ACCA IFRS Seminar in Shenzhen 16 September 2006

Transcription

1 ACCA IFRS Seminar in Shenzhen 16 September 2006 IFRS Nelson Lam CFA FCCA FCPA(Practising) MBA MSc BBA CPA(US) ACA Nelson 1 Today s Agenda Introduction Presentation and Disclosure IFRS and PRC GAAP IFRS, IASB and and IFRS Approach Balance Sheet IAS IAS Property, plant and and equipment Items under IFRS IAS IAS Leases IAS IAS Investment property IAS IAS Intangible Assets Financial IAS IAS Recognition and and measurement Instruments IAS IAS and and IFRS 7 Presentation and and Disclosures IFRS Other Issues 3 Business combinations IAS IAS Effects of of changes in in foreign exchange rates IAS IAS Consolidated and and separate financial statements IAS IAS Impairment of of assets IAS IAS 1 and and 8 Comprehensive but Simple Real Cases and Examples Overview of of PRC GAAP and and its its convergence to to IFRS Compare IFRS and and ASBE (PRC Accounting Standards) Nelson 2 1

2 Introduction Question first 1. What are IFRS and IAS? 2. Why is it important to know IFRS for PRC entity? 3. What is the general approach adopted by IFRS? Nelson 3 What is IFRS and IASB? IASB (International Accounting Standards Board) 国际会计准则理事会 An independent and privately-funded accounting standard setter, based in London Responsible to issue ( 负责发布 ) IFRSs (International Financial Reporting Standards) 国际财务报告准则 IASC (International Accounting Standards Committee) 国际会计准则委员会 IASB s predecessor ( 国际会计准则理事会的前身 ) Responsible to issue IASs (International Accounting Standards) 国际会计准则 IFRSs include IASs ( 国际财务报告准则包括国际会计准则 ) Nelson 4 2

3 IFRS, IAS and Interpretations International Financial Reporting Standards (IFRSs) are: Standards and Interpretations issued by the IASB and comprise: International Financial Reporting Standards (IFRS 国际财务报告准则 ) ; International Accounting Standards (IAS 国际会计准则 ); and Interpretations ( 解释 ). As at 1 September 2006, there totally 7 sets of IFRS 31 sets of IAS 20 sets of Interpretation (SIC and IFRIC Interpretations) More are coming On On top top of of these, IASB also also has has a set set of: of: Framework for for the the Preparation and and Presentation of of Financial Statements (( 财务报表的编制及列报框架 )) Nelson 5 Why IFRS in PRC? Value-Added for Today.. On 15 Feb. 2006, the MOF released 39 new Chinese Accounting Standards for Business Enterprises (ASBE) 企业会计准则 Effective from 1 Jan and mandatory for all listed Chinese enterprises ( 新会计准则将于 2007 年 1 月 1 日起在上市公司率先实施 ) The new ASBE are substantially in line with IFRSs ( 趋同 ) except for certain modifications that reflect China s unique circumstances and environment Nelson 6 3

4 IFRS Approach Financial Position (in balance sheet) Asset Liability Equity Financial Performance (in income statement) Income Expenses Balance Sheet Approach a resource controlled ( 控制的资源 )by the enterprise as a result of past events ( 过去事件 ) and from which future economic benefits ( 未来经济利益 ) are expected to flow to the enterprise a present obligation ( 现在责任 ) of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits the residual interest ( 剩余的利益 ) in the assets of the enterprise after deducting all its liabilities increases ( 增加 ) in economic benefits during a period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity other than those relating to contributions from equity participants decreases ( 减少 ) in economic benefits during a period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants Nelson 7 IFRS Approach Definition 定义 Balance Sheet Approach IFRS Approach What is it? Recognition 确认 When is it recognised? Measurement 计量 Presentation and disclosure 列报及披露 How much is recognised and carried? How is it showed in the accounts? Nelson 8 4

5 IFRS Approach Definition Recognition is is the the process of of incorporating in in the the balance sheet or or income statement an an item item that that meets meets the the Definition ( 满足定义 ( )) of of an an element and and satisfies the the Criteria for for Recognition( 满足确认条件 )) Recognition Criteria for for recognition (( 确认条件 )) an an item item that that meets the the definition of of an an element should be be recognized if: if: it it is is probable that that any any future future economic benefit benefit associated with with the the item item will will flow flow to to or or from fromthe the enterprise ( 有关的经济利益很可能流入企业 ( ); ); and and the the item item has has a cost cost or or value valuethat can can be be measured with with reliability (( 该项目的成本或价值能够可靠地计量 ). ) Nelson 9 IFRS Approach Definition Recognition Measurement Historical cost 历史成本 Current cost 重置成本 Realisable (settlement) value 可变现价值 Fair value less cost to sell Present value 现值 Value in use Presentation and disclosure Nelson 10 5

6 Property, Plant and Equipment (IAS 16) Nelson 11 Recognition Principle Updated Recognition criteria (capitalisation) for Initial Cost 初始成本 Subsequent Expenditure 后续支出 Previous Now Criteria not the same Same criteria Probable that future Probable that future economic benefit of of economic benefits in in the asset will flow to to excess of of the originally the enterprise assessed standard of of Cost measured performance of of the reliably existing asset will flow to to the entity Probable that future economic benefit of of the asset will flow to to the entity Cost measured reliably Same criteria applied to to both costs Expenditure not fulfilling the recognition criteria will be charged to income statement Clearer approach on on so-called Component Accounting Nelson 12 6

7 Recognition Principle Updated Case Capitalise 2005 Annual Report stated its accounting policy on cost of restoring and improving PPE as follows: The plant components are depreciated over the period to overhaul. Major costs incurred in restoring the plant components to their normal working condition to allow continued use of the overall asset are capitalised and depreciated over the period to the next overhaul. Improvements are capitalised and depreciated over their expected useful lives to the Group Nelson 13 Measurement at Recognition PPE that qualifies for recognition as an asset shall be measured at its cost, which comprises: a) its purchase price, including import duties and nonrefundable purchase taxes, after deducting trade discounts and rebates; b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. Purchase Price 购买价款 Directly Attributable Cost 相关成本 Dismantling Cost 预计弃置费用 Nelson 14 7

