A company operates under an agreement between subscribers or shareholders. It is common to also have articles of association for a company, which are more detailed rules and regulations regarding meetings, resolutions and activities of the company. Replace the fourth paragraph of section (a) with the following: Directors must agree not to fetter their discretion. As the powers delegated to the directors are held in trust for them by the company, they must not restrict their exercise of future discretion. Chapter 2 Section Page 28 New section 15 Financial reporting framework Additional bullet point in left hand column of table, first row (after 'asset management') Providing credit rating services Insert the following text as a new section 15 after the existing section on management commentary: 15 Integrated Reporting In recent years users of financial statements have become increasingly interested not only in the financial performance of a company, but also in the social, environmental and ethical performance. Understanding a company's approach to corporate social responsibility is relevant to these users because they want assurance that the company that they have invested in or have dealings with complies with legal requirements, ethical standards and other international norms. Furthermore, investors and other parties increasingly expect companies to actively engage in actions that have a positive impact on the environment, consumers, communities, employees and other stakeholders. Integrated reporting is the latest development in corporate social responsibility reporting Development of integrated reporting Initially reporting on corporate social responsibility took the form of environmental and social reports. Environmental reports detail the effect, both positive and negative, on the environment of a company's operations, such as levels of waste and pollution, and recycling levels. Social reports detail the impact of a business on society, for example through social networks, the effect of business methods on health and human rights and employment policies. 2

9 December 2014 and June 2015 Supplement More recently the concept of social and environmental reporting expanded to form sustainability reporting. This incorporates the wider issue of sustainability in an environmental, social and ethical context. It addresses the issue of whether a business can meet the needs of the present world without compromising the ability of future generations to meet their own needs. For example, a company which uses renewable energy or recycled products is contributing to environmental sustainability Sustainability reporting in Hong Kong In August 2012, the HKEx issued its Environmental, Social and Governance (ESG) Reporting Guide and announced that it would make sustainability reporting 'recommended best practice' for listed companies for reporting periods ending on or after 31 December Companies following the Guide provide disclosures on workplace quality, environmental protection, operating practices and community involvement. Subject to consultation, the HKEx is likely to increase the obligation level of certain ESG disclosures to 'comply or explain' by More recent developments The most recent development in corporate social responsibility reporting is the emergence of integrated reporting. This links environmental, social and sustainability issues to financial strategy and results. It is sometimes referred to as 'triple bottom line reporting' i.e. reporting on 'profit, the planet and people' (financial, environmental and social issues). An integrated report is described by the International Integrated Reporting Council (the IIRC) as 'a concise communication about how an organisation's strategy, governance, performance and prospects, in the context of its external environment, leads to the creation of value in the short, medium and long term.' 15.2 Drivers of integrated reporting Demand from stakeholders has accelerated the development of integrated reporting. In particular, stakeholders are concerned with how a business is operating in a sustainable way. There are three key reasons for this: (1) Social, environmental and ethical considerations are a key part of the investment decision for many investors, with ethical investment growing in popularity. (2) The ethical performance of a company also impacts on business relationships; for example, a reporting entity may not wish to be associated with a supplier whose ethical stance does not fit with its own. (3) Environmental and ethical issues in particular represent a source of risk to a company with possible financial implications Benefits of integrated reporting Integrated reporting has benefits for both the reporting entity and investors. From the reporting entity's perspective, integrated reporting provides a reporting environment that is conducive to understanding and implementing their strategy. This helps to drive internal performance and attract capital. Specific benefits include: 3

10 Financial Reporting Better stakeholder relations Lower operational and strategic risk Enhanced reputation and a stronger brand Customer loyalty Improved access to capital at a lower cost Reduced regulatory intervention New business opportunities Opportunities for business alliances From an investor's perspective, integrated reporting makes the connections between strategy, governance, performance and prospects and as a result investors can assess more effectively the combined impact of diverse factors Integrated reporting framework The IIRC issues the Integrated Reporting Framework (the IR Framework) in December 2013, with the intention that this is used to accelerate the adoption of integrated reporting globally. Currently integrated reporting is adopted by certain entities on a voluntary basis. Most of those entities that have adopted this form of reporting are large multinational corporations and are taking part in the IIRC s pilot programme. This programme is running until September Companies taking part in it include PepsiCo, Unilever, HSBC and CLP Holdings Limited of China. The IR Framework includes two sections: Part 1 provides guidance on using the Framework and the fundamental concepts of integrated reporting. Part 2 discusses guiding principles and content elements related to the preparation and presentation of an integrated report Fundamental concepts The fundamental concepts of integrated reporting are: Value creation for the organisation and others The capitals (resources and the relationships used and affected by the organisation) The value creation process (the linkage between business model and ability to create value) Guiding principles Seven guiding principles underlie the preparation and presentation of an integrated report: (1) Strategic focus and future orientation (2) Connectivity of information (3) Stakeholder relationships (4) Materiality (5) Conciseness (6) Reliability and completeness (7) Consistency and comparability 4

