The following presentation and disclosures are required to be considered:

Transcription

1 SECTION A CASE QUESTIONS (Total: 75 marks) Answer 1(a) Although CCG has prepared a group reporting package in accordance with HKFRSs in the past for consolidation purposes, the group reporting package is not a complete set of financial statements. Accordingly, in the year 2015, CCG is a first-time adopter when it presents the first annual financial statements that include an explicit and unreserved statement of compliance with HKFRSs, and these financial statements are made available to CCG s shareholders. While CCG is a first-time adopter in 2015 (i.e. the first HKFRS reporting period will be the year ended 31 December 2015), the date of transition would be 1 January The following presentation and disclosures are required to be considered: Three statements of financial position i.e. as at 31 December 2015, 31 December 2014 and 1 January 2014 (the date of transition); and related notes as at the date of transition; An explanation of the impact of its transition from Australian Accounting Standards to HKFRSs on the reported financial position, financial performance and cash flows of the first-time adopter. Reconciliations of equity and reported total comprehensive income from previous GAAP to HKFRSs as at 1 January 2014 and 31 December 2014, together with explanations of the reconciling items. The correction of errors made under previous GAAP shall be identified separately in the reconciliation. Answer 1(b) The date of acquisition is the date on which the acquirer (Lucky Holdings) obtains control of the acquiree (CCG). Lucky Holdings controls CCG when Lucky Holdings is exposed to variable returns from its involvement with CCG, and has the ability to affect those returns through its power over the relevant activities of CCG. The date of acquisition cannot be reached before the shareholders of Lucky Holdings approved the share exchange transaction on 15 Feb 2015 because the passing of control is conditional on their approval, i.e. the voting rights are not transferred and the board of directors remained unchanged until the shareholders approval. Therefore, the acquisition date should be 1 March 2015, at which time Lucky Holdings obtained the power to control CCG s operations because Lucky Holdings shares were issued (i.e. consideration was paid in exchange for additional interests in 60% equity) and Lucky Holdings had the right to appoint the majority of the board of directors of CCG. Final Examination (December 2016 Session) Paper I 1 of 13

2 Answer 1(c) HKFRS 8 Operating segments requires operating segments to be identified on the basis of internal reports about the components of the entity that are regularly reviewed by the chief operating decision maker ( CODM ) in order to allocate resources to the segment and to assess its performance. Mr Luo is identified as CODM from the Group s perspective. Because (1) CC Mining and CC Property are engaged in revenue-earning activities; (2) the discrete financial information of both CC Mining and CC Property is separately available and provided to Mr Luo; and (3) it is believed that Mr Luo has regularly reviewed this separate information for resource allocation and performance assessment, in particular when making decisions about the spin-off proposal of the property businesses (which include CC Property), CC Mining and CC Property are regarded as two operating segments under HKFRS 8. Answer 2 The management of Lucky Holdings shall consider whether Lucky Estate and CC Property are qualified as a disposal group and are classified as held for distribution to owners, in accordance with HKFRS 5 Non-current Assets Held for Sale and Discontinued Operations. The non-current asset (or disposal group) is classified as held for distribution to owners when the entity is committed to distribute the asset (or disposal group) to the owners. For this to be the case, the asset (or disposal group) must be available for immediate distribution in its present condition and the distribution must be highly probable. For the distribution to be highly probable, actions to complete the distribution must have been initiated and should be expected to be completed within one year from the date of classification. Actions required to complete the distribution should indicate that it is unlikely that significant changes to the distribution will be made or that the distribution will be withdrawn. Although the Board of Directors of Lucky Holdings had approved and announced the Proposed Spin-off and the plan of the separate listing of the property businesses, the probability of shareholders approval should be considered as part of the assessment of whether the sale is highly probable. In addition, the separate listing of the significant property businesses housed in NewCo is subject to regulatory approval. The pending regulatory approval may prevent the classification of the assets or disposal of the group as held for distribution. The management should consider all available evidence and apply judgement based on the facts and circumstances in assessing the classification as held for distribution. Final Examination (December 2016 Session) Paper I 2 of 13