8 Measurement after Recognition An entity shall choose either: Cost Model ( 成本模式 ) Revaluation Model ( 重估模式 ) as its accounting policy and the entity shall apply that policy to an entire class of PPE. No matter cost model or revaluation model is adopted, depreciation and impairment are also requirement on PPE. Depreciation 折旧 Impairment 减值 Nelson 15 Measurement after Recognition Revaluation Model What is fair value? Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm s length transaction. All All IFRS/IAS have same definition on on fair value now. The fair value of land and buildings is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. items of PPE is usually their market value determined by appraisal. If there is no market-based evidence of fair value because of the specialised nature of the item of PPE and the item is rarely sold, an entity may need to estimate fair value using an income or a depreciated replacement cost approach Nelson 16 8

9 Leases (IAS 17) Nelson Lam CFA FCCA FCPA(Practising) MBA MSc BBA CPA(US) ACA Nelson 17 Classification of Leases The classification of leases adopted in IAS 17 Is based on the extent to which risks and rewards ( 风险和报酬 ) incidental to ownership of a leased asset lie the the lessor or the leseee. Risks and Rewards Finance Lease Operating Lease A finance lease ( 融资租赁 ) is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. An operating lease ( 经营租赁 ) is a lease other than a finance lease Nelson 18 9

10 Classification Lease of L&B Lease of land Lease of land and buildings Lease of land and of buildings are classified as operating or finance leases in the same way as leases of other assets but Land and Building Problematic area Land only Building only Nelson 19 Classification Lease of Land Lease of land Lease of land is classified in the same way as leases of other assets But as land normally has an indefinite economic life ( 不确定经济寿命 ) If title of leasehold land ( 土地产权 ) is not expected to pass to the lessee Lessee normally does not receive substantially all of the risks and rewards incidental to the ownership In which case the lease of land will be an operating lease ( 经营租赁 ) payment acquiring such leasehold represents prepaid lease payments ( 预付款 ) amortised over the lease term in accordance with the pattern of benefits provided ( 在利用润表中摊销 ) Land only Leasehold land without title pass Operating Lease Nelson 20 10

11 Classification Lease of L&B Lease of land Lease of land and buildings If a lease contains land and buildings elements 2 elements are considered separately for lease classification If title of both elements is expected to pass to the lessee Both elements are classified as finance lease Title passed to the lessee? No Yes If title of land or both elements is NOT expected to pass to the lessee The land element alone is normally classified as an operating lease The building element is considered separately Land Operating Lease Building Finance Lease Nelson 21 Classification Lease of L&B Lease of land and buildings To classify and account for a lease of land and buildings the minimum lease payments ( 最低租赁付款额 ), including any lump-sum upfront payments, are allocated between the land ( 土地 ) and the buildings ( 楼宇 ) elements in proportion to the relative fair values ( 对比公允值 ) of the leasehold interests in the land element and buildings element of the lease at the inception of the lease ( 租赁开始日 ) Land only Building only Nelson 22 11

12 Classification Lease of L&B Lease of land and buildings If the lease payments cannot be allocated ( 不能可靠分配 ) reliably between the 2 elements the entire lease is classified as a finance lease ( 融资租赁 ) unless it is clear that both elements are operating leases, in which case the entire lease is classified as an operating lease ( 经营租赁 ) For a lease of land and building if the land is immaterial The lease may be treated as a single unit and classified as finance or operating leases Land only Building only Nelson 23 Classification Lease of L&B Lease of land and buildings Minimum lease payment allocated in in proportion to to the the relative fair fair values of of land and and building elements 以土地及楼宇的对比公允值分配最低租赁付款额 Title passed to the lessee? No Can land and building be reliably separated? Yes Land Building Yes No Operating Lease Finance Lease Nelson 24 12

13 Classification Lease of L&B Example Entity A make a payment to obtain a land use right for 50 years then, constructed a building on the land for own use 10 years later, Entity B acquired the interest of the land and building for own use Assuming Entity B acquired the property at $20 million and A similar land has a fair value of $12M Construction cost of a similar building is $4M $ 20M to to be be separated in in proportion to to the relative fair values of of the land and building element at at the inception of of the lease, i.e. by by $12M to to $ 4M Then, the separate measurement will result in: in: Land = $ 15M ($20M $12M // $16M) Building = $ 5M ($20M $ 4M 4M // $16M) Nelson 25 Classification Lease of L&B Case Accounting policy on land use right (annual report 2005): Land use rights are recognised initially at cost, being the consideration paid for the rights to use and occupy the land. Land use rights are amortised using the straight-line method to write off the cost over their estimated useful lives of 30 to 70 years. Land use rights are not separately presented from building, when they are acquired together with the building at inception and the costs attributable to the land use rights cannot be reasonably measured and separated from that of the building Nelson 26 13

14 Investment Property (IAS 40) Nelson 27 Definitions Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals ( 赚取租金 ) or for capital appreciation ( 资本增值 ) or both, rather than for a) use in the production or supply of goods or services or for administrative purposes; or b) sale in the ordinary course of business How s about property held by the lessee under an operating lease? Examples of of investment property under IAS IAS include: Property leased leased out outunder under operating leases leases ( 己租出物业 ) Property held held for for long-term capital capital appreciation( 待增值物业 ) Property held held for for a currently undetermined future future use use ( 未决定用途物业 ) Vacant Vacant property to to be be leased leased out outunder under operating leases leases ( 待出租空置物业 ) Nelson 28 14

15 Definitions Extend to Operating Leases A property interest that is held by a lessee under an operating lease ( 经营租赁 ) may be classified and accounted for as An entity has a choice investment property if, and only if the property would otherwise meet the definition of an investment property and the lessee uses the Fair Value Model ( 公允值模式 ) This classification alternative is available on a property-by-property basis However, once this classification alternative is selected for one such property interest held under an operating lease, all properties classified as investment property shall be accounted for using the Fair Value Model Simple? How s about Let s property term this held classification by the lessee as under an operating Operating lease? Lease IP Alternative Nelson 29 Definitions Owner-Occupied Property Introduce a new term, owner-occupied property (i.e.one kind of PPE) Refer back to IAS 16 for definition of property, plant and equipment Property, plant and equipment are tangible items that: a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and b) are expected to be used during more than one period. Both for rental, how to distinguish? For example, how to distinguish: A flat leased out for rental ( 出租楼房 )? A staff quarter ( 员工宿舍 ) charged at a fee or a hotel ( 酒店 )? Cash Flow ( 现金流 ) Extent of Ancillary Services ( 附属服务 ) Investment Property Owner-occupied Property Nelson 30 15