11 December 2014 and June 2015 Supplement Content elements An integrated report must include the following eight key content elements: (1) Organisational overview and external environment (2) Governance (3) Business model (4) Risks and opportunities (5) Strategy and resource allocation (6) Performance (7) Outlook (8) Basis of preparation and presentation Existing section 15.1 (will be section 16.1) Page 60 Replace the last paragraph of section 15.1 with the following: Subsequent to the completion of phase 1 of the project in 2010, remaining work was deferred. In late 2012, however, the project was reactivated as an IASB-only project. A Conceptual Framework discussion paper was issued in 2013 to obtain feedback from constituents on the remaining phases of the project before the development of an exposure draft (expected in 2014). In particular the discussion paper suggests: Improvements to the existing definitions of assets and liabilities and additional guidance to support those definitions Improvements to the guidance on when assets and liabilities should be recognised New Guidance on when assets and liabilities should be derecognised Guidance to assist standard setters in selecting the most appropriate measurement basis for an asset or liability Increased disclosure of information about different classes of equity Principles to assist standard setters in deciding which items of income and expense should be recognised in profit or loss, and which should be recognised in other comprehensive income, and when items of other comprehensive income should be reclassified to profit or loss The development of disclosure concepts for the Conceptual Framework Chapter 3 Section and Page Small company reporting Replace section and with the following: Qualifying Hong Kong Companies A company incorporated under the Hong Kong Companies Ordinance qualifies for reporting under the SME-FRF and SME-FRS if it satisfies the reporting exemption criteria set out in section 359 of the new Companies Ordinance. The qualifying categories are: A private company that is not a member of a group Any size 100% written approval from shareholders is required each year 5

12 Financial Reporting Small private company A group of small private companies Small company limited by guarantee Group of small companies limited by guarantee Larger eligible private company Group of eligible companies Must not exceed two of: Total annual revenue of HK$100m Total assets of HK$100m at the reporting date 100 employees Each company in the group must qualify as a small private company and the aggregate amounts for the group must not exceed 2 of 3 of the size tests for small private companies Total annual revenue no more than HK$25m Each company in the group must qualify as a small private company limited by guarantee and the aggregate annual revenue must not exceed HK$25m Must not exceed two of: Total annual revenue of HK$200m Total assets of HK$200m at the reporting date 100 employees Each company in the group must qualify as a small private company or eligible larger company and the aggregate amounts for the group must not exceed 2 of 3 of the size tests for larger eligible private companies No shareholder approval is required No shareholder approval is required No member approval is required No member approval required 75% shareholder approval required with no objections The parent and all of the subsidiaries that are not small private companies must have obtained the relevant shareholder approval Where size limits apply, in general a company will be required to pass the size tests for two consecutive years before becoming eligible in the third year. Similarly a company would have to fail the tests for two consecutive years in order to become ineligible in the third year. 6

13 December 2014 and June 2015 Supplement The following types of company are not eligible for the reporting exemption and may not apply the SME-FRF and SME-FRS: (a) Companies that are authorised under the Banking Ordinance to carry out banking business (b) Companies that accept, by way of trade or business (other than banking business), loans of money at interest or repayable at a premium other than on terms involving the issue of debentures or other securities (c) Companies that are licensed under Part V of the Securities and Futures Ordinance to carry on a regulated business (d) Companies that carry on an insurance business, other than solely as an agent In addition, groups that contain such companies are not eligible for the reporting exemption and cannot apply the SME-FRF and SME-FRS in the preparation of their consolidated financial statements. Section Page 69 Section 3.2 Page 71 Replace the existing section with the following: Overseas companies Subject to any specific requirements imposed by the law of the company's place of incorporation and subject to its constitution, overseas companies qualify for reporting under the SME-FRF and SME-FRS when they meet the same requirements that a Hong Kong company is required to meet. Replace the existing section 3.2 with the following: Section 3.2 The requirements of the SME-FRF and SME-FRS The SME-FRF and SME-FRS are a briefer and simpler set of accounting rules than full HKFRS. They provide an accruals base framework in which the use of fair value for re-measuring assets or liabilities is not allowed. Disclosure requirements focus on basic financial information. If the SME-FRS does not cover an event or transaction, management are required to apply judgment in order to develop an accounting policy consistent with the historical cost convention. There is no requirement to fall back to full HKFRS. The SME-FRF and SME-FRS were first issued in 2005 and have been revised in 2014 as a result of the new Companies Ordinance. Key areas in which the SME-FRS differs from full HKFRS include the following: (a) There is no requirement to provide a statement of cash flows; however guidance is provided for its preparation should an entity choose to do so. (SME-FRS para 1.1) (b) Changes in equity may be disclosed in a note rather than in a separate primary statement. (SME-FRS para 1.32) (c) Leasehold interests in land from the Government of the HKSAR, or elsewhere with similar features, are accounted for as property, plant and equipment. (SME-FRS para 3.13) 7

14 Financial Reporting (d) There is no separate category of 'investment property'. Instead, the definition of property, plant and equipment includes properties held for rental purposes or investment potential. (SME-FRS para 3.1) (e) The recognition of deferred tax is prohibited. Instead the only tax expense recognised is that calculated based on profits assessed for tax purposes for the period, i.e. as is payable to the taxation authorities in respect of that period. (SME-FRS para 14.6) (f) Only investments in securities are covered; these are carried at historical cost (less impairment). (SME-FRS paras 6.1 & 6.7) (g) Entities can choose whether or not to use a discounting technique in the impairment test. (SME-FRS para 9.8) (h) There is no specific section of the SME-FRS dealing with share-based payments or employee benefits, nor lease accounting for lessors. Chapter 5 Section Page 106 Section 1.10 Page 118 Property, plant and equipment Add the following text immediately under the heading 'Small separate assets', before the existing text. Although HKAS 16 provides criteria that must be met in order for an item of property, plant or equipment to be recognised as an asset, it does not prescribe a unit of measurement for recognition i.e. what value an item should have in order to be recognised as an asset rather than expensed. Replace the existing text with the following: 1.10 Current developments The IASB issued Clarification of Acceptable Methods of Depreciation and Amortisation (Amendments to IAS 16 and IAS 38) in May This is to be adopted by HKICPA and so result in amendments to HKAS 16 and HKAS 38. The amendments clarify that depreciation methods must reflect a pattern of consumption of economic benefits from an asset rather than a pattern of generation of economic benefits by an asset. Therefore a revenue-based method of depreciation is not allowed. A revenue-based method of depreciation is a method whereby the depreciation charge in a given year is calculated based on the revenue earned in that year as a proportion of total revenues expected to be generated by the asset over its useful life. Chapter 6 Section 1.1 Page 126 Investment property Immediately before self-test question 1 add the following text: Use of judgment HKAS 40 is clear that judgment should be applied in order to determine whether a property is an investment property. Judgment should also be used to determine whether the acquisition of an investment property is the acquisition of an asset/group of assets or a business combination within the scope of HKFRS 3. In order to determine this, the guidance in both HKAS 40 and HKFRS 3 should be applied. 8

15 December 2014 and June 2015 Supplement Chapter 8 Section 2.10 Page 160 Section Page 166 Section 4.5 Page 166 Section 4.8 Page 171 Section 4.13 Page 180 Intangible assets and impairment of assets Replace the existing text with the following: 1.10 Current developments The IASB issued Clarification of Acceptable Methods of Depreciation and Amortisation (Amendments to IAS 16 and IAS 38) in May This is to be adopted by HKICPA and so result in amendments to HKAS 16 and HKAS 38. The amendments clarify that amortisation methods must reflect a pattern of consumption of economic benefits from an asset rather than a pattern of generation of economic benefits by an asset. Therefore a revenue-based method of amortisation is not allowed. A revenue-based method of amortisation is a method whereby the amortisation charge in a given year is calculated based on the revenue earned in that year as a proportion of total revenues expected to be generated by the asset over its useful life. Additional points under the heading (b) Internal sources of information (vi) There is a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss flowing from the asset. (vii) There are operating losses or net cash outflows for the asset when current period amounts are aggregated with budgeted amounts for the future. Add the following text immediately before the heading Fair value less costs to sell Note that where either fair value less costs to sell or value in use exceed an asset's carrying amount, the asset is not impaired and it is not necessary to estimate the other amount. Add the following text to the introduction. The final sentence of the existing introduction is included for clarity: If it is not possible to calculate the recoverable amount for an individual asset, the recoverable amount of the asset's cash generating unit should be measured instead, unless: (a) The asset's fair value less costs to sell is higher than its carrying amount, or (b) The asset's value in use can be estimated to be close to its fair value less costs to sell and fair value less costs to sell can be measured. Replace points (e) and (f) with the following text: (e) The recoverable amount of the asset (cash-generating unit) and whether the recoverable amount of the asset (cash-generating unit) is its fair value less costs to sell or its value in use. (f) If the recoverable amount is fair value less costs to sell, the entity should disclose the following information: (i) The level of the HKFRS 13 fair value hierarchy within which the fair value measurement of the asset (or CGU) is categorised in its entirety (without taking into account whether the costs to sell are observable). 9