3 If Lucky Estate and CC Property as the disposal group are classified as held for distribution, they are measured at the lower of their carrying amount and fair value less costs to distribute. In addition, the assets and liabilities of the disposal group classified as held-for-distribution are presented separately from other assets and liabilities in the statement of financial position. If Lucky Estate and CC Property are not classified as held for distribution since the classification criteria under HKFRS 5 are not fully satisfied, the assets and liabilities in the disposal group are measured in accordance with the applicable HKFRSs. The announcement of the Spin-off plan and whether the conditions precedent to the Spin-off Proposal are met subsequent to the reporting period, such material non-adjusting events shall also be disclosed in the notes to the financial statements. Answer 3 Strengths (1) Leading real estate developer with listing status in Hong Kong and a market leader with a well-known brand name in property management and after sales service. (2) Established brand name with decades of experience and well diversified. (3) Set up numerous subsidiaries and operations across Europe, the Americas and Asia. The Group s business has covered over 30 countries. (4) Equipped with a professional management team to source smart money constantly to support its international business and operational activities. Weaknesses (1) The management lacks expertise in financial risk management, especially the knowhow on the estimation of crude oil price change of the global market. (2) The Group is heavily reliant on the real estate operation and the performance would be affected due to changes in property or land prices in Hong Kong. Opportunities (1) Further development of the Group s infrastructure business in Europe such as transportation and water plants business. (2) Excessive and keen demand for residential and commercial properties in the Hong Kong market. Final Examination (December 2016 Session) Paper I 3 of 13

4 Threats (1) Adverse economic conditions across global markets would negatively affect the Group s business because of its presence around the world. (2) High volatility in both domestic and overseas financial markets. (3) Expected decrease in private consumption and investment in Hong Kong and global markets. Answer 4(a) The reasons for a corporate spin-off: - The spin-off increases corporate focus, leading to greater value for the seller (Lucky Holdings). - The company which is seeking buyers for parts of its business, is not getting a good offer from other firms. In order to increase the marketability, the company may decide to spin off its business. - If the spun-off business unit is publicly traded, then investors find it easier to value the parent and subsidiary after the spin-off. Answer 4(b) Spin-offs differ from sales in 2 ways: - The parent firm receives no cash from a spin-off but the sale of the business unit provides needed cash to the seller. - The initial stockholders of the spun-off division/unit are often the same as the parent s stockholders. However, the buyer in a sell-off is often another company. Answer 5(a) New shares issued = 5 million Total shares = 20 + (5 x 60%) = 23 million Total earnings = $85 + $25 - $10 (double counted portion) = $100 million EPS = $100 / 23 = $4.35 Final Examination (December 2016 Session) Paper I 4 of 13

5 Answer 5(b) Value = (20 million $40) + (10 million x 60% x $20) $800 million + $120 million = $920 million Shares = 23 million Price = $920 / 23 = $40 per share So Lucky Holdings shareholders wealth is unchanged. CCG s former shareholders have stock worth: $40 3 million = $120 million (i.e. $120 million / 6 million shares = $20 per share) P/E of merged firm = $920 million / $100 million = 9.2 The P/E of the new merged firm is between the P/Es of the two original firms. Answer 6(a) The HKICPA s Code of Ethics for Professional Accountants ( the Code ) requires a professional accountant to identify, evaluate and address threats to compliance with the fundamental principles. Familiarity threats may occur when due to a close relationship, a professional accountant becomes too sympathetic to the interests of others. Simon Snow, as a professional accountant in business knew Thomas Chiswick s son for years and this might affect his judgment in the selection of the appropriate candidate for the post of Associate Finance Director. Self-interest threats may occur as a result of the financial or other interests of a professional accountant. With a self interest motive, Simon might be too eager to hire Jerry due to his long association with Jerry. In addition, as a senior management staff, Simon might gain indirectly if he could influence the success of the tender by Lucky Structure in Country X if he did a favour to Thomas Chiswick (a committee member of Country X s tenderer selection panel) by offering his son a job with a good salary and status. Final Examination (December 2016 Session) Paper I 5 of 13

6 Answer 6(b) The recruitment and interview process for the Associate Finance Director should have guidelines and considerations as follows: Simon declares his interest with regard to knowing the applicant and his father. Simon maintains independence and objectivity in the recruitment process, if he is involved. Select more than one applicant for interview. First interview shall be conducted by the Human Resource department. Involve more than one interviewer from the Corporate Financing department to screen the candidates. Recruitment process follows the recruiting guidelines or formal policy of the Group. Prepare adequate documentation for the conclusion of employee selection. Answer 6(c) The management trainee, Ada Chan, is the cousin of one of the audit team members, Bobo Wong, and this creates a familiarity threat. Ada is not an immediate family member of Bobo and thus it may not be necessary to remove Bobo from the engagement team. The engagement team should understand Ada s roles and responsibilities as the management trainee in Lucky Holdings Accounting Department and avoid having Bobo involved in the audit of the respective areas, or carry out an independent review on those audit areas performed by Bobo. Also, the engagement team members should not accept Ada s offer to purchase the supermarket cash coupons using her staff discount as this creates a self-interest threat. It is difficult to determine whether the discount is trivial and inconsequential and it may be seen to be intended to influence the judgement of the engagement team. Answer 7(a)(i) According to HKSA 600 Special considerations audits of group financial statements (including the work of component auditors), a significant component is a component identified by the group engagement team (i) that is of individual financial significance to the group, or (ii) that, due to its specific nature or circumstances, is likely to include significant risks of material misstatement of the group financial statements. Final Examination (December 2016 Session) Paper I 6 of 13