16 Definitions Owner-Occupied Property Cash Flow One of the key indicators in determining the classification between investment property and owner-occupied property Investment Property Owner-occupied property held to earn rentals or for capital appreciation or both therefore, generates cash flows largely independently of the other assets held by an entity. the production or supply of goods or services (or the use of property for administrative purposes) generates cash flows that are attributable not only to property, but also to other assets used in the production or supply process Nelson 31 Definitions Owner-Occupied Property Cash Flow Ancillary Investment services not Property significant Extent of Ancillary Services investment property owner-occupied property provided by an entity to the occupants of a property it holds is also considered e.g. a owner-managed hotel is not an investment property Significant Owner-occupied ancillary services property provided If owner-managed hotel was classified as investment property before 2005, it should be reclassified as property, plant and equipment (IAS 16) or lease (IAS 17) Nelson 32 16

17 Definitions Owner-Occupied Property It may be difficult to determine whether ancillary services are so significant that a property does not qualify as investment property for example, there may be a spectrum from one end to another: Ancillary services not significant Passive investor Investment property Use IAS 40 How to determine those in between these 2 ends? Significant ancillary services provided Significant exposure to variation in the cash flows Owner-occupied Use IAS 16 Then, judgement ( 判断 ) is required to determine Entities should develop consistent criteria ( 一致条款 ) for use in exercising the judgement Nelson 33 Measurement after Recognition Introduce Cost Model & choose ( 选择 ) either or Fair Value Model Cost Model 公允值模式 成本模式 IAS 40 implicitly implies that the choice can only be elected on the first-time adoption of IAS 40 The model chosen should be applied to all investment properties, except for some identified exceptions. However, even Cost Model is adopted, IAS 40 still requires all entities to determine the fair value of investment property For disclosure purpose, the fair value of the investment property has to be disclosed in notes to the financial statement! an entity is only encouraged, but not required, to rely on a professional valuer s valuation in determining the fair value Nelson 34 17

18 Measurement after Recognition After initial recognition, an entity that chooses shall measure all of its investment property at fair value, except in some restricted cases. A gain or loss arising from a change in the fair value of investment property shall be recognised in profit or loss for the period in which it arises Fair Value Model Fair value is defined as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm s length transaction Same definition used in other IFRSs and IASs But IAS 40 provides more explanations unique for a fair value of a property The fair value of investment property shall reflect market conditions at the balance sheet date No depreciation is required Nelson 35 Measurement after Recognition Case Accounting policy on investment property (annual report 2005): Property held to earn rentals which is not occupied by the Group is classified as investment property. Investment property comprises land and buildings. The Group adopts the fair value model to account for its investment property. Fair value is based on active market prices, adjusted, if necessary, for any difference in the nature, location or condition of the specific asset. Where active market price information is not available, the Group uses alternative valuation methods such as discounted cash flow projections or recent prices on less active markets. These valuations are reviewed annually by an independent valuer. Changes in fair values are recorded in the profit and loss account Nelson 36 18

19 Measurement after Recognition Fair Value Model If an entity has previously measured an investment property at fair value it shall continue to measure the property at fair value until disposal or cessation to be investment property, even if comparable market transactions become less frequent or market prices become less readily available. Once you you chose Fair Fair Value Model, you you cannot fall fall back to to Cost Model Nelson 37 Intangible Assets (IAS 38) Nelson 38 19

20 Definition of Intangible Assets An intangible asset is an identifiable non-monetary asset without physical substance. An asset is a resource: a) controlled by an entity as a result of past events; and b) from which future economic benefits are expected to flow to the entity. Monetary assets are money held and assets to be received in fixed or determined amounts of money Identifiability 可辨认性 Control 控制 Future economic benefit 未来经济利益 Nelson 39 Recognition and Initial Measurement Intangible assets may arise from Separate acquisition Acquisition as as part of of a business combination Acquisition by by way of of a government grant Exchange of of assets Internally generated goodwill Our Focus Today Internally generated intangible assets ( 内部产生无形资产 ) Nelson 40 20

21 Recognition and Initial Measurement Expenditure on research shall be expensed and cannot be capitalised. Research and Development An intangible asset arising from development ( 开发 ) (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following: a) the technical feasibility ( 技术上可行 ) of completing the intangible asset so that it will be available for use or sale. b) its intention to complete ( 有意图完成 ) the intangible asset and use or sell it. c) its ability to use or sell ( 有能使用或出售 ) the intangible asset. d) how the intangible asset will generate probable future economic benefits ( 有经济利益流 ). e) the availability of adequate technical, financial and other resources to complete ( 有足够技术 财产和其它资源完成 ) the development and to use or sell the intangible asset. f) its ability to measure reliably ( 可靠计量支出 ) the expenditure attributable to the intangible asset during its development Nelson 41 Recognition and Initial Measurement Research and Development The cost of an internally generated intangible asset is the sum of expenditure incurred from the date when the intangible asset first meets the recognition criteria ( 由满足确认条件日开始资本化 ). prohibits reinstatement of expenditure previously recognised as an expense Nelson 42 21

22 Recognition and Initial Measurement Example When can the cost be capitalised? Research and Development Date 1 Date 2 Date 3 Research Development Expensed and cannot be restated Capitalised as intangible asset Date 1 Date of development commenced Date 2 Date of recognition criteria meet Date 3 Date of new developed product ready for intended use Nelson 43 Recognition and Initial Measurement An entity is developing a new production process. During 2005, expenditure incurred was $1,000, of which a) $900 was incurred before 1 Dec and b) $100 was incurred between 1 Dec and 31 Dec The entity is able to demonstrate that, at 1 Dec. 2005, the production process met the criteria for recognition as an intangible asset. The recoverable amount of the know-how embodied in the process is estimated to be $500. During 2006, expenditure incurred is $2,000. At the end of 2006, the recoverable amount of the know-how embodied in the process is estimated to be $1,900. Example Expensed Capitalised No impairment Capitalised Impairment = $ Nelson 44 22