16 Financial Reporting (ii) For fair value measurements categorised within Levels 2 and 3 of the fair value hierarchy, a description of the valuation technique(s) used to measure fair value less costs to sell. If there has been a change in valuation technique, the entity should disclose that change and the reasons for making it. (iii) For fair value measurements categorised within Levels 2 and 3 of the fair value hierarchy, each key assumption on which management has based its determination of fair value less costs to sell. Key assumptions are those to which the asset's (CGU's) recoverable amount is most sensitive. The entity should also disclose the discount rate used in the current measurement and previous measurement if fair value less costs to sell is measured using a present value technique. Section 4.14 Page 180 Ignore this section as amendments to HKAS 36 have now been made and are reflected in changes to the Learning Pack made above. Chapter 9 Section 7 Page 209 Leases Replace the text in section 7 under the heading Current Developments with the following: In August 2010, the IASB and American standards board, FASB, issued an Exposure Draft of a new standard on leases with the intention of replacing IAS 17. A revised exposure draft was issued in May It is highly likely that such a new standard will in turn be adopted by the HKICPA and so replace HKAS 17. The 2010 and 2013 Exposure Drafts both propose that there is no distinction between operating and finance leases, and instead all leases are accounted for in the same way. In the lessee's accounts, for all leases lasting more than one year a lease liability and a right-of-use asset would be recognised, initially measured at the present value of fixed lease payments during the noncancellable period. The recognition of lease expenses and cash flows would depend on whether the underlying asset is consumed by the lessee. Type A leases would be those where the underlying asset is consumed by the lessee (e.g. motor vehicles and equipment); Type B leases would be those where not more than an insignificant amount of the underlying asset is consumed by the lessee (e.g. property). Expenses and cash flows would be recognised as follows: Statement of profit or loss Statement of cash flows TYPE A LEASES Amortisation and interest Principal paid and interest paid TYPE B LEASES Single lease expense Total cash paid From a lessor perspective, leases are classified as type A or Type B and accounted for as follows: 10

17 December 2014 and June 2015 Supplement Statement of financial position Statement of profit or loss TYPE A LEASES The asset is derecognised and instead a lease receivable is recognised together with a residual asset (a retained interest in the underlying asset) Profit on the lease at the start of the lease is recognised together with interest income TYPE B LEASES The asset continues to be recognised Rental income is recognised The 2013 exposure draft is currently being redeliberated. Chapter 11 Section 5 Page 240 Provisions, contingent liabilities and contingent assets Replace the last paragraph of this section with the following: The project was deferred in 2010 and added to the IASB's research programme in The issues have been considered in conjunction with the Conceptual Framework work on elements and measurement (see Chapter 2, section 16.1 above). The IASB intends to discuss how IAS 37 (HKAS 37) could be replaced or revised in 2015 in the light of likely revisions to the Conceptual Framework. Chapter 12 Section 3 Page 260 Construction contracts Replace the text in section 3 under the heading Current Developments with the following: The IASB issued IFRS 15 Revenue from Contracts with Customers in May The new standard replaces IAS 11 and IAS 18; HKICPA will adopt the new standard as HKFRS 15 and it will replace HKAS 11 and HKAS 18 in due course. The new standard is considered in more detail in Chapter 14. Chapter 13 Section 1.3 Page 269 Section 1.3 Page 269 Share-based payment Replace the definition of vesting conditions with the following: A vesting condition is a condition that determines whether the entity receives the services that entitle the counterparty to receive cash, other assets or equity instruments of the entity under a share-based payment arrangement. A vesting condition is either a service condition or a performance condition. Add the following definitions: A service condition is a vesting condition that requires the counterparty to complete a specified period of service during which services are provided to the entity. If the counterparty, regardless of the reason, ceases to provide service during the vesting period, it has failed to satisfy the condition. A service condition does not require a performance target to be met. 11

18 Financial Reporting A performance condition is a vesting condition that requires: (a) The counterparty to complete a specified period of service (i.e. a service condition); the service requirement can be explicit or implicit; and (b) Specified performance targets to be met while the counterparty is rendering the service required in (a). The period of achieving the performance target(s): (a) Shall not extend beyond the end of the service period; and (b) May start before the service period on the condition that the commencement date of the performance target is not substantially before the commencement of the service period. A performance target is defined by reference to: (a) The entity's own operations (or activities) or the operations or activities of another entity in the same group (i.e. a non-market condition); or (b) The price (or value) of the entity's equity instruments or the equity instruments of another entity in the same group (including shares and share options) (i.e. a market condition). A performance target might relate either to the performance of the entity as a whole or to some part of the entity (or part of the group), such as a division or an individual employee. A market condition is a performance condition upon which the exercise price, vesting or exercisability of an equity instrument depends that is related to the market price (or value) of the entity's equity instruments (or the equity instruments of another entity in the same group) such as: (a) Attaining a specified share price or a specified amount of intrinsic value of a share option; or (b) Achieving a specified target that is based on the market price (or value) of the entity's equity instruments (or the equity instruments of another entity in the same group) relative to an index of market prices of equity instruments in other entities. A market condition requires the counterparty to complete a specified period of service (i.e. a service condition); the service condition can be explicit or implicit. Section Page 271 Add the following text as a new fourth paragraph immediately before the sentence 'On the vesting date the entity should revise the estimate to equal the number of equity instruments that actually vest': When estimating the number of equity instruments that are expected to vest, all service conditions and performance conditions other than market conditions should be taken into account. Market performance conditions (i.e. conditions related to share price) are not considered when estimating the number of equity instruments expected to vest as they are instead taken into account when determining the fair value of the equity instrument at the grant date. 12

19 December 2014 and June 2015 Supplement Chapter 14 Section 4 Page 312 Revenue Replace the text within section 4 under the heading Current Developments with the following: The IASB issued IFRS 15 Revenue from Contracts with Customers in May 2014; this standard replaces both IAS 11 and IAS 18 as well as IFRIC 13, IFRIC 15, IFRIC 18 and SIC 31. When adopted by HKICPA as HKFRS 15, the new standard will replace HKAS 11 and HKAS 18, together with the relevant Hong Kong interpretations. The new standard takes a five step approach to revenue recognition: (1) Identify a contract with a customer. (2) Identify separate performance obligations in the contract (such that if more than one good or service is promised, each is accounted for separately only if it could be sold separately or the customer could benefit from the good or service either alone or together with resources which are readily available). (3) Determine the 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. (4) Allocate the transaction price to the separate performance obligations in proportion to the standalone selling price of the goods or services underlying each performance obligation. (5) Recognise revenue when (or as) the entity satisfies a performance obligation. The standard also addresses the accounting treatment of the costs of obtaining a contract with a customer. It states that the costs of fulfilling a contract which are not eligible for capitalisation in accordance with another standard are capitalised only if they: Relate directly to a contract Generate or enhance resources which will be used to satisfy future performance obligations, and Are expected to be recovered. For many companies this new approach will not result in a significant change to the amount or timing of revenue recognised. In other cases there will be a change, for example, when a mobile phone contract is sold and a handset is provided free of charge, the standard would now require separate up front recognition of revenue relating to the handset. Chapter 16 Section 5 Page 372 Employee benefits Add a new section 5.9 between the existing 5.8 Further issues the asset ceiling and 5.9 Summary of accounting treatment 5.9 Further issues employee contributions Where employees make contributions to defined benefit plans, the accounting treatment of the contributions depends on whether they are discretionary or required by the plan and whether they are linked to service or not. Employee contributions are not linked to service when they are required to reduce a deficit in the plan. 13

20 Financial Reporting If employee contributions are discretionary, they reduce service cost for the entity. If employee contributions are required by the formal terms of the plan: If they are linked to service, they reduce service cost for the entity If they are not linked to service, they affect remeasurements of the net defined benefit liability/asset Where contributions from employees are set out in the formal terms of the plan and they are linked to service, the timing of recognition of the contributions is dependent on whether the amount of contribution is related to the number of years of service. The amount of contribution is not related to the number of years of service where it is a fixed amount, a fixed percentage of salary or dependent on the employee's age. If the amount of contribution is related to the number of years of service, the contribution is attributed to the periods of service. If the amount of contribution is not related to the number of years of service it may be recognised as a reduction of the service cost in the period in which the related service is rendered. The following diagram provided in Appendix A of HKAS 19 summarises the varying treatments: Contributions from employees or third parties Set out in the terms of the plan (or arise from a constructive obligation that goes beyond those terms) Dependent on number of years of service Linked to service Independent of number of years of service Reduce service cost by being attributed to periods of service Reduce service cost in the period in which the related service is rendered Not linked to service (e.g. to reduce a deficit) Affect remeasurements Discretionary Reduce service cost upon payment to the plan Section 7 Page 375 Ignore this section as the proposal has now been issued as an amendment to HKAS 19 and is reflected in the changes to the chapter above. 14

21 December 2014 and June 2015 Supplement Chapter 18 Section Page 402 Financial instruments Replace the existing text after Self-test question 3 with the following: At maturity a compound instrument may be redeemed or converted. Where the instrument is redeemed for cash, the liability element of the instrument is derecognised and cash payment recognised; where the instrument is converted, the liability element is derecognised and instead recognised as equity. The original equity element of the instrument remains within equity, however may be transferred to a different account within equity. Convertible instruments which are not compound instruments Certain types of convertible debt instrument meet the definition of a financial liability and therefore are not compound instruments and do not require the splitaccounting approach described above. As we have seen the definition of a financial liability includes a contract that will or may be settled in the entity's own equity instruments and is a: (i) Non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own equity instruments (ii) Derivative that will or may be settled other than by the exchange of a fixed amount of cash or other financial asset for a fixed number of the entity's own equity instruments. Where the 'fixed for fixed test' described in (ii) is failed, i.e. a fixed amount of cash (or other financial asset) is not exchanged for a fixed number of equity instruments, the convertible debt instrument is classified as a liability in its entirety. The 'fixed for fixed' test is always failed in the following circumstances, and may be failed in others: Where the conversion ratio changes based on the issuing entity's share price, since the number of equity instruments issued on conversion is not fixed Where the convertible debt instrument is denominated in a foreign currency, since the amount of cash exchanged for shares on conversion is not fixed in the functional currency of the issuing entity Where the conversion option is not classified as equity it is an embedded derivative. Although the convertible instrument is classified in its entirety as a liability, it is therefore made up of two liability elements: (i) A financial liability host instrument (ii) A financial liability embedded derivative The accounting treatment applied to embedded derivatives and their host instruments is considered in more detail in section 5 of this chapter. Section Page 410 Replace the existing text within section with the following (the example should be retained): Where a financial asset is measured at fair value, the gain or loss resulting from remeasurement at each reporting date is recognised in profit or loss unless: (a) It is part of a hedging relationship (see section 6) (b) It is an investment in an equity instrument and the entity has made an irrevocable election to present gains and losses on that investment in other comprehensive income 15

22 Financial Reporting Section Page 414 New section 4.4 Page 414 Replace the first paragraph with the following: A financial liability which is held for trading and classified as fair value through profit or loss is remeasured to fair value each year in accordance with HKFRS 13 with any gain or loss recognised in profit or loss unless it is part of a hedging relationship (see section 6). Insert the following text as a new section 4.4 before the existing section Measurement of financial instruments at fair value HKFRS 13 Fair Value Measurement was issued in 2011 and must be applied when measuring financial instruments that HKFRS 9 requires to be measured at fair value Determining fair value basic principles HKFRS 13 defines fair value as 'the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date'. This is an exit price i.e. the price to dispose of a financial instrument rather than acquire one. Fair value is a market-based measurement, not an entity-specific measurement and it takes into account market conditions at the measurement date. Because it is a market-based measurement, fair value is measured using the assumptions that market participants would use when pricing an asset, taking into account any relevant characteristics of that asset. It is assumed that the transaction to sell the asset or transfer the liability takes place either: (a) In the principal market for the asset or liability; or (b) In the absence of a principle market, in the most advantageous market for the asset or liability. The principal market is the market which is the most liquid (has the greatest volume and level of activity) for that asset or liability. In most cases the principal market and the most advantageous market will be the same. Fair value is not adjusted for transaction costs. Under HKFRS 13, these are not a feature of the asset or liability, but may be taken into account when determining the most advantageous market Valuation techniques In order to determine the fair value of a financial instrument, a valuation technique must be applied. Approaches to the valuation of financial instruments may include: (a) Income approaches. Valuation techniques that convert future amounts (e.g. cash flows or income and expenses) to a single current (i.e. discounted) amount. The fair value measurement is determined on the basis of the value indicated by current market expectations about those future amounts. (b) Market approaches. Valuation techniques that use prices and other relevant information generated by market transactions involving identical or comparable (i.e. similar) assets, liabilities or a group of assets and liabilities, such as a business. 16

23 December 2014 and June 2015 Supplement (c) Cost approaches. Valuation techniques that reflect the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost). HKFRS 13 does not require the use of a specific valuation technique, nor does it provide a hierarchy of techniques, however in given circumstances it accepts that one technique may be more appropriate than another. Entities may use more than one valuation technique to measure fair value in a given situation. A change of valuation technique is considered to be a change of accounting estimate in accordance with HKAS 8, and must be disclosed in the financial statements Inputs to valuation techniques HKFRS 13 states that valuation techniques applied must be those which are appropriate and for which sufficient data are available. Entities should maximise the use of relevant observable inputs and minimise the use of unobservable inputs. The standard contains a fair value hierarchy that categorises the inputs into valuation techniques: Level 1 Level 2 Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for example: Level 3 Quoted prices for similar assets in active markets Quoted prices for identical or similar assets in non-active markets Inputs other than quoted prices that are observable for the asset such as interest rates Unobservable inputs for the asset or liability, using the entity's own assumptions about market exit value. Level 3 inputs are used to measure fair value to the extent that relevant observable inputs are not available, so allowing for situations where there is little, if any, market activity for an asset at the measurement date. The fair value measurement of an item is categorised in its entirety at the same level of the fair value hierarchy as the lowest level input that is significant to the entire measurement Considerations when applying HKFRS 13 to financial instruments The following should be considered when applying HKFRS 13 to various financial instruments: If a quoted item has a bid price (the price that buyers are willing to pay) and an ask price (the price that sellers are willing to achieve), the price within the bid-ask spread that is most representative of fair value is used to measure fair value. The use of bid prices for financial assets and the use of ask prices for financial liabilities is permitted but not required. IFRS 13 does not preclude the use of mid-market pricing. 17

24 Financial Reporting In the case of equity shares, a control premium is considered when measuring the fair value of a controlling interest. Similarly, any noncontrolling interest discount is considered where measuring a noncontrolling interest. The valuation of unlisted equity investments involves significant judgment and different valuation techniques are likely to result in different fair values; however this does not mean that any of the techniques are incorrect. Certain techniques are better suited to particular types of business, for example an asset based approach is relevant to property companies whilst an income approach is more relevant to service businesses. It is likely that valuation will be based on some unobservable inputs and as a result the overall fair value will be classified as a Level 3 measurement. When determining the fair value of loans, counterparty credit risk must be taken into account ie the risk that the counterparty will fail to pay an amount of the loan. This may be achieved when using an income approach to valuation by applying a current market credit spread in the discount rate applied to the cash flows of the loan. When determining the fair value of a financial liability, own credit risk (i.e. the risk that the entity will fail to discharge its own obligation) must be taken into account. The fair value of a financial liability from the perspective of the issuer is the same in absolute amount as the fair value of the asset from the perspective of the holder Disclosure An entity should disclose the fair value measurement of a financial instrument measured at fair value at the reporting date, together with the level of fair value hierarchy within which the fair value measurement is categorised. Additional disclosures are required where a fair value measurement is classified as a Level 3 measurement: A description of the valuation technique and the inputs used in the fair value measurement together with quantitative information about the significant unobservable inputs used in the fair value measurement A reconciliation from the opening balance to the closing balance, disclosing separately changes attributable to purchases and gains and losses recognised in other comprehensive income. The line item in other comprehensive income must also be disclosed A description of the valuation processes used by the entity A narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs if a change in those inputs might result in a significantly higher or lower fair value measurement A narrative description of any interrelationships between unobservable inputs used in the measurement A statement (if relevant) that changing one or more of the unobservable inputs to reflect reasonably possible alternative assumptions would change fair value significantly, together with disclosure of the calculation of the effect of such a change 18

25 December 2014 and June 2015 Supplement Existing section 4.4 Pages Section 5.2 Page 419 Section 8.1 Page 437 Existing section 4.4 is renumbered 4.5 Existing section is renumbered 4.6 Existing section is renumbered Existing section is renumbered Existing section 4.5 is renumbered 4.7 Existing section 4.6 is renumbered 4.8 Add the following text immediately before section 5.2.1: Earlier in the chapter we saw that where convertible debt is denominated in a foreign currency or has a variable conversion ratio based on share price, then it is not split into equity and liability components for accounting purposes. Instead the conversion option is treated as an embedded derivative within a financial liability host contract. Applying the HKFRS 9 guidance detailed above, the embedded derivative is separated from the debt instrument host and accounted for separately since: (a) The economic characteristics and risks of a debt contract are not closely related to those of a share warrant (b) A separate share warrant meets the definition of a derivative (c) The debt instrument is not measured at fair value through profit or loss (unless specifically designated as such to provide more relevant information) Therefore two financial liabilities are recognised: (i) A debt instrument measured at amortised cost, and (ii) An embedded derivative (representing the conversion option) measured at fair value through profit or loss. Replace the existing text within section 8.1 with the following: The issue of the first part of IFRS 9 in 2009 represented the culmination of the first stage of a long-standing project carried out by the IASB and FASB to reduce complexity surrounding financial instruments. As more stages in the project are completed, IFRS 9 is added to such that it will eventually replace IAS 39 in its entirety. As each part of IFRS 9 is issued, it is adopted by HKICPA to become HKFRS 9. The current HKFRS 9 was issued in three stages: HKFRS 9 (2009) deals with the recognition and measurement of financial assets. HKFRS 9 (2010) expands this to include the recognition and measurement of financial liabilities and embedded derivatives. HKFRS 9 (2013) further expands this to include hedge accounting. HKFRS 9 as issued in 2009 and 2010 is examinable in Module A and included within the main body of this chapter. The chapters of HKFRS 9 which were issued in 2013 and deal with hedge accounting are not fully examinable and are dealt with in this section as a current development. 19

26 Financial Reporting The outstanding stage of the financial instruments project on impairment is also dealt with in this section Hedge Accounting New requirements on hedge accounting were incorporated into IFRS 9/HKFRS 9 in The requirements replace the 'rule-based' requirements for hedge accounting currently in IAS 39/HKAS 39, and align the accounting more closely with risk management activities of an entity. Note that although the new hedge accounting requirements have been incorporated into HKFRS 9, there is no effective date for their application and therefore they do not fall within the cut off rules for Module A and will not be examinable at the December 2014 or June 2015 sittings. The new model for hedge accounting differs from that in IAS 39/HKAS 39 in the following key areas: Eligibility of hedging instruments Eligibility of hedged items Qualifying criteria for applying hedge accounting Rebalancing Discontinuation of hedging relationships Accounting for the time value component of options and forward contracts There are also limited changes in the accounting for hedge relationships. Eligibility of hedging instruments IAS 39/HKAS 39 permit entities to designate derivative instruments as hedging instruments; in addition non-derivative financial instruments may be hedging instruments for hedges of foreign currency risk. Under IFRS 9/HKFRS 9 eligibility of a financial instrument as a hedging instrument depends on whether the instrument is measured at fair value through profit or loss (FVTPL) rather than whether it is a derivative instrument. Therefore non-derivative instruments may be used as a hedging instrument for all types of risks, not only foreign currency risks, provided they are measured at FVTPL. Eligibility of hedged items IAS 39/HKAS 39 permits entities to designate recognised assets or liabilities, firm commitments, highly probable forecast transactions, and net investments in foreign operations as hedged items. In addition, for financial assets and financial liabilities, entities may designate certain risk components of the asset or liability (e.g. interest-rate risk, foreign currency risk) as the hedged item, provided that the risk is separately identifiable and reliably measurable. IFRS 9/HKFRS 9 also allows entities to designate risk components of nonfinancial assets and liabilities as hedged items provided that the risk component is separately identifiable and can be reliably measured. In addition the new standard allows certain group exposures to be designated as a hedged item. Qualifying criteria for applying hedge accounting The IAS 39/HKAS 39 80%-125% hedge effectiveness test of whether a hedging relationship qualifies for hedge accounting has been removed by IFRS 9/HKFRS 9 and replaced with a principles-based approach. To qualify for hedge 20