7 Answer 7(a)(ii) Property development, and Retail since these components have a significant contribution to the Lucky Holdings revenue, they are financially significant to the Group and thus an audit of the financial information using component materiality should be performed. Infrastructure it does not have a significant contribution to the Group s revenue during the year, however, it has significant investments in property, plant and equipment, which has the risk of impairment. In addition, the acquisition of the new infrastructure businesses in Europe is likely to include higher risks to material misstatement to the group financial statements and thus, one or more of the following should be performed: (i) an audit or review of the financial information of the component using component materiality; (ii) an audit of one or more account balances, classes of transactions or disclosures relating to the likely significant risks of material misstatement of Lucky Holdings financial statements; and/or (iii) specified audit procedures relating to the risks of material misstatement of Lucky Holdings financial statements. Others since the group of companies are individually insignificant, J&J can plan to perform analytical procedures at group level and consider, in aggregate, whether sufficient appropriate audit evidence on which to base the group audit opinion can be obtained. If additional audit evidence has to be obtained, J&J can select components that were not significant and plan to perform one or more of the types of work listed above for financially significant components, or review the financial information of the component. Answer 7(b) The proper opinion is as follows: In our opinion, the accompanying special purpose financial information (or the financial information included in the reporting package) for CCG as at 31 December 2015, and for the year then ended has been prepared, in all material respects, in accordance with the accounting policies and instructions in Lucky Star Holdings Limited s financial reporting procedures manual dated 30 September Answer 7(c) Since Wings Retail has a programme of inventory counting throughout the year and no inventory count will be arranged at the year-end, the audit work will focus on tests of controls during the year rather than substantive audit work at the year-end. Final Examination (December 2016 Session) Paper I 7 of 13

8 J&J has to verify that the management has ensured: (i) (ii) all inventory items in all locations are counted at least once a year; adequate inventory records are maintained that can be compared to sales and purchases transactions with inventory movements; (iii) the inventory count arrangements during the year and the respective inventory count instructions are as rigorous as those for a year-end inventory count; (iv) all material differences identified in the inventory count are investigated and corrected; and (v) all corrections to inventory movements are approved by authorised personnel who have not been involved in the inventory count. For planned inventory counts, J&J should select, attend and observe the inventory count to test the operating effectiveness of the controls. Since the inventory is situated in several locations (flagship retail chains in Asia), J&J has to consider at which locations attendance is appropriate, taking into account the materiality of the inventory and the assessment of the risk of material misstatement. For completed inventory counts, J&J should select and test whether they have been performed as scheduled and planned and whether the differences are investigated and properly corrected. Although the focus is on test of controls, some further substantive audit work (such as rolling forward from the last completed count) has to be performed at the year-end to ascertain the existence and completeness of the inventory. * * * END OF SECTION A * * * Final Examination (December 2016 Session) Paper I 8 of 13

9 SECTION B ESSAY QUESTIONS (Total: 25 marks) Answer 8 Date: To: From: dd mm yyyy Simon Snow, CFO of Lucky Holdings Advisor of ABC Tax advice for Spin-Off Proposal and Separate Listing Plan Dear Sir, Please find below the Hong Kong tax implications for each step under the spin-off / separate listing plan: Step 1: No Hong Kong tax implications. Step 2: Hong Kong profits tax For the disposal of shares of CC Property, the gain would only accrue to CCG and should not have any Hong Kong profits tax implications. When Lucky Holdings disposed of the shares of Lucky Estate to NewCo, there will be a gain to Lucky Holdings if the sales proceeds exceed the cost of investments. Whether the gain is taxable depends on whether the gain is (i) capital in nature; and (ii) offshore sourced. Since the restructuring is carried out in Hong Kong, the sale contracts of shares of Lucky Estate and CC Property are likely effected in Hong Kong. Coupled with the likely fact that the shares of Lucky Estate were procured in Hong Kong, the source of the gain is likely onshore sourced. If the investments in Lucky Estate are considered as trading stock, the Inland Revenue Department ( IRD ) may invoke the principle under Sharkey v Werner (36 TC 275) or Petrotim Securities Ltd v Ayres (41 TC 389) to impose a gain based on the open market value of the shares of Lucky Estate. There are, however, arguments that this principle should not be applicable in Hong Kong according to the decision of CIR v Quitsubdue Limited (1 HKRC90-099). In determining the open market value, the value of NewCo upon its future disposal (i.e. upon listing) may also be taken into account according to the decision of Wing Tai Development Co Ltd v CIR (HKTC 1115). Final Examination (December 2016 Session) Paper I 9 of 13

10 Whether the gain is capital in nature or whether the investments are considered trading stock is a matter of fact depending on a number of factors such as the six badges of trade, including: 1. The subject matter of realisation since the shares of both Lucky Estate and CC Property are unlisted shares, it is unlikely that Lucky Holdings would acquire them for trading purposes. 2. The length of ownership shares of Lucky Estate have been acquired for more than 1 year, but it would be good to ascertain exactly how long the shares have been acquired. 54.6% of CC Property shares have been acquired for only one year, this may point to short term selling holding purposes. It is required to ascertain how long the 45.4% of shares have been procured. 3. Frequency of transaction need to ascertain whether Lucky Holdings has a similar transaction history in the past. 4. Supplementary work in connection with the property realised no apparent supplementary work has been carried out. 5. Circumstances leading to the realisation since the disposal is part of the restructuring for a separate listing, it could be argued that the intention within the group is still to hold the shares for long term purposes, because just the company holding the shares is different. 6. Motive the shares in question have been classified as long term investments in the financial statements, this would point to a long term holding intention. If the aforesaid outstanding information are obtained, there should be much stronger support that the shares are held for long term investment purposes, i.e. the gain, if any, would be capital in nature and non-taxable. Hong Kong stamp duty Hong Kong stamp duty of 0.2% would be imposed on the higher of the amount of consideration or the open market value upon the disposal of shares of Lucky Estate. S.45 relief is not applicable because the 90% shareholding relationship between Lucky Holdings (transferor) and NewCo (transferee) would cease within 2 years. No Hong Kong stamp duty is applicable for the transfer of shares of CC Property as it is an Australian company. Final Examination (December 2016 Session) Paper I 10 of 13

11 Step 3: Hong Kong profits tax There is no gain recognised upon the distribution of the shares, so there is no Hong Kong profits tax implications. Hong Kong stamp duty Upon distribution of shares of NewCo, there is a change of ownership of the shares. If the share register of NewCo is kept in Hong Kong, stamp duty of 0.2% on the higher of the consideration or the market value of the shares distributed would be payable. However, note that, after the listing of NewCo, the transfer of the shares of NewCo would be required to be registered in Hong Kong. This, however, does not necessarily mean that the share register of NewCo would also be kept in Hong Kong before the listing. Accordingly, the place where the share register of NewCo is kept before the listing will need to be ascertained in order to determine whether any Hong Kong stamp duty is payable. Step 4: Hong Kong profits tax / stamp duty When NewCo issues 5% of its shares to senior executives, there is no Hong Kong profits tax or stamp duty payable. Hong Kong salaries tax There is a risk that the IRD could raise 2 alternative challenges: (A) There was an option to acquire the shares granted to the senior executives because the senior executives should have the right to or not to acquire the shares. Accordingly, the gain realised by the senior executives in exercising the right should be taxable under s.9(1)(d). (B) The underestimated value of shares granted should be taxable under s.9(1)(a) that the subscription price based on the net book value of NewCo is lower than its open market value, especially if the share price goes up a lot during the listing process. For example, the value attributable to intangible assets, say goodwill, may not have been recorded in the book. Nevertheless, the senior executives could argue that: Re (A), there could be 3 defence points: Final Examination (December 2016 Session) Paper I 11 of 13

12 1. There was no option to acquire the shares granted to the senior executives. What was acquired by the senior executives are the shares only, not the right to acquire the shares. The legal documents in relation to the share acquisition would have to be obtained in order to determine whether an option to acquire the shares has been granted. 2. There was no gain upon exercise of the share option under s.9(4)(b) for the reason that the unlisted shares which were subscribed for in full consideration based on their net book value of the audited accounts should already reflect their open market value. 3. Half of the shares are subject to restriction to sell within 2 years after the listing. The value of these shares should be subject to a discount in calculating their value. An independent valuation report on the shares of NewCo at the time of subscription is required to ascertain whether there is any understatement in the subscription price of the shares and the amount that should be taxable. Re (B), there is no gain for the following two arguments: 1. Even where the share value is higher than its net book value, the excess may not be readily convertible into cash at the time when the shares are procured by the senior executives; however, a similar argument is not acceptable to IRD (DIPN38) and D37/ There is no underestimated value (see similar arguments to points 2 & 3 of (A)) Step 5: When the shares of NewCo are listed by introduction, no new shares would be issued for public subscription. There would not be any Hong Kong tax implications. Kind regards Signed xxx Tax Advisor Final Examination (December 2016 Session) Paper I 12 of 13

13 Answer 9 As Lucky Estate holds equity interests in Chinese companies, the transfer of shares of Lucky Estate and NewCo during the steps may trigger Enterprise Income Tax at 10% due to the indirect transfer of equity interest in Chinese companies according to Guoshuihan [2009] 698 and State Administration of Taxation s Public Notice [2015] No. 7. * * * END OF EXAMINATION PAPER * * * Final Examination (December 2016 Session) Paper I 13 of 13