23 Measurement after Recognition An entity shall choose either: Cost Model 成本模式 Revaluation Model 重计模式 Depreciation 折旧 Impairment 减值 as its accounting policy If an intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same model, unless there is no active market for those assets. An active market ( 活跃市场 ) is is a market in in which all the following conditions exist: a) a) the items traded in in the market are homogeneous; b) b) willing buyers and sellers can normally be found at at any time; and c) c) prices are available to to the public Nelson 45 Measurement after Recognition No matter, which of the following model is used by an entity: Cost Model or Revaluation Model IAS 38 sets out that an entity shall assess whether the useful life of an intangible asset is ( 有限 ) ( 不确定 ) Finite or Indefinite New Concept If finite the length of, or number of production or similar units constituting, that useful life. Amortisation required An intangible asset has an indefinite useful life when based on an analysis of all of the relevant factors there is no foreseeable limit (not mean infinite ) to the period over which the asset is expected to generate net cash inflows for the entity. Amortisation not required Nelson 46 23

24 Measurement after Recognition An intangible asset with an indefinite useful life shall not be amortised ( 不应摊销 ). In accordance with IAS 36 Impairment of Assets, an entity is required to test an intangible asset with an indefinite life for impairment ( 减值测试 )by comparing its recoverable amount with its carrying amount a) annually, and b) whenever there is an indication that the intangible asset may be impaired. Indefinite The useful life of such intangible asset shall be reviewed each period to determine whether events and circumstances continue to support an indefinite useful life assessment for that asset. If they do not (support an indefinite useful life assessment for that asset) such change in the useful life assessment shall be accounted for as a change in an accounting estimate in accordance with IAS Nelson 47 Measurement after Recognition Assessing the useful lives of intangible assets Example The broadcasting licence is renewable every 10 years if the entity provides at least an average level of service to its customers and complies with the relevant legislative requirements. The licence may be renewed indefinitely at little cost and has been renewed twice before the most recent acquisition. The acquiring entity intends to renew the licence indefinitely and evidence supports its ability to do so. Historically, there has been no compelling challenge to the licence renewal. The technology used in broadcasting is not expected to be replaced by another technology at any time in the foreseeable future. Therefore, the licence is expected to contribute to the entity s net cash inflows indefinitely Nelson 48 24

25 Measurement after Recognition Example Assessing the useful lives of intangible assets The broadcasting licence would be treated as having an indefinite useful life because it it is expected to contribute to the entity s net cash inflows indefinitely. Therefore, the licence would not be amortised until its useful life is determined to be finite. The licence would be tested for impairment in accordance with IAS 36 annually and whenever there is an indication that it it may be impaired Nelson 49 Financial Instruments (IAS 32, IAS 39 and IFRS 7) Anyone who says they understand IAS 39 has not read it Professor Sir David Tweedie Chairman of IASB Nelson 50 25

26 Topics to be discussed Definitions (IAS 39) Initial recognition and measurement (IAS 39) Financial assets measurement (IAS 39) Financial assets impairment (IAS 39) Presentation and disclosure (IAS 32) Disclosure (IFRS 7) Some Complicated Issues Not To To Be Be Covered Nelson 51 Definitions Financial Instruments A financial instrument (( 金融工具 )) is is any any contract that that gives rise rise to to a financial asset (( 金融工具 )) of of one one entity, and and a financial liability (( 金融负债 )or )or equity instrument (( 权益工具 )) of of another equity Financial instrument Financial asset Financial liability or Equity instrument of one entity of another entity Nelson 52 26

27 Definitions Financial Instruments Financial asset ( 金融资产 ) is any asset that is: Cash An equity instrument of another entity A contractual right i) to receive cash or another financial asset from another entity ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity A contract that will or may settled in the entity s own equity instruments and is i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity s own equity instruments; or ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity s own equity instruments. Financial instrument Financial asset Financial liability or Equity instrument Derivative Nelson 53 Definitions Financial Instruments Financial liability ( 金融负债 ) is any liability that is A contractual right i) to deliver cash or another financial asset from another entity ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity A contract that will or may settled in the entity s own equity instruments and is i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity s own equity instruments; or ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity s own equity instruments. Equity instruments ( 权益工具 ) Financial instrument is any contract that evidences a residual interest ( 剩余利益 ) in the assets of an entity after deducting all of its liabilities. Financial asset Financial liability or Equity instrument Derivative Nelson 54 27

28 Definitions Derivative Derivative 价值升降随濳在指针变动 Value change based on an underlying 少或无初始投资 Little or no initial net investment 在未来日子结算 Settled at a future date is a financial instrument or other contract within the scope of IAS 39 with all 3 of the following characteristics: a) its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable (sometimes called the underlying ); b) it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and c) it is settled at a future date. Financial instrument Financial asset Financial liability or Equity instrument Derivative Nelson 55 Definitions Derivative Typical example: Future and forward Swap and options 价值升降随濳在指针变动 Value change based on an underlying 少或无初始投资 Little or no initial net investment 在未来日子结算 Settled at a future date Type of contract Interest Rate Swap Currency Swap (Foreign Exchange Swap) Commodity Swap Equity Swap Credit Swap Total Return Swap Purchased or Written Treasury Bond Option Purchased or Written Currency Option Currency Futures/Forward Commodity Futures/Forward Equity Forward Underlying variable Interest rates Currency rates Currency rates Currency rates Commodity prices Example Commodity prices Equity prices (equity of another entity) Credit rating, credit index or credit price Total fair value of the reference asset and interest rates Interest rates Equity prices Nelson 56 28

29 Initial Recognition & Measurement Financial instrument Financial asset Financial liability An entity shall recognise a financial asset or a financial liability on its balance sheet when and only when the entity becomes a party to the contractual provisions of the instruments Implies trade date accounting ( 交易日入帐 ) Except for a regular way purchase or sale of financial assets ( 普通买卖途径 ) Initial Recognition Trade Date Accounting Regular Way of Financial Assets As a consequence of this principle, an entity recognise all of its contractual rights and obligations under derivatives in its balance sheet as assets and liabilities respectively. Examples include: Committing to a purchase of equity securities Committing to write a derivative option Nelson 57 Initial Recognition & Measurement Financial instrument Financial asset Financial liability When a financial asset or financial liability is recognised initially ( 初次计量 ), an entity shall measure the financial asset or a financial liability at its fair value,plus transaction costs except for those classified at fair value through profit or loss What is it? Initial Recognition Trade Date Accounting No transaction cost will be initially recognised for financial instruments at fair value through profit or loss Regular Way of Financial Assets Initial Measurement Fair Value 公允价值 Nelson 58 + Transaction Cost 交易成本 29

30 Initial Recognition & Measurement Example Fair value at Initial Recognition Low Interest Loan Entity A grants a 3-year loan of $50,000 to a related party, B, on 1 Jan as one kind of financial assistance to support B s operation. A charges B at a interest rate of 2% as A expects the return on B s future operation would be higher. A charges another related party at a current market lending rate of 6% Discuss the implication of the loan. On On initial recognition, Entity A should recognise the the carrying amount of of the the loan loan at at the the fair fair value of of the the payments that that it it will will receive from from the the related party. How How is is the the fair fair value of of the the payments at at initial recognition calculated? Nelson 59 Initial Recognition & Measurement Example Cash inflow Discount factor $50,000 x 2% = $ 1,000 1 / (1 + 6%) 1 $ 1,000 1 / (1 + 6%) 2 $ 51,000 1 / (1 + 6%) 3 Fair value at initial recognition Present value $ 943 $ 890 $ 42,821 $ 44,654 Discounting the the interest and and principal repayments using the the market rate rate of of 6%, 6%, Entity A will will recognise an an originated loan loan of of $44,654. The The difference of of $ 5,346 is is expensed immediately as as the the expectation about future operating profit of of Entity B does not not qualify for for recognition as as an an intangible asset Nelson 60 30

31 Measurement after Recognition FA at FV through P/L 1. Financial assets at fair value through profit or loss Financial instrument Financial asset Financial liability AFS financial assets HTM investments Loans and receivables 2. Available-for-sale financial assets 3. Held-to-maturity investments 4. Loans and receivables Initial recognition and measurement principle for financial assets and financial liabilities are the same (to be discussed later) But, IAS 39 further defines financial asset into 4 categories for subsequent measurement (financial liability to be discussed later) The 4-category classification will affect the subsequent measurement of of financial assets, but not the initial measurement Nelson 61 Measurement after Recognition FA at FV through P/L Definition for Financial Assets at Fair Value through P/L ( 公允价值计量在损益中 ) A financial asset that meets one of the following 2 conditions. a. It is classified as held for trading ( 交易性 ), if it is: i. incurred principally for the purpose of selling or repurchasing it in the near term; ii. there is evidence of a recent actual pattern of short-term profit-taking on the asset; or iii. a derivative (except for a derivative that is a designated and effective hedging instrument). b. Upon initial recognition, an entity may designate ( 指定 ) a financial asset as at fair value through profit or loss if specific condition is met. An entity has NO choice An entity has a choice Nelson 62 31

32 Measurement after Recognition FA at FV through P/L AFS financial assets Definition for Available-for-sale financial assets ( 可供出售金融资产 ) Those non-derivative financial assets ( 非衍生金融资产 ) that are designated ( 指定 ) as available for sale, or An entity has a choice Those not classified into other categories ( 没有分类的 ) Implies Except for those held for trading, all the remaining financial assets can be designated as AFS financial assets Loans and receivables and HTM investments can also be initially designated as AFS financial assets Nelson 63 Measurement after Recognition FA at FV through P/L AFS financial assets HTM investments Definition for Held-to-Maturity Investments ( 持有至到期投资 ) Non-derivative financial assets ( 非衍生金融资产 ) with fixed or determinable payments ( 固定或可确定回收金额 ) and fixed maturity ( 固定到期日 ) That the entity has the positive intention and ability ( 有明确意图及能力 ) to hold to maturity, other than those initially designated as FA at FV through P/L those designated as AFS financial assets those that meet the definition of loans and receivables A debt debt instrument with with a variable interest interest rate rate can can satisfy satisfy the the criteria criteria for for a HTM HTM investment. Equity Equity instruments cannot cannot be be HTM HTM investments either either because they they have have an an indefinite life life (such (such as as ordinary shares) or or because the the amounts the the holder holder may may receive receive can can vary vary in in a manner that that is is not not predetermined (such (such as as for for share share options, warrants and and similar similar rights). rights) Nelson 64 32

33 Measurement after Recognition Subject to to Tainting Rule below HTM investments Definition for Held-to-Maturity Investments Subject to limited exemption, an entity shall not classify any financial assets as held to maturity ( 以下情况下, 没有金融资产能分类为持有到期资产 ) if the entity has, during the current financial year or during the two preceding financial years, sold or reclassified ( 出售或重新分类 ) more than an insignificant amount of HTM investments before maturity (more than insignificant in relation to the total amount of HTM investments) Nelson 65 Measurement after Recognition FA at FV through P/L AFS financial assets HTM investments Loans and receivables Definition Non-derivative financial assets ( 非衍生金融资产 ) with fixed or determinable payments ( 贷款和应收款项 ) that are not quoted in an active market, other than those the entity intends to sell immediately or in the near term (which shall be classified as held for trading) those initially designated as FA at FV through P/L those initially designated as AFS financial assets those for which the holder may not recover substantially all of its the initial investment, other than because of credit deterioration, which shall be classified as AFS financial assets Examples include: loan assets, trade receivables, rental deposits, deposits held by banks Nelson 66 33

34 Measurement after Recognition Classification determine Subsequent Measurement FA at FV through P/L AFS financial assets HTM investments Loans and receivables at Fair Value ( 公允价值 ) at Fair Value at Cost at Amortised Cost ( 摊余成本 ) at Amortised Cost Except for investments in equity instruments that do not have a quoted market price in an active market, and whose fair value cannot be reliably measured Nelson 67 Measurement after Recognition A Financial Held for trading (or Yes Asset derivative)? No Upon initial recognition, Yes designated at FA at FV through P/L (if allowed)? No Designated as AFS Yes financial assets? No With fixed/determinable No payments? Yes No With fixed maturity? Yes Has positive intention and ability to hold to No maturity and fulfils tainting rule? With quote in Yes an active market? With quote in an active market? Yes No No May recover substantially all initial investments Yes Yes No Derivative? No Yes Designated and effective hedging instrument? No Yes Hedge Accounting To be discussed later Has a quote at active No No Has a quote at active market or fair value can market or fair value can be reliably measured? be reliably measured? Yes Yes HTM Loans and AFS financial Cost FA at FV investments at receivables at assets at less Impairment through P/L Nelson amortised cost amortised cost fair value 68 34

35 Measurement after Recognition Subsequent Measurement FA at FV through P/L AFS financial assets HTM investments Loans and receivables at Fair Value Gain or loss shall be recognised in profit or loss at Fair Value Gain or loss recognised directly in equity at Cost Except for Impairment losses and at Amortised Cost Foreign exchange gains and losses (financial asset is treated as if it were at Amortised Cost carried at amortised cost in the foreign currency for translation purpose) Cumulative gain or loss recognised directly in equity shall be transferred to profit or loss on derecognition of the financial asset Nelson 69 Measurement after Recognition Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. Active market exists ( 有活跃市场 ) A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange and similar entities. The existence of published price quotations in an active market is the best evidence of fair value and when they exist they should be used to measure the financial asset (or financial liability) For an asset held (or liability to be issued) Current bid price ( 现行出价 ) For an asset to be acquired (liability held) Current ask price ( 现行要价 ) If the current bid and asking prices not available Price of most recent transaction Nelson 70 35

36 Measurement after Recognition Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. No active market ( 无活跃市场 ) An entity establishes fair value by using a valuation technique ( 估值技术 ) To establish what the transaction price would have been on the measurement date in an arm s length exchange motivated by normal business considerations Valuation techniques include Using recent arm s length market transactions ( 最近市场交易价 ) between knowledgeable, willing parties Discounted cash flow analysis ( 现金流量折现法 ) Option pricing models ( 期权定价模式 ) Nelson 71 Measurement after Recognition Subsequent Measurement FA at FV through P/L AFS financial assets HTM investments Loans and receivables at Fair Value at Fair Value at Cost at Amortised Cost ( 摊余成本 ) at Amortised Cost Amortised cost of a financial instrument is: the amount at which the financial instrument is measured at initial recognition ( 初始确认金额 ) minus principal repayments( 偿还的本金 ), plus or minus the cumulative amortisation ( 累计摊销额 ) using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility ( 减值损失 ) Nelson 72 36

37 Measurement Impairment FA at FV through P/L AFS financial assets HTM investments Loans and receivables Subsequent Measurement at Fair Value at Fair Value at Cost at Amortised Cost at Amortised Cost Impairment Outside Outside the the scope scope of of IAS IAS At each balance sheet date assess whether there is any objective evidence ( 客观证据 ) that a financial asset (or group of financial assets) is impaired. Conditions must be fulfilled in recognising impairment loss Nelson 73 Measurement Impairment FA at FV through P/L AFS financial assets HTM investments Loans and receivables at Fair Value at Fair Value at Cost Outside Outside the the scope scope of of IAS IAS Impairment (if there is objective evidence) Implicitly, no impairment review is needed as gain or loss on change in fair value is recognised in profit or loss 2 conditions to effect impairment loss 1. when a decline in its fair value has been recognised directly in equity and 2. there is objective evidence that it is impaired Then, the cumulative loss recognised directly in equity shall be removed from equity and recognised in profit or loss even the asset has not been derecognised. Impairment loss is measured as the difference between the carrying amount of the financial asset, and the present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset Nelson 74 37

38 Measurement Impairment FA at FV through P/L AFS financial assets HTM investments Loans and receivables at Fair Value at Fair Value at Cost at Amortised Cost at Amortised Cost Outside Outside the the scope scope of of IAS IAS Impairment (if there is objective evidence) The amount of impairment loss is measured as the difference between the asset s carrying amount ( 账面价值 ), and the present value of estimated future cash flows ( 预计未来现金流量现值 ) (excluding future credit losses that have not been incurred) discounted at the financial asset s original effective interest rate (i.e. the effective interest rate computed at initial recognition) The carrying amount of the asset shall be reduced either directlyor through use of an allowance account. The amount of the loss shall be recognised in profit or loss ( 计入当期损益 ) Nelson 75 Measurement Impairment FA at FV through P/L AFS financial assets HTM investments Loans and receivables at Fair Value at Fair Value at Cost Implication? at Amortised Cost at Amortised Cost Outside Outside the the scope scope of of IAS IAS Impairment (if there is objective evidence) Sequence of Impairment Assessment First assesses whether objective evidence of impairment exists ( 单独减值测试 ) individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If an entity determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not ( 集体减值测试 ) it includes the asset in a group of financial assets with similar credit risk characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment Nelson 76 38

39 Measurement Impairment Example Impairment Based on Ageing Analysis Entity A calculates impairment in the unsecured portion of loans and receivables on the basis of a provision matrix that specifies fixed provision rates for the number of days a loan has been classified as non-performing as follows: 0% if less than 90 days 20% if days 50% if days, and 100% if more than 365 days Can the results be considered to be appropriate for the purpose of calculating the impairment loss on loans and receivables? Not Not necessarily. IAS IAS requires impairment or or bad bad debt debt losses to to be be calculated as as the the difference between the the asset s carrying amount and and the the present value of of estimated future cash flows discounted at at the the financial instrument s original effective interest rate. rate Nelson 77 Measurement Impairment Case Hang Seng Bank (2004 Annual Report) Provisions for bad and doubtful debts On adoption of HKAS 39 (similar to IAS 39), Impairment provisions for advances assessed individually are calculated using a discounted cash flow analysis for the impaired advances. Collective assessment of impairment for individually insignificant items or items where no impairment has been identified on an individual basis is made using formula-based approaches or statistical methods. Impairment provisions for advances will be presented as individually assessed and collectively assessed instead of specific provisions and general provisions. There will be no significant change in the net charge for provisions to profit and loss account Nelson 78 39

40 Measurement Summary FA at FV through P/L AFS financial assets HTM investments Subsequent Measurement at Fair Value to P/L at Fair Value to Equity From Equity to P/L at Cost To P/L at Amortised Cost Impairment Not required To P/L Reversal N/A Related objectively to an event for debt instrument only Related objectively to an event Reclassification Not allowed To HTM or AFS at Cost To AFS at Fair Value To AFS Loans and receivables at Amortised Cost To P/L Related objectively to an event Not described in IAS 39; implicitly, not feasible Nelson 79 Presentation and Disclosure IAS IAS Financial Instruments: IAS IAS Financial Instruments: Disclosure and and Presentation Presentation (( 列报列报 )) Aims Aims at at enhancing financial Aims Aims at at establishing principles statement users users understanding of of for for presenting financial the the significance of of financial instruments as as liabilities or or instruments to to an an entity s entity s equity equity and and for for offsetting financial position, performance financial assets assets and and financial and and cash cash flows. flows. liabilities. From Contains requirements for for the the presentation IFRS 7 Financial Instruments: of of financial instruments Disclosures (( 披露披露 ) and and identifies the the ) information that that should should be be Aims Aims at at providing disclosures to to disclosed about about them. them. evaluate the the significance of of financial instruments and and the the nature nature and and extent extent of of risks risks arising arising from from financial instruments Nelson 80 40

41 Presentation under IAS 32 Presentation from the perspective of the issuer on Liability and equity Compound financial instruments Treasury shares Interests, dividends, losses and gains The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument. (assess the substance) Nelson 81 Presentation under IAS 32 Presentation from the perspective of the issuer on Liability and equity No delivery of cash or financial asset No delivery of variable no. of own shares An instrument can be an equity instrument if, and only if, both conditions (a) and (b) below are met. a) The instrument includes no contractual obligation: i) to deliver cash or another financial asset; or ii) to exchange financial instrument under conditions that are potentially unfavourable to the issuer. b) If the instrument will or may be settled in the issuer s own equity instruments, it is: i) a non-derivative that includes no contractual obligation to deliver a variable no. of its own equity instruments; or ii) a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments Nelson 82 41

42 Presentation under IAS 32 IAS 32 also requires extensive disclosures Liability and equity Compound financial instruments Treasury shares Interests, dividends, losses and gains Disclosure Risk management policies and hedging activities Terms, condition and accounting policies Interest rate risk risk Credit risk risk Fair value (for (for the the instrument not not carried at at fair fair value) Other disclosures (including derecognition, collateral, effect on on income statement and equity, reclassification, impairment, and etc) Disclosure requirements amended by by IFRS 7 Offsetting ( 抵销 ) Financial assets and and financial liabilities are are offset when and and only when 1) 1) there is is a legally enforceable right to to set set off, off, and and e.g. Can discounted 2) 2) the the entity intends to to settle on on a net net basis bills meet? Nelson 83 Disclosure under IFRS 7 The objective of IFRS 7 is to require entities to provide disclosures in their financial statements that enable users to evaluate: 1) the significance of financial instruments for the entity s financial position and financial performance; and 2) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks. Significance Balance sheet Income statement Other disclosures Nature and Extent Qualitative disclosures Quantitative disclosures Nelson 84 42

43 Disclosure under IFRS 7 IFRS 7 supersedes (from 1 Jan. 2007) Full IAS 30 Para. 51 to 95 of IAS 32 As compared with IAS 30 and 32, IFRS 7 has the following attributes: 1. Apply to all entities while IAS 30 applies to financial institution only 2. Is more correlation with the categories of financial instruments as defined in IAS Aim at simplifying the disclosure requirements of IAS 32 on risks but introduced some new disclosures 4. IAS 32 has exemption for comparative on first year of adoption but IFRS 7 only provides exemption on the nature and extent of risks. Significance Nature and Extent Nelson 85 Disclosure under IFRS 7 Nature and Extent Quantitative Disclosures Market risk IFRS 7 requires the disclosures of sensitivity analysis ( 敏感性分析 ). The disclosures of sensitivity analysis can be achieved by 2 approaches: 1. Sensitivity analysis for each type of market risk ( 市场风险 ) 2. Sensitivity analysis that reflects interdependencies ( 关联性 ) between risks variables For For example VaR VaR (Value at at Risk) Sensitivity analysis Nelson 86 43

44 Disclosure under IFRS 7 Case Early adopted HKFRS 7 (same as IFRS 7) in 2005 and its annual report states that (extract only): Risk management techniques, such as Value-at-Risk ( VaR ) based on historical simulation and portfolio stress testing, are used to identify, measure and control foreign exchange risk, equity price risk and interest rate risks of the Group s investments. VaR measures the expected maximum loss over a given time interval (a holding period of 10 trading days is used by the Group) at a given confidence level (95 per cent confidence interval is adopted by the Group) based on historical data (one year is used by the Group). The Board sets a limit on total VaR of the Group and VaR is monitored on a weekly basis Nelson 87 Disclosure under IFRS 7 Case Early adopted HKFRS 7 (same as IFRS 7) in 2005 and its annual report states that (extract only): The VaR for each risk factor and the total VaR of the investments of the Group and HKEx during the year were as follows: Group HKEx Average Highest Lowest Average Highest Lowest $million $million $million $million $million $million Foreign exchange risk Equity price risk Interest rate risk Total VaR Nelson 88 44

45 Business Combinations (IFRS 3) Nelson 89 Objective of IFRS 3 Scope Method of of accounting Application of of the method To specify the financial reporting by an entity when it undertakes a business combination ( 企业合并 ) In particular, IFRS 3 specifies that all business combinations should be accounted for by applying the purchase method ( 购买法 ) Therefore, the acquirer: a) recognises the acquiree s identifiable assets, liabilities and contingent liabilities at their fair values at the acquisition date, and b) recognises goodwill, which is subsequently tested for impairment rather than amortised Nelson 90 45

46 Application of the Method Scope Method of accounting Applying the purchase method involves the following steps: Application of of (a) the method Identifying an acquirer (b) Measuring the cost of the business combination (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date Nelson 91 Application of the Method Scope Method of accounting Application of of the method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date Nelson 92 46

47 Application of the Method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date 对合并成本进行分配 At the acquisition date, the acquirer shall allocate the cost of a business combination by: recognising the acquiree s identifiable assets, liabilities and contingent liabilities ( 可辨认资产 负债和或有负债 ) that satisfy the recognition criteria at their fair values at that date except for non-current assets (or disposal groups), that are classified as held for sale in accordance with IFRS 5, which shall be recognised at fair value less costs to sell Also implies Subsidiary acquired for temporary purpose is also consolidated but, if conditions met, it is valued and presented in accordance with IFRS 5 Cost of Business Combination Identifiable assets, liabilities and contingent liabilities Nelson 93 Application of the Method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date 对合并成本进行分配 Any difference between a) the cost of the business combination and b) the acquirer s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities so recognised shall be accounted for as goodwill ( 商誉 ) or negative goodwill ( 负商誉 ) Cost of Business Combination Identifiable assets, liabilities and contingent liabilities Goodwill Nelson 94 47

48 Application of the Method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date 对合并成本进行分配 Recognition criteria: 1. Asset other than an intangible asset Probable that its future economic benefit will flow in Its fair value can be measured reliably 2. Liability other than a contingent liability Probable that an outflow of resources with economic benefit will be required to settle the obligation Its fair value can be measured reliably 3. Contingent liability ( 或有负债 ) or intangible asset ( 无形资产 ) Its fair value can be measured reliably Aligned with IAS 37 Liabilities Intangible assets Contingent liabilities Any special? Assume Probable fulfilled Nelson 95 Application of the Method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date 对合并成本进行分配 Contingent liabilities Under IFRS 3 或有负债 the acquirer recognises separately a contingent liability of the acquiree as part of allocating the cost of a business combination only if its fair value can be measured reliably. After their initial recognition, the acquirer shall measure contingent liabilities that are recognised separately under IFRS 3 at the higher of: a) the amount that would be recognised in accordance with IAS 37, and b) the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue Nelson 96 48

49 Application of the Method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date 对合并成本进行分配 Goodwill ( 商誉 ) acquired in a business combination at the acquisition date shall be recognised as an asset and initially measured that goodwill at its cost after initial recognition shall be measured at cost less any accumulated impairment losses shall NOT be amortised instead, shall be tested for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired in accordance with IAS 36 Identifiable assets, liabilities and contingent liabilities Goodwill Nelson 97 Application of the Method (c) Allocating (b) to assets acquired and liabilities and contingent liabilities assumed at the acquisition date 对合并成本进行分配 Negative goodwill ( 负商誉 ) For our discussion purpose, No such name as negative goodwill now Negative Goodwill is still used Now termed as excess of the acquirer s interest in the net fair value of the acquiree s identifiable assets, liabilities and contingent liabilities over the cost of a business combination If there is such excess, the acquirer shall: a) reassess the identification and measurement of the acquiree s identifiable assets, liabilities and contingent liabilities and the measurement of the cost of the combination; and b) after that reassessment, recognise immediately in profit or loss any such excess remaining Nelson 98 49

50 Application of the Method Case The purchase method of accounting is used to account for the acquisition of subsidiaries by HSBC. The cost of an acquisition is measured at the fair value of the consideration at the date of exchange, together with costs directly attributable to that acquisition. The acquired identifiable assets, liabilities and contingent liabilities are measured at their fair values at the date of acquisition. The excess of the cost of acquisition over the fair value of the Group s share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the Group s share of the net assets of the subsidiary acquired, the difference is recognised directly in the income statement Nelson 99 Effects of Changes in Foreign Exchange Rates (IAS 21) Nelson

51 Approach in IAS 21 Determine Functional Currency 功能货币 Translate Foreign Currency Transactions Translate Foreign Operation or Whole Set 1. In preparing financial statements, each entity determines its functional currency. 2. The entity translates foreign currency items or transactions ( 外币项目或交易 ) into its functional currency and reports the effects of such translation. 3. The results and financial position of any individual entity (say subsidiary, associate or branches) within the reporting entity (say parent) whose functional currency differs from the presentation currency ( 功能货币与列报货币 ) of the reporting entity are translated. 4. If the entity s presentation currency differs from its functional currency, its results and financial position are also translated into the presentation currency Nelson 101 Approach in IAS 21 Determine Functional Currency 功能货币 Critical Translate Foreign Currency Transactions Translate Foreign Operation or or Whole Whole Set Set Nelson

52 Indicators to Determine Determine Functional Currency Functional currency ( 功能货币 ) is is the the currency of of the the primary economic environment in in which the the entity operates. Primary indicators a) the currency i) that mainly influences sales prices for goods and services, and ii) of the country whose competitive forces and regulations mainly determine the sales price of its goods and services. b) the currency that mainly influences labour, material and other costs of providing goods or service. Other indicators in determining functional currency a) the currency in which funds from financing activities (ie issuing debt and equity instruments) are generated. b) the currency in which receipts from operating activities are usually retained Nelson 103 Indicators to Determine Determine Functional Currency Functional currency ( 功能货币 ) is is the the currency of of the the primary economic environment in in which the the entity operates. When the above indicators are mixed and the functional currency is not obvious management uses its judgement to determine the functional currency that most faithfully represents the economic effects of the underlying transactions, events and conditions. An entity s functional currency reflects the underlying transactions, events and conditions that are relevant to it once determined, the functional currency is not changed unless there is a change in those underlying transactions, events and conditions. If the functional currency is the currency of a hyperinflationary economy, the entity s financial statements are restated in accordance with IAS 29 An entity cannot avoid restatement in accordance with IAS 29 by, for example, adopting as its functional currency a currency other than the functional currency determined in accordance with IAS 21 (such as the functional currency of its parent) Nelson

53 Indicators to Determine Determine Functional Currency Functional currency ( 功能货币 ) is is the the currency of of the the primary economic environment in in which the the entity operates. Foreign currency (( 外币外币 )) is is a currency other than than the the functional currency of of the the entity. Presentation currency (( 列报货币 )) is is the the currency in in which the the financial statements are are presented. Foreign operation (( 境外业务 )) is is an an entity that that is is a subsidiary, associate, joint joint venture or or branch of of a reporting entity, the the activities of of which are are based or or conducted in in a country or or currency other than than those of of the the reporting entity Nelson 105 Indicators to Determine Example Functional currency ( 功能货币 ) is is the the currency of of the the primary economic environment in in which the the entity operates. If Entity A, a UK incorporated, reports its financial statements in GBP. However, its production office is located in PRC but only serves for accounting purpose. All the other operation, trading and finance souring are located in PRC and all the transactions are denominated in RMB. Which currency is the foreign currency of Entity A under IAS 21? Under previous practice in in some locations The reporting currency is is UK GBP The foreign currency is is RMB Under IAS 21 The functional currency is is RMB The foreign currency is is UK GBP Nelson

54 Indicators to Determine Case Annual Report and Accounts 2005 Accounting policy on foreign currency translation Both the parent company financial statements and the Group financial statements are presented in US dollars, which is the Group s functional and presentation currency. Annual Report 2005 Items included in the financial statements of each of HSBC s entities are measured using the currency of the primary economic environment in which the entity operates ( the functional currency ). The consolidated financial statements of HSBC are presented in US dollars, which is the Group s presentation currency Nelson 107 Consolidated and Separate Financial Statements (IAS 27) Nelson