Financial Reporting Update January 2018

Transcription

1 Financial Reporting Update January 2018 LAM Chi Yuen Nelson 林智遠 CFA Charter Holder, FCPA(Practising) MBA MSc BBA CPA(U.S.) FCA FCCA FCPA(Aust.) FSCA Egypt Stephanie & Nelson Nelson Consulting Limited 1 Malbork 2013 Nelson PolandConsulting Limited Photo taken by Stephanie and Nelson

2 Effective for 2017 Dec. Year End Selected new interpretations and amendments to HKFRSs Amendments to HKAS 7 Disclosure Initiative (Statement of Cash Flows) Amendments to HKAS 12 Recognition of Deferred Tax Assets for Unrealised Losses Annual Improvements to HKFRSs Cycle (Amendments to HKFRS 12) Amendments to HKFRS for Private Entities Effective for periods beginning on/after 1 Jan Jan Jan Jan Nelson Consulting Limited Updated to HKICPA Update. 213 of January Effective for 2018 Dec. Year End Selected new interpretations and amendments to HKFRSs HKFRS 9 (2014) Financial Instruments Amendments to HKFRS 9 Clarify the Basis for Conclusions HKFRS 15 Revenue from Contracts with Customers Amendments to HKFRS 15 Effective Date of HKFRS 15 Revenue from Contracts with Customers Amendments to HKFRS 15 Clarifications to HKFRS 15 Revenue from Contracts with Customers Amendments to HKFRS 2 Classification and Measurement of Share-based Payment Transactions Amendments to HKFRS 4 Applying HKFRS 9 and HKFRS 4 Amendments to HKAS 40 Transfers of Investment Property Annual Improvements to HKFRSs Cycle (Amendments to HKFRS 1 and HKAS 28) Hong Kong (IFRIC) Interpretation 22 Foreign Currency Transactions and Advance Consideration Effective for periods beginning on/after 1 Jan Jan Jan Jan Jan Jan Jan Jan Jan Nelson Consulting Limited Updated to HKICPA Update. 213 of January

3 Effective after 2018 Dec. Year End Selected new interpretations and amendments to HKFRSs HKFRS 16 Leases Hong Kong (IFRIC) Interpretation 23 Uncertainty over Income Tax Treatments Amendments to HKFRS 9 Prepayment Features with Negative Compensation. Amendments to HKAS 28 Investments in Associates and Joint Ventures Amendments to HKFRS 10 and HKAS 28 Sale or Contribution of Assets between an Investor and its Associate or Joint Venture HKFRS 17 Insurance Contracts Effective for periods beginning on/after 1 Jan Jan Jan Jan Jan (a date to be determined by the IASB) 1 Jan Nelson Consulting Limited Updated to HKICPA Update. 213 of January Today s Agenda Recap and Update Comprehensive Examples Flowchart New or Revised HKFRS Effective for 2017 New or Revised HKFRS Effective for 2018 New or Revised HKFRS Effective for and after 2019 Full presentation can be found in: Nelson Consulting Limited 6 3

4 Today s Agenda New or Revised HKFRS Effective for 2017 Full presentation can be found in: Nelson Consulting Limited 7 Rovaniemi 2013 Nelson Finland Consulting Limited Photo taken by Stephanie and Nelson

5 Disclosure Initiative (Amendments to HKAS 7 Statement of Cash Flows) Nelson Consulting Limited 9 Amendments to HKAS 7 In 2016, the IASB amended IAS 7, and the HKICPA then followed to amend HKAS 7, as part of the IASB s Disclosure Initiative project HKAS 7 then requires entities to provide disclosures that enable users of financial statements to evaluate changes in liabilities arising from financing activities, including both changes arising from cash flows and non cash changes (HKAS 7.44A) Nelson Consulting Limited 10 5

6 Amendments to HKAS 7 To the extent necessary to satisfy the new requirement, an entity is required to disclose the following changes in liabilities arising from financing activities: 1. changes from financing cash flows; 2. changes arising from obtaining or losing control of subsidiaries or other businesses; 3. the effect of changes in foreign exchange rates; 4. changes in fair values; and 5. other changes. To fulfil the disclosure requirement, an entity can provide a reconciliation between the opening and closing balances in the statement of financial position for liabilities arising from financing activities, including the changes as identified above Nelson Consulting Limited 11 Amendments to HKAS 7 Example Reconciliation of liabilities arising from financing activities 2015 Cash flows n cash changes 2016 Acquisition New leases $ $ $ $ $ Long term borrowings 1, ,490 Lease liabilities (90) Long term debt 1, , Nelson Consulting Limited 12 6

7 Effective Date Disclosure Initiative (Amendments to HKAS 7), issued in January 2016, added paragraphs 44A 44E. An entity shall apply those amendments for annual periods beginning on or after 1 January Earlier application is permitted. When the entity first applies those amendments, it is not required to provide comparative information for preceding periods. (HKAS 7.60) Nelson Consulting Limited 13 Deferred Tax Assets for Unrealised Losses (Amendments to HKAS 12 Income Taxes) Nelson Consulting Limited 14 7

8 Amendments to HKAS 12 In 2016, the IASB issued amendments to IAS 12, and then HKICPA followed the same, to clarify the requirements on recognition of deferred assets for unrealised losses, including the deferred tax assets related to debt instruments measured at fair value Nelson Consulting Limited 15 Amendments to HKAS 12 When an entity assesses whether taxable profits will be available against which it can utilise a deductible temporary difference, it considers whether tax law restricts the sources of taxable profits against which it may make deductions on the reversal of that deductible temporary difference. If tax law imposes no such restrictions, an entity assesses a deductible temporary difference in combination with all of its other deductible temporary differences. However, if tax law restricts the utilisation of losses to deduction against income of a specific type, a deductible temporary difference is assessed in combination only with other deductible temporary differences of the appropriate type (HKAS 12.27A) Nelson Consulting Limited 16 8

9 Amendments to HKAS 12 In estimating probable future taxable profit, the estimate may include the recovery of some of an entity s assets for more than their carrying amount if there is sufficient evidence that it is probable that the entity will achieve this. (HKAS 12.29A) Nelson Consulting Limited 17 Amendments to HKAS 12 Example Happy Limited measures a fixed rate debt instrument at fair value (which is lower than the maturity value). HKAS 12 requires Happy to consider whether there is sufficient evidence to conclude that it is probable that Happy will recover the instrument for more than its carrying amount. When Happy expects to hold a fixed rate debt instrument until maturity and collect all the contractual cash flows, this may be the case that it is probable that Happy will recover the instrument for more than its carrying amount Nelson Consulting Limited 18 9

10 Effective Date Recognition of Deferred Tax Assets for Unrealised Losses (Amendments to HKAS 12), issued in January 2016, amended paragraph 29 and added paragraphs 27A, 29A and the example following paragraph 26. An entity shall apply those amendments for annual periods beginning on or after 1 January Earlier application is permitted. If an entity applies those amendments for an earlier period, it shall disclose that fact Nelson Consulting Limited 19 Effective Date An entity shall apply those amendments retrospectively in accordance with HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. However, on initial application of the amendment, the change in the opening equity of the earliest comparative period may be recognised in opening retained earnings (or in another component of equity, as appropriate), without allocating the change between opening retained earnings and other components of equity. If an entity applies this relief, it shall disclose that fact. (HKAS 12.98H) Nelson Consulting Limited 20 10

11 Annual Improvements Cycle Nelson Consulting Limited 21 A. Improvements : Introduction Annual Improvement Project A vehicle for making non urgent but necessary amendments to IFRS (and consequentially HKFRSs) Introduced by the IASB in 2007 and issued each year The amendments contained in Annual Improvements Cycle Are issued in February Nelson Consulting Limited 22 11

12 A. Improvements : Introduction HKFRS Amended HKFRS 1 First time Adoption of Hong Kong Financial Reporting Standards HKFRS 12 Disclosure of Interests in Other Entities HKAS 28 Investments in Associates and Joint Ventures Subject of Amendments Deletion of short term exemptions for first time adopters Clarification of the scope of HKFRS 12 Measuring an associate or joint venture at fair value Effective in 2018 Effective in 2017 Effective in Nelson Consulting Limited 23 A. Improvements : HKFRS 1 In Annual Improvements to IFRS Standards Cycle, the Board (IASB) deleted the short term exemptions in paragraphs E3 E7 and the related effective date paragraphs. They included Disclosures about financial instruments (HKFRS 7) Employee benefits (HKAS 19) Investment entities (HKFRS 10) The Board noted that the reliefs provided in those paragraphs were no longer applicable. The reliefs provided had been available to entities only for reporting periods that had passed. (HKFRS 1.BC99) Nelson Consulting Limited 24 12

13 A. Improvements : HKFRS 1 Annual Improvements to HKFRS Standards Cycle, issued in February 2017, amended paragraphs 39L and 39T and deleted paragraphs 39D, 39F, 39AA and E3 E7. An entity shall apply those amendments for annual periods beginning on or after 1 January (HKFRS 1.39AD) Nelson Consulting Limited 25 A. Improvements : HKFRS 12 Except as described in HKFRS 12.B17, the requirements in HKFRS 12 (Disclosure of Interests in Other Entities) apply to an entity s interests listed in HKFRS 12.5 that are classified (or included in a disposal group that is classified) as held for sale or discontinued operations in accordance with HKFRS 5 n current Assets Held for Sale and Discontinued Operations. (HKFRS 12.5A) Nelson Consulting Limited 26 13

14 A. Improvements : HKFRS 12 Annual Improvements to HKFRS Standards Cycle, issued in February 2017, added paragraph 5A and amended paragraph B17. An entity shall apply those amendments retrospectively in accordance with HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors for annual periods beginning on or after 1 January (HKFRS 12.C1D) Nelson Consulting Limited 27 A. Improvements : HKAS 28 When an investment in an associate or a joint venture is held by, or is held indirectly through, an entity that is a venture capital organisation, or a mutual fund, unit trust and similar entities including investment linked insurance funds, the entity may elect to measure that investments at fair value through profit or loss in accordance with HKFRS 9. An entity shall make this election separately for each associate or joint venture, at initial recognition of the associate or joint venture. (HKAS 28.18) Added by AI Nelson Consulting Limited 28 14

15 A. Improvements : HKAS 28 twithstanding the requirement in HKAS 28.36, if an entity that is not itself an investment entity has an interest in an associate or joint venture that is an investment entity, the entity may, when applying the equity method, elect to retain the fair value measurement applied by that investment entity associate or joint venture to the investment entity associate s or joint venture s interests in subsidiaries. This election is made separately for each investment entity associate or joint venture, at the later of the date on which (a) the investment entity associate or joint venture is initially recognised; (b) the associate or joint venture becomes an investment entity; and (c) the investment entity associate or joint venture first becomes a parent. (HKAS 28.36A) Added by AI Nelson Consulting Limited 29 A. Improvements : HKAS 28 Annual Improvements to HKFRS Standards Cycle, issued in February 2017, amended paragraphs 18 and 36A. An entity shall apply those amendments retrospectively in accordance with HKAS 8 for annual periods beginning on or after 1 January Earlier application is permitted. If an entity applies those amendments for an earlier period, it shall disclose that fact. (HKAS 28.45E) Nelson Consulting Limited 30 15

16 HKFRS for Private Entities Small vs. Large Nelson Consulting Limited 31 Key Changes (HKICPA Update. 175) Allowing an option to use the revaluation model for property, plant and equipment; and Replacing the modified text in section 29 Income Tax of HKFRS for PE with the revised section 29 of the amendments to the IFRS for SMEs. As a result of this change, the recognition and measurement requirements for deferred income taxes of HKFRS for PE, IFRS for SMEs and IAS 12 Income Taxes are now aligned. The other amendments clarify the existing requirements or add supporting guidance, instead of changing the underlying requirements in the standard Nelson Consulting Limited 32 16

17 Kyoto 2013 Japan Nelson Consulting Limited Photo taken by Stephanie and Nelson Today s Agenda New or Revised HKFRS Effective for 2018 Full presentation can be found in: Nelson Consulting Limited 34 17

18 HKFRS 9 Financial Instruments Nelson Consulting Limited 35 HKFRS 9 Financial Instruments 1. Objective 2. Scope 3. Recognition and Derecognition 4. Classification 5. Measurement 6. Hedge Accounting 7. Effective Date and Transition Nelson Consulting Limited 36 18

19 Chapter 4.1 Classification of FA Unless para of HKFRS 9 (so called fair value option ) applies, an entity shall classify financial assets as subsequently measured at either amortised cost, fair value through other comprehensive income, or fair value through profit or loss on the basis of both: a) the entity s business model for managing the financial assets; and b) the contractual cash flow characteristics of the financial asset. (para ) Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited 37 Chapter 4.1 Classification of FA Determine the category of a financial asset for subsequent measurement Choose fair value option (designate at fair value through profit or loss)? Held within a business model to collect contractual cash flow? Contractual cash flows are solely principal and interest? Held within a business model to collect contractual cash flow and selling FA? Contractual cash flows are solely principal and interest? Entitle and elect to present fair value changes in other comprehensive income Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited Source: Advanced Financial Reporting (2016) by Nelson Lam, KP Yuen and Jasmine Kwong 38 19

20 Chapter 4.1 Classification of FA Even the common understanding views that there are three categories in HKFRS 9 for the classification and subsequent measurement of a financial asset, a financial asset can be classified into the following five categories or sub categories: 1. Financial asset at amortised cost; 2. Financial asset (not being investment in equity instrument) at fair value through other comprehensive income; 3. Financial asset, being investment in an equity instrument, irrevocable elected to measure at fair value through other comprehensive income. 4. Financial asset at fair value through profit or loss; and 5. Option to designate a financial asset at fair value through profit or loss; Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited 39 Chapter 4.1 Classification of FA A financial asset shall be measured at fair value through profit or loss unless it is measured at amortised cost in accordance with para or at fair value through other comprehensive income in accordance with parag A. However an entity may make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value in other comprehensive income (see para ). (para ) Amortised Cost Fair Value Through Other Comprehensive income Entitle and elect to present fair value changes in other comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited 40 20

21 Chapter 5.7 Gains and Losses At initial recognition, an entity may make an irrevocable election to present in other comprehensive income subsequent changes in the fair value of an investment in an equity instrument within the scope of HKFRS 9 that is neither held for trading nor contingent consideration recognised by an acquirer in a business combination to which HKFRS 3 applies. (para ) If an entity makes the above election in para , it shall recognise in profit or loss dividends from that investment in accordance with para A. (para ) For those classified as measured at fair value Part of hedging relationship Fair value option? Equity instrument? Held for trading? and/or contingent consideration? Entitle and elect to present fair value changes in other comprehensive income Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited Source: Intermediate Financial Reporting, 3rd (2017) by Nelson Lam & Peter Lau 41 Chapter 5.7 Gains and Losses This election (para ) is made on an instrument by instrument (ie share byshare) basis. Amounts presented in other comprehensive income shall not be subsequently transferred to profit or loss. However, the entity may transfer the cumulative gain or loss within equity. (para. B5.7.1) The gain or loss that is presented in other comprehensive income in accordance with para includes any related foreign exchange component. (para. B5.7.3) Fair Value Through Other Comprehensive income For those classified as measured at fair value Part of hedging relationship Fair value option? Equity instrument? Held for trading? and/or contingent consideration? Entitle and elect to present fair value changes in other comprehensive income Nelson Consulting Limited Source: Intermediate Financial Reporting, 3rd (2017) by Nelson Lam & Peter Lau 42 21

22 Chapter 4.3 Embeded Derivatives Contract meets the definition of derivative Is the derivative a financial guarantee contract? Is the derivative a designated and effective hedging instrument? Derivative other than financial guarantee contract and designated and effective hedging instrument Accounting for as financial guarantee contract Apply hedge accounting Accounting for derivatives Nelson Consulting Limited Source: Advanced Financial Reporting (2016) by Nelson Lam, KP Yuen and Jasmine Kwong 43 Chapter 4.3 Embeded Derivatives Hybrid contract with financial asset host? Other hybrid contract Economic characteristics and risks of the embedded derivative closely related? Embedded derivative meets the definition of derivative? Hybrid contract measured at fair value through profit or loss? Separate the embedded derivative from the host Hybrid contract with financial asset host Accounted for as other financial assets t to separate the embedded derivative from the host Embedded derivative n financial asset host Accounted for as other derivatives Apply applicable HKFRS Nelson Consulting Limited Source: Advanced Financial Reporting (2016) by Nelson Lam, KP Yuen and Jasmine Kwong 44 22

23 HKFRS 9 Financial Instruments 1. Objective 2. Scope 3. Recognition and Derecognition 4. Classification 5. Measurement 6. Hedge Accounting 7. Effective Date and Transition Nelson Consulting Limited 45 Chapter 5 Measurement Initial measurement Except for trade receivables within the scope of para , at initial recognition, an entity shall measure a financial asset or financial liability at its fair value To align HKFRS 15 Initial Measurement Fair Value plus or minus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. (para ) However, if the fair value of the financial asset or financial liability at initial recognition differs from the transaction price, an entity shall apply para. B5.1.2A. (para A) + Transaction Cost Nelson Consulting Limited 46 23

24 Chapter 5 Measurement Subsequent Measurement of Financial Assets After initial recognition, an entity shall measure a financial asset in accordance with para at: a. amortised cost; b. fair value through other comprehensive income; or c. fair value through profit or loss. (para ) Amortised Cost Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited 47 Chapter 5 Measurement Subsequent Measurement of Financial Assets An entity shall apply the impairment requirements in Section 5.5 to financial assets that are measured at amortised cost in accordance with para (i.e. under the hold to collect business model) and to financial assets that are measured at fair value through other comprehensive income in accordance with para A (i.e. under the hold to collect and sell business model). (para ) Impairment requirements applied to these two categories only (implied that equity instruments are not subject to impairment requirements) 1 2 Amortised Cost Fair Value Through Other Comprehensive income Entitle and elect to present fair value changes in other comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited 48 24

25 Chapter 5.5 Impairment Recognition of Expected Credit Losses General Approach An entity shall recognise a loss allowance for expected credit losses on a financial asset that is measured in accordance with para or 4.1.2A, a lease receivable, a contract asset or a loan commitment and a financial guarantee contract to which the impairment requirements apply in accordance with para. 2.1(g), 4.2.1(c) or 4.2.1(d). (para ) HKFRS 9 defines expected credit losses as: The weighted average of credit losses with the respective risks of a default occurring as the weights Nelson Consulting Limited 49 Chapter 5.5 Impairment To understand and apply these requirements, an entity has to ascertain the scope of the impairment in HKFRS 9, the concept of expected credit losses, the approach in recognition of expected credit losses, the financial instruments with the scope in recognition of expected credit losses but not falling within the three stage model, the assessment of the credit risk on a financial instrument since initial recognition, the determination of financial instruments being credit impaired, and the three stage model in such recognition Nelson Consulting Limited 50 25

26 Chapter 5.5 Impairment Is the financial instrument a purchased or originated credit impaired financial asset? Is simplified approach for trade receivables, contract assets and lease receivables applicable? Does the financial instrument have low credit risk at the reporting date? Is the low credit risk simplification applied? Recognise 12 month expected credit losses Has there been a significant increase in credit risk since initial recognition? Always recognise a loss allowance for changes in lifetime expected credit losses, and Calculate a credit adjusted effective interest rate Is the financial instrument a credit impaired financial asset? (Section ) Stage 1 Stage 2 Stage 3 Calculate interest revenue on gross carrying amount Calculate interest revenue on gross carrying amount Calculate interest revenue on amortised cost Nelson Consulting Limited Adapted from the flowchart after HKFRS 9.IE Recognise lifetime expected credit losses Chapter 5.5 Impairment Scope in Recognition of Expected Credit Losses In HKFRS 9, not only financial assets but also some financial instruments may fall within the scope in recognition of expected credit losses. HKFRS 9 specifically requires to an entity to recognise a loss allowance for expected credit losses on the following financial assets: 1. Financial asset at amortised cost; 2. Financial asset (not being investment in equity instrument) at fair value through other comprehensive income ; 3. Lease receivable, 4. Contract asset, or 5. Loan commitment and financial guarantee contract to which the impairment requirements apply in accordance with HKFRS Nelson Consulting Limited 52 26

27 Chapter 5.5 Impairment The Concept of Expected Credit Losses The main change of the impairment requirements in HKFRS 9 is the introduction of the expect credit loss to replace the incurred loss model. The IASB considered that, for those financial assets being the debt instruments, the effect of changes in credit risk are more relevant to an investor s understanding of the likelihood of the collection of future contractual cash flows than the effects of other changes, for example changes in market interest rates. The expected credit losses can be further divided into two types: 12 month expected credit losses (recognised in Stage 1 of the impairment stages); and lifetime expected credit losses (recognised in Stage 2 and 3 of the impairment stages and for specific financial instruments) Nelson Consulting Limited 53 Chapter 5.5 Impairment Approach in Recognition of Expected Credit Losses To achieve the objective and comply the impairment requirements in HKFRS 9, an entity is required to have the following 3 kinds of assessment: 1. Asset type assessment to assess the type of the financial asset and determine whether it is a) purchased or originated credit impaired financial assets; b) trade receivables, contract assets and lease receivables for which the entity applies simplified approach; or c) other financial assets. 2. Credit risk assessment To assess the credit risk on the financial asset; and 3. Credit impaired assessment To determine whether the financial asset is credit impaired Nelson Consulting Limited 54 27

28 Chapter 5.5 Impairment Is the financial instrument a purchased or originated credit impaired financial asset? Is simplified approach for trade receivables, contract assets and lease receivables applicable? Asset type assessment Does the financial instrument have low credit risk at the reporting date? Is the low credit risk simplification applied? Has there been a significant increase in credit risk since initial recognition? Credit risk assessment Credit impaired assessment Is the financial instrument a credit impaired financial asset? (Section ) Nelson Consulting Limited 55 Chapter 5.5 Impairment Is the financial instrument a purchased or originated credit impaired financial asset? Is simplified approach for trade receivables, contract assets and lease receivables applicable? Asset type assessment Asset type assessment The financial instruments with the scope in recognition of expected credit losses but not falling within the three stage model Before having credit risk assessment, an entity is required to directly recognise lifetime expected credit losses for two types of financial instruments: 1. Purchased or originated credit impaired financial assets; and 2. Trade receivables, contract assets and lease receivables for which the entity applies simplified approach Nelson Consulting Limited 56 28

29 Chapter 5.5 Impairment Is the financial instrument a purchased or originated credit impaired financial asset? Is simplified approach for trade receivables, contract assets and lease receivables applicable? Always recognise a loss allowance for changes in lifetime expected credit losses, and Calculate a credit adjusted effective interest rate Recognise lifetime expected credit losses Is the financial instrument a credit impaired financial asset? (Section ) Stage 2 Stage 3 Calculate interest revenue on Calculate interest revenue on gross carrying amount amortised cost Nelson Consulting Limited Adapted from the flowchart after HKFRS 9.IE Chapter 5.5 Impairment Example Is simplified approach for trade receivables, contract assets and lease receivables applicable? Bonnie Corporation is a manufacturer and has a portfolio of trade receivables of $30 million in 2015 and operates only in Singapore. Bonnies determines that: The customer base consists of a large number of small clients. The trade receivables are categorised by common risk characteristics that are representative of the customers abilities to pay all amounts due in accordance with the contractual terms. The trade receivables do not have a significant financing component in accordance with HKFRS Nelson Consulting Limited 58 29

30 Chapter 5.5 Impairment Example In accordance with HKFRS 9, the loss allowance for such trade receivables is always measured at an amount equal to lifetime time expected credit losses. Is simplified approach for trade receivables, contract assets and lease receivables applicable? To determine the expected credit losses for the portfolio, Bonnie uses a provision matrix. The provision matrix is based on its historical observed default rates over the expected life of the trade receivables and is adjusted for forward looking estimates. At every reporting date, the historical observed default rates are updated and changes in the forward looking estimates are analysed. In this case, it is forecast that economic conditions will deteriorate over the next year Nelson Consulting Limited 59 Chapter 5.5 Impairment Example On that basis, Bonnie estimates the following provision matrix: 1 30 days days days Over 90 days Current past due past due past due past due Is simplified approach for trade receivables, contract assets and lease receivables applicable? Default rate 1% 3% 5% 10% 15% Trade receivables from the large number of small customers amount to $30 million and are measured using the provision matrix as follows: Gross carrying Default Lifetime expected amount rate credit loss allowance Current $15,000,000 1% $150, days past due 7,500,000 3% 225, days past due 4,000,000 5% 200, days past due 2,500,000 10% 250,000 Over 90 days past due 1,000,000 15% 150,000 $30,000,000 $975, Nelson Consulting Limited 60 30

31 Chapter 5.5 Impairment Does the financial instrument have low credit risk at the reporting date? Is the low credit risk simplification applied? Credit risk assessment Has there been a significant increase in credit risk since initial recognition? Credit risk assessment At each reporting date, for all financial instruments, other than purchased or originated credit impaired financial assets, or financial assets that simplification approach is applied, an entity is required to assess whether the credit risk on a financial instrument has increased significantly since initial recognition Nelson Consulting Limited 61 Chapter 5.5 Impairment Credit risk assessment Risk of Default and Past Due Information HKFRS 9 incorporates two rebuttable presumptions in assessing significant increases in credit risk and risk of default: i. 30 Days past due rebuttable resumption in respect of significant increases in credit risk Regardless of the way in which an entity assesses significant increases in credit risk, there is a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due (HKFRS ). ii. 90 Days past due rebuttable resumption in respect of default occurred In defining default, there is a rebuttable presumption that default does not occur later than when a financial asset is 90 days past due unless an entity has reasonable and supportable information to demonstrate that a more lagging default criterion is more appropriate Nelson Consulting Limited 62 31

32 Chapter 5.5 Impairment Credit impaired assessment the determination of financial instruments being credit impaired, In HKFRS 9, after assessing credit risk and ascertaining past due information, an entity has to determine whether the financial instrument is credit impaired. Credit impaired assessment Is the financial instrument a credit impaired financial asset? (Section ) Nelson Consulting Limited 63 Chapter 5.5 Impairment Three Stage Model By applying such impairment approach in HKFRS 9 to a financial instrument and based on the result of credit risk assessment, an entity may, as explained by the IASB, divide the impairment requirements into three impairment stages: Stage 1 Performing financial instrument stage; Stage 2 Underperforming financial instrument stage; and Stage 3 n performing financial instrument stage Nelson Consulting Limited 64 32

33 Chapter 5.5 Impairment Increase in credit risk since initial recognition Stage 1 Performing Stage 2 Underperforming Stage 3 n Performing Asset type assessment Other financial assets only Credit risk assessment significant increase in (or low) credit risk Credit impaired assessment Impairment recognition 12 month expected credit losses Interest revenue t credit impaired Effective interest on gross carrying amount Other financial assets and those simplification approach applied Significant increase in credit risk Lifetime expected credit losses Credit impaired Effective interest on amortised cost Nelson Consulting Limited Adapted Adapted from the from IASB s Project Summary issued of IFSR in July 9 (July ) 65 Chapter 5.5 Impairment Is the financial instrument a purchased or originated credit impaired financial asset? Is simplified approach for trade receivables, contract assets and lease receivables applicable? Does the financial instrument have low credit risk at the reporting date? Is the low credit risk simplification applied? Recognise 12 month expected credit losses Has there been a significant increase in credit risk since initial recognition? Always recognise a loss allowance for changes in lifetime expected credit losses, and Calculate a credit adjusted effective interest rate Is the financial instrument a credit impaired financial asset? (Section ) Stage 1 Stage 2 Stage 3 Calculate interest revenue on gross carrying amount Calculate interest revenue on gross carrying amount Calculate interest revenue on amortised cost Nelson Consulting Limited Adapted from the flowchart after HKFRS 9.IE Recognise lifetime expected credit losses 33

34 How will it be affected by HKFRS 9? Stage 1 Stage 2 Stage 3 Lifetime expected credit losses HKFRS 9 (HKFRS 9) Nelson Consulting Limited 67 Chapter 7 Effective Date and Transition An entity shall apply HKFRS 9 for annual periods beginning on or after 1 January Earlier application is permitted. (HKFRS 9.7.1) With some restrictions, an entity may elect to early apply some requirements only. (HKFRS ) An entity shall apply HKFRS 9 retrospectively, in accordance with HKAS 8, except as specified in para and HKFRS 9 shall not be applied to items that have already been derecognised at the date of initial application. (HKFRS ) Nelson Consulting Limited 68 34

35 Chapter 7 Effective Date and Transition For the purposes of the transition provisions in para , and 7.3.2, the date of initial application is the date when an entity first applies those requirements of HKFRS 9 and must be the beginning of a reporting period after the issue of HKFRS 9. Depending on the entity s chosen approach to applying HKFRS 9, the transition can involve one or more than one date of initial application for different requirements. (HKFRS ) HKFRS 9 provides further transition arrangements for Classification and measurement Impairment Hedge accounting Nelson Consulting Limited 69 Chapter 7 Effective Date and Transition Classification and measurement At the date of initial application, an entity shall assess whether a financial asset meets the condition in para (a) (i.e. hold to collect business model) or 4.1.2A(a) (i.e. hold to collect and sell business model) on the basis of the facts and circumstances that exist at that date. The resulting classification shall be applied retrospectively irrespective of the entity s business model in prior reporting periods. (HKFRS ) 1 2 Amortised Cost Fair Value Through Other Comprehensive income Nelson Consulting Limited 70 35

36 Chapter 7 Effective Date and Transition Classification and measurement At the date of initial application an entity may designate: a. a financial asset as measured at fair value through profit or loss in accordance with paragraph 4.1.5; or b. an investment in an equity instrument as at fair value through other comprehensive income in accordance with paragraph Such a designation shall be made on the basis of the facts and circumstances that exist at the date of initial application. That classification shall be applied retrospectively. (HKFRS ) 3 5 Fair Value Through Other Comprehensive income Fair Value Through Profit or Loss Nelson Consulting Limited 71 Chapter 7 Effective Date and Transition Classification and measurement If an entity previously accounted at cost (in accordance with HKAS 39), for an investment in an equity instrument that does not have a quoted price in an active market for an identical instrument (ie a Level 1 input) (or for a derivative asset that is linked to and must be settled by delivery of such an equity instrument) it shall measure that instrument at fair value at the date of initial application. Any difference between the previous carrying amount and the fair value shall be recognised in the opening retained earnings (or other component of equity, as appropriate) of the reporting period that includes the date of initial application. (HKFRS ) 3 Fair Value Through Other Comprehensive income 4 5 Fair Value Through Profit or Loss Nelson Consulting Limited 72 36

37 Chapter 7 Effective Date and Transition Impairment An entity shall apply the impairment requirements in Section 5.5 retrospectively in accordance with HKAS 8 subject to para and (HKFRS ) At the date of initial application, an entity shall use reasonable and supportable information that is available without undue cost or effort to determine the credit risk at the date that a financial instrument was initially recognised (or for loan commitments and financial guarantee contracts at the date that the entity became a party to the irrevocable commitment in accordance with para ) and compare that to the credit risk at the date of initial application of HKFRS 9. (HKFRS ) Nelson Consulting Limited 73 Chapter 7 Effective Date and Transition Impairment When determining whether there has been a significant increase in credit risk since initial recognition, an entity may apply: a. the requirements in para and B B5.5.24; and b. the rebuttable presumption in para for contractual payments that are more than 30 days past due if an entity will apply the impairment requirements by identifying significant increases in credit risk since initial recognition for those financial instruments on the basis of past due information. (HKFRS ) Nelson Consulting Limited 74 37

38 Chapter 7 Effective Date and Transition Impairment If, at the date of initial application, determining whether there has been a significant increase in credit risk since initial recognition would require undue cost or effort, an entity shall recognise a loss allowance at an amount equal to lifetime expected credit losses at each reporting date until that financial instrument is derecognised (unless that financial instrument is low credit risk at a reporting date, in which case paragraph (a) applies). (HKFRS ) Nelson Consulting Limited 75 Foreign Currency Transactions and Advance Consideration (HK(IFRIC) Interpretation 22) Nelson Consulting Limited 76 38

39 HK(IFRIC) Int. 22 Background HKAS 21 The Effects of Changes in Foreign Exchange Rates requires that: A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction. (HKAS 21.21) The date of a transaction is the date on which the transaction first qualifies for recognition in accordance with HKFRSs. (HKAS 21.22) Nelson Consulting Limited 77 HK(IFRIC) Int. 22 Background When an entity pays or receives consideration in advance in a foreign currency, it generally recognises a non monetary asset or non monetary liability before the recognition of the related asset, expense or income. The related asset, expense or income (or part of it) is the amount recognised applying relevant Standards, which results in the derecognition of the non monetary asset or non monetary liability arising from the advance consideration. (para. 2) Nelson Consulting Limited 78 39

40 HK(IFRIC) Int. 22 Background Example For example, paragraph 106 of HKFRS 15 Revenue from Contracts with Customers requires that if a customer pays consideration, or an entity has a right to an amount of consideration that is unconditional (i.e. a receivable), before the entity transfers a good or service to the customer, the entity shall present the contract as a contract liability when the payment is made or the payment is due (whichever is earlier) Nelson Consulting Limited 79 HK(IFRIC) Int. 22 Scope This Interpretation applies to a foreign currency transaction (or part of it) when an entity recognises a non monetary asset or non monetary liability arising from the payment or receipt of advance consideration before the entity recognises the related asset, expense or income (or part of it). (para. 4) This Interpretation does not apply when an entity measures the related asset, expense or income on initial recognition: (a) at fair value; or (b) at the fair value of the consideration paid or received at a date other than the date of initial recognition of the non monetary asset or nonmonetary liability arising from advance consideration (for example, the measurement of goodwill applying HKFRS 3 Business Combinations). (para. 5) Nelson Consulting Limited 80 40

41 HK(IFRIC) Int. 22 Scope An entity is not required to apply this Interpretation to: (a) income taxes; or (b) insurance contracts (including reinsurance contracts) that it issues or reinsurance contracts that it holds. (para. 6) Nelson Consulting Limited 81 HK(IFRIC) Int. 22 Issue This Interpretation addresses how to determine the date of the transaction for the purpose of determining the exchange rate to use on initial recognition of the related asset, expense or income (or part of it) on the derecognition of a non monetary asset or nonmonetary liability arising from the payment or receipt of advance consideration in a foreign currency. (para. 7) Nelson Consulting Limited 82 41

42 HK(IFRIC) Int. 22 Conclusion Applying paragraphs of HKAS 21, the date of the transaction for the purpose of determining the exchange rate to use on initial recognition of the related asset, expense or income (or part of it) is the date on which an entity initially recognises the non monetary asset or non monetary liability arising from the payment or receipt of advance consideration. (para. 8) If there are multiple payments or receipts in advance, the entity shall determine a date of the transaction for each payment or receipt of advance consideration. (para. 9) Nelson Consulting Limited 83 HK(IFRIC) Int. 22 Conclusion Example On Day 1, HKABC entered into a contract with a supplier to purchase a machine for use in its business. On Day 2, under the contract terms, HKABC pays the supplier a fixed purchase price of US$1,000. On Day 3, HKABC takes delivery of the machine. HKABC initially recognises a non monetary asset translating US$1,000 into its functional currency at the spot exchange rate between the functional currency and the foreign currency on Day 2. Applying HKAS 21.23(b), HKABC does not update the translated amount of that nonmonetary asset Nelson Consulting Limited 84 42

43 HK(IFRIC) Int. 22 Conclusion Example On Day 3, HKABC takes delivery of the machine and then, HKABC derecognises the non monetary asset, and recognises the machine as property, plant and equipment applying HKAS 16. On initial recognition of the machine, HKABC recognises the cost of the machine using the exchange rate at the date of the transaction, which is Day 2 (the date of initial recognition of the non monetary asset) Nelson Consulting Limited 85 Effective Date An entity shall apply this Interpretation for annual reporting periods beginning on or after 1 January Earlier application is permitted. If an entity applies this Interpretation for an earlier period, it shall disclose that fact. (HK(IFRIC)Int. 22.A1) Nelson Consulting Limited 86 43

44 Transition On initial application, an entity shall apply this Interpretation either: (a) retrospectively applying HKAS 8; or (b) prospectively to all assets, expenses and income in the scope of the Interpretation initially recognised on or after: (i) the beginning of the reporting period in which the entity first applies the Interpretation; or (ii) the beginning of a prior reporting period presented as comparative information in the financial statements of the reporting period in which the entity first applies the Interpretation. (HK(IFRIC)Int. 22.A2) Nelson Consulting Limited 87 Transition An entity that applies para. A2(b) (i.e. prospective application of this Interpretation) shall, on initial application, apply the Interpretation to assets, expenses and income initially recognised on or after the beginning of the reporting period in para. A2(b)(i) or (ii) for which the entity has recognised non monetary assets or non monetary liabilities arising from advance consideration before that date. (HK(IFRIC)Int. 22.A3) Nelson Consulting Limited 88 44

45 Auschwitz 2013 Nelson Poland Consulting Limited Photo taken by Stephanie and Nelson HKFRS 15 Revenue from Contracts with Customers Nelson Consulting Limited 90 45

46 HKFRS 15 Issued in 2014 Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied HKFRS 15 establishes a comprehensive framework for determining whento recognise revenue and how muchrevenue to recognise. The core principle is that an entity recognises revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services Under HKFRS 15, an entity applies a 5 step approach in recognising revenue Nelson Consulting Limited 91 HKFRS 15 Issued in 2014 Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Effective Date An entity shall apply HKFRS 15 for annual reporting periods beginning on or after 1 January (HKICPA Update. 174) Earlier application is permitted. If an entity applies HKFRS 15, it shall disclose that fact Nelson Consulting Limited 92 46

47 HKFRS 15 Issued in 2014 Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied HKFRS 15 supersedes the following Standards: a. HKAS 11 Construction Contracts b. HKAS 18 Revenue c. HK(IFRIC) Int 13 Customer Loyalty Programmes d. HK(IFRIC) Int 15 Agreements for the Construction of Real Estate e. HK(IFRIC) Int 18 Transfers of Assets from Customers f. HK(SIC) Int 31 Revenue Barter Transactions Involving Advertising Services Nelson Consulting Limited 93 Contents in HKFRS 15 Issued in 2014 A. Objective B. Scope C. Recognition Today s update Identifying the contract (Step 1) Identifying performance obligations (Step 2) