I refer to your query regarding the accounting treatment for the devaluation of Renminbi (RMB).

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1 SECTION A CASE QUESTIONS (Total: 50 marks) To : Ms Amanda Cheng, Director From : Deborah Lam, Accounting Manager Date : dd/mm/yyyy Subject : Appropriate accounting treatment for the devaluation of Renminbi (RMB) I refer to your query regarding the accounting treatment for the devaluation of Renminbi (RMB). Answer 1 Devaluation of Renminbi (RMB) Borrowing costs are defined in HKAS 23 as interests and other costs that an entity incurs in connection with the borrowing of funds. An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. Paragraph 6 of HKAS 23 specifies that borrowing costs may include exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. The gains and losses that are an adjustment to interest costs include the interest rate differential between borrowing costs that would be incurred if the entity borrowed funds in its functional currency, and borrowing costs actually incurred for foreign currency borrowings. In general, foreign exchange differences can be considered as an adjustment to interest costs if they narrow the cost differences between borrowings in functional and foreign currencies. In the past, the exchange gain from foreign currency borrowings together with their lower interest rates would move the borrowing costs of RMB and USD borrowings further apart. Accordingly, such exchange gain cannot be recognised as an adjustment to interest costs. With the devaluation of the RMB, exchange losses arising from foreign currency borrowings compensate for the lower interest rates of the foreign currency borrowings and are likely to represent an adjustment to interest costs. Such exchange losses bring the borrowing costs for borrowings in foreign currencies and functional currency closer. They are therefore eligible for capitalisation in the qualifying assets as part of the cost of that asset. Therefore, exchange losses of foreign currency borrowing in entities with RMB as functional currency can be capitalised in the qualifying assets to the extent that they are regarded as an adjustment to interest costs. Module A (December 2016 Session) Page 1 of 13

2 I hope the above explanation has answered your question. Please feel free to contact me if you have further queries. Best Regards, Deborah Lam Answer 2 Disposal of a major line of business Since PHL intends to dispose of the major line of its business operations which meet the definition of component of an entity, and the criteria to be classified as held for sale, it meets the criteria of discontinued operation under HKFRS 5 Non-current Assets Held for Sale and Discontinued Operations (HKFRS 5.32). Therefore PHL should disclose a single amount in the statement of comprehensive income comprising the total of (i) the post-tax profit or loss of discontinued operations and (ii) the post-tax gain or loss recognised on the measurement of fair value less costs to sell or on the disposal of the assets or disposal groups constituting the discontinued operation (HKFRS 5.33). Also, PHL should: (a) (b) (c) measure the non-current assets or disposal groups classified as held for sale at the lower of carrying amount and fair value less costs to sell (HKFRS 5.15). not depreciate the non-current assets while it is classified as held for sale or while it is part of the disposal group classified as held for sale (HKFRS 5.25). present separately in the statement of financial position the asset classified as held for sale, and the assets and liabilities included within the disposal group classified as held for sale (HKFRS 5.38). At the date the held for sale criteria were met, it is anticipated that PHL will realise RMB 80 million for the disposed business. A plan to dispose of net assets is an indication of impairment. HKFRS 5.18 requires that immediately before the classification of the disposal group as held for sale, the carrying amounts of all the assets and liabilities in the group should be measured in accordance with applicable HKFRSs. Therefore, PHL should recognise an impairment loss for any write-down of the disposal group to fair value less cost to sell (HKFRS 5.20). Non-current assets 102,000 Inventories 24,000 Current liabilities (8,000) Thus, carrying amount 118,000 Compare with proceeds expected 80,000 Impairment loss 38,000 Module A (December 2016 Session) Page 2 of 13

3 A2 Classify disposal group as held for sale and recognise impairment Dr Impairment loss RMB 38 million Dr Disposal group (Assets) RMB 88 million Cr Non-current assets RMB 102 million Cr Inventories RMB 24 million Dr Current liabilities RMB 8 million Cr Disposal group (Liabilities) RMB 8 million The assets and liabilities of the disposal group should be presented separately in the statement of financial position. Thus assets should be shown as RMB 88 million (Non-current asset RMB Inventories RMB 24 Impairment RMB 38) million. The liability of the disposal group should also be shown separately as RMB 8 million. Answer 3 Impairment review of SPL Goodwill on the acquisition of SPL Book value of identifiable net assets acquired 500,000 Fair value adjustment of non-current assets 40,000 Fair value of identifiable net assets acquired 540,000 Consideration transferred 480,000 Non-controlling interest (540 x 20%) 108,000 Thus, total cost of acquisition 588,000 Goodwill 48,000 Since PHL measures non-controlling interests as its proportionate interest in the net identifiable assets of a subsidiary at the acquisition date, rather than at fair value, goodwill attributable to non-controlling interests is included in the recoverable amount of the related cash-generating unit (SPL s recoverable amount) but is not recognised in the parent s consolidated financial statements (C4 of Appendix C of HKAS 36). Therefore, PHL should gross up the carrying amount of goodwill allocated to SPL to include the goodwill attributable to the non-controlling interests. This adjusted carrying amount is then compared with the recoverable amount of the unit to determine whether the cash-generating unit is impaired. Module A (December 2016 Session) Page 3 of 13

4 Impairment review of SPL Goodwill recognised 48,000 Relevant assets at 31 Dec ,000 Carrying amount at 31 Dec ,000 Goodwill for NCI (48 x 20/80) 12,000 Adjusted carrying amount at 31 Dec ,000 Recoverable amount 628,000 Impairment loss 90,000 Since the directors of PHL believed that any impairment of assets was not due to the current assets, the impairment loss is not allocated to the current assets. Thus, for the impairment of SPL, goodwill of RMB 60 million should be first written off, then the balance RMB 30 million (i.e. RMB (90 60) million) allocated to the non-current assets. Because PHL recognised the goodwill only up to 80% ownership interest in SPL, PHL should only recognise RMB 48 million goodwill impairment loss and RMB 30 million impairment loss on non-current assets. A3 Recognise impairment of SPL Dr Impairment loss (I/S) RMB 78 million Cr Goodwill RMB 48 million Cr Non-current assets RMB 30 million Module A (December 2016 Session) Page 4 of 13

5 Answer 4 Worksheet for the consolidated statement of Financial Position of PHL as at 31 December 2015: PHL SPL Ref Consolidated Non-current assets 1,102, ,400 40, ,530,000 3, ,4 A2 A3 16,000 6, ,000 30,000 Investment in SPL 480, , Investment in ADL 120,000 - E1 2, ,750 9,000 E2 Goodwill 48,000 1, A3 48, Disposal group 88,000 A2 88,000 Inventories 225, ,000 A2 24, ,000 Accounts Receivables 124,000 80, ,000 Cash 2,000 1,600 3,600 2,053, ,000 2,273,350 Share capital 662, , , ,000 Retained earnings 294, , , ,030 4, , ,800 4,5 2,880 2,250 E1 38,000 78,000 A2,E2 A3 6,000 Other comprehensive 400, , , ,000 income E2 3,000 Non-controlling interests 1 108, , ,000 3, ,200 4,5 720 Non-current liabilities 519, , ,000 Disposal group A2 8,000 8,000 Current liabilities 178,000 20,000 8,000 A2 190,000 2,053, ,000 2,273,350 Module A (December 2016 Session) Page 5 of 13

6 Reconciliation of NCI (not required by the question): Book Value of net assets of SPL RMB ( )m x 20% = 104,000 Unrealised profit (RMB 6m x 2/5) = RMB 2.4m x 20% = (480) Fair Value adj (RMB 40m x 6/10) = RMB 24m x 20% = 4, ,320 Answer 4 Consolidation journal entries (All figures in ) (not required by the question) J1 Elimination of investment in SPL Dr Share capital 100,000 Dr Retained earnings 240,000 Dr Other comprehensive income 160,000 Dr Goodwill 48,000 Dr Non-current assets 40,000 Cr Investment in SPL 480,000 Cr Non-controlling interests 20% 108,000 J2 Dr NCI share of post-acquisition retained earnings of SPL up to the end of the year Retained earnings 4,000 (20% x (RMB 260m RMB 240m) Cr Non-controlling interests 4,000 J3 Additional depreciation for fair value adj in SPL Dr Retained earnings (RMB 40m x 4/10) x 80% 12,800 Dr Non-controlling interests (20%) 3,200 Cr Non-current assets (Accumulated depreciation) 16,000 J4 Eliminate gain on machine sold by SPL to PHL Dr Retained earnings (RMB 6m x 80%) 4,800 Dr Non-controlling interests (RMB 6m x 20%) 1,200 Cr Non-current assets (RMB (25m 19m)) 6,000 J5 Depreciation adjustment for the machine sold by SPL to PHL Dr Non-current assets (RMB 6m x 3/5) 3,600 Cr Retained earnings (80%) 2,880 Cr Non-controlling interests (20%) 720 E1 Dr Amortisation of fair value adjustment in ADL Retained earnings 2,250 (RMB 20m x 3/8) x 30% associate Cr Investment in ADL 2,250 Module A (December 2016 Session) Page 6 of 13

7 E2 Share of post-acquisition retained earnings and comprehensive income of ADL up to the end of the year Dr Investment in ADL 9,000 Cr Retained earnings 6,000 (30% x (RMB 120m RMB 100m)) Cr Comprehensive income (30% x (RMB 100m RMB 90m) 3,000 Answer 5 Reconciliation of investment in associate Book Value of net assets of ADL RMB ( )m x 30% = 105,600 Fair Value adj (RMB 20m x 5/8) = RMB 12.5m x 30% = 3,750 Implicit goodwill for investment in ADL 17, ,750 Calculation of goodwill for the acquisition of ADL Book value of net assets of ADL at acquisition = 322,000 Fair value increment = 20,000 Fair value of identifiable net assets of ADL = 342,000 x 30% 102,600 Consideration transferred = 120,000 Implicit goodwill for investment in ADL 17,400 * * * END OF SECTION A * * * Module A (December 2016 Session) Page 7 of 13

8 SECTION B ESSAY / SHORT QUESTIONS (Total: 50 marks) Answer 6(a) Property A Property A remained classified as an inventory in accordance with HKAS 2 which is measured at the lower of cost and net realisable value as at 31 December 2015 as the commencement of the operating lease to another party was in February As the net realisable value as at 31 December 2015, i.e. the estimated resale price, was below the acquisition cost, Property A shall be written down to the net realisable value and such write-down shall be recognised as an expense in profit or loss. Property B Property B is reclassified from inventories in accordance with HKAS 2 to an owner-occupied property in accordance with HKAS 16 which is carried at cost less accumulated depreciation and any accumulated impairment losses from 1 September 2015 onwards. Property C Property C is reclassified from owner-occupied property in accordance with HKAS 16 to investment property in accordance with HKAS 40 upon the end of the owner-occupation from 1 September 2015 even though the new lease was entered into in January Pursuant to HKAS 40.61, when an owner-occupied property becomes an investment property that will be carried at fair value, Property C shall be accounted for under HKAS 16 up to the date of change in use. Any difference at that date between the carrying amount of the property in accordance with HKAS 16 and its fair value is handled in the same way as a revaluation in accordance with HKAS 16. In other words, the resulting increase in the carrying amount of Property C is recognised in other comprehensive income as a revaluation surplus and accumulated in equity as a revaluation reserve. Module A (December 2016 Session) Page 8 of 13

9 Answer 6(b) (i) Property A Journal entries for initial recognition on 20 January 2015: Dr Inventory HK$4,852,000 Cr Cash / Payable HK$4,852,000 Journal entries for write-down to net realisable value as at 31 December 2015: Dr Write-down expense HK$352,000 (HK$4,852,000-HK$4,500,000) Cr Inventory HK$352,000 (ii) Property B Journal entries for reclassification from inventory to owner-occupied property on 1 September 2015: Dr Property, plant and equipment HK$18,600,000 Cr Inventory HK$18,600,000 Journal entries for depreciation expense for the period from 1 September 2015 to 31 December 2015: Dr Depreciation expense HK$133,813 [HK$18,600,000*4 months / (50 years*12 months 44 months)(i.e. from 1 January 2012 to 31 August 2015)] Cr Property, plant and equipment HK$133,813 / accumulated depreciation (iii) Property C Journal entries for depreciation expense for the period from 1 January 2015 to 31 August 2015: Dr Depreciation expense HK$680,000 (HK$51,000,000/50/12*8) Cr Property, plant and equipment HK$680,000 / accumulated depreciation Module A (December 2016 Session) Page 9 of 13

10 Journal entries for recognition of revaluation reserve for the difference between the carrying amount and the fair value of Property C as at 1 September 2015 and reclassification of Property C from owner-occupied property to investment property: Dr Investment property HK$40,000,000 Cr Property, plant and equipment HK$37,420,000 (HK$38,100,000 - HK$680,000) Cr Revaluation reserve (HK$40,000,000 - HK$37,420,000) HK$2,580,000 Journal entries for recognition of refurbishment costs for the year ended 31 December 2015: Dr Investment property HK$2,400,000 Cr Cash / payable HK$2,400,000 Journal entries for recognition of fair value change of investment property for the year ended 31 December 2015: Dr Fair value change P/L HK$300,000 Cr Investment property (HK$42,100,000 - HK$40,000,000 - HK$2,400,000) HK$300,000 Module A (December 2016 Session) Page 10 of 13

11 Answer 7(a) 1. Investments in the shares of Star Limited shall be measured initially and subsequently at fair value in accordance with HKFRS 9 as they are not a financial asset with contractual terms which give rise on specific dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. The gain or loss arising from the fair value change shall be recognised in profit or loss. The investments shall be presented as current assets as HRL expected that HRL will sell the shares of Star Limited in the short term. 2. The bank loan shall be measured initially at fair value less direct transaction costs in accordance with HKFRS 9 and subsequently at amortised cost. It shall be classified as a current liability as there is a clause in the loan agreement that gives the bank the unconditional right to call the loan at any time. HRL does not have an unconditional right to defer settlement of the liability for at least twelve months after 31 December The swap shall be measured initially and subsequently at fair value in accordance with HKFRS 9 as it is not a financial asset with contractual terms which gives rise on specific dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. It is also not eligible for designation as at fair value through comprehensive income as the swap is not an equity instrument. The gain or loss arising from the fair value change shall be recognised in profit or loss. The swap shall be presented as a non-current liability as the tenor of the swap is two years from 1 September 2015 and will mature on 31 October 2017, which is over twelve months after 31 December Answer 7(b) Bank Loan In accordance with paragraph 39(a) and (c) of HKFRS 7, HRL shall disclose a maturity analysis based on the earliest possible date that the borrower could be required to repay and describe how it manages the liquidity risk inherent in this contractual maturity analysis. In addition, where HRL does not expect the lender to exercise its rights to demand repayment, the internal information on liquidity risk would generally be based on expected repayment dates with reference to the schedule of repayments set out in the term loan agreements. Such expected cash flow information should be also disclosed in accordance with paragraph 34(a) of HKFRS 7 as mentioned by HK Interpretation 5. Foreign currency swap For the market risk disclosures of the foreign currency swap under HKFRS 7, it shall be described in the financial statements that the swap is exposed to other price risk and a sensitivity to show the effect on profit or loss of reasonably possible changes in the forward exchange rate of the Renminbi against the HK$ together with the methods and assumptions used in preparing such a sensitivity analysis should be disclosed. Module A (December 2016 Session) Page 11 of 13

12 As the investments are measured at fair value on a recurring basis in the financial statements after initial recognition, the following should be disclosed under HKFRS 13: the level of the fair value hierarchy within which the fair value measurement is categorised in its entirety (Level 1, 2 or 3); and a description of the valuation techniques and inputs used to develop those measurements. Answer 8(a) For the first financial year beginning on or after 3 March 2014, GHL and TCL can qualify for the reporting exemption if it meets the relevant size tests in that first financial year (i.e. the year ended 31 December 2015); and/or in the immediately preceding financial year (i.e. the year ended 31 December 2014) according to the Transition Provision in SME-FRF and SME-FRS. For the year ended 31 December 2014, GHL failed to meet two out of three of the size tests to qualify as a larger eligible private company, i.e. total assets exceed HK$200 million and the number of employees is over 100. For the year ended 31 December 2015, GHL failed to meet two out of three of the size tests to qualify as a larger eligible private company, i.e. total assets exceed HK$200 million and the number of employees is over 100. As GHL is required to pass the size tests in 2014, and/or in 2015 before becoming eligible for the first year, i.e. 2015, GHL is not qualified to prepare its financial statements under SME-FRS for the year ended 31 December For the years ended 31 December 2014 and 2015, TCL met two out of three of the size tests to qualify as a small private company, i.e. both total annual revenue and total assets are less than HK$100 million and the number of employees is less than 100. No shareholder approval is required. Accordingly, TCL is qualified to prepare its financial statements under SME-FRS for the year ended 31 December However, since its subsidiary, GHL, failed to qualify as a larger eligible private company, TCL cannot report its consolidated financial statements under SME-FRS for the year ended 31 December Module A (December 2016 Session) Page 12 of 13

13 Answer 8(b) As both TCL and GHL do not have public accountability and publish general purpose financial statements for external users, they are eligible and can opt to prepare their financial statements under HKFRS for Private Entities. Answer 8(c) The statement is incorrect. Some companies may be reluctant to apply SME-FRF even if they are eligible. Reasons not to switch to the simplified regime might include one or more of the following: some companies are used to prepare the financial statements in accordance with full HKFRSs. When they switch to applying SME-FRF, this would constitute a change in accounting framework which shall be treated as a change in accounting policy and would be applied retrospectively as required by the transition provision in SME-FRF and SME-FRS, unless it is impracticable to determine the cumulative effect of the change or it may result in undue costs to do so; the financial statements are for external users (such as lenders, customers, or other stakeholders) and it is commonly believed by readers that full HKFRSs are more widely accepted; for some companies, changing to the SME-FRF and SME-FRS may not materially simplify the financial statements; if a company is part of a listed group that has to prepare consolidated HKFRS or IFRS financial statements and so preparing the financial statements of the company under the SME-FRS may require extra time, and hence cost, to track the necessary consolidation adjustments; and in the near future, if a company is likely to be part of an initial public offering, or of interest to private equity investors, it would be considered necessary to apply full HKFRSs in producing its financial statements. * * * END OF EXAMINATION PAPER * * * Module A (December 2016 Session) Page 13 of 13

Qualification Programme Examination Panelists Report. Module A Financial Reporting (December 2016 Session)

Qualification Programme Examination Panelists Report Module A Financial Reporting (December 2016 Session) (The main purpose of the following report is to summarise candidates common weaknesses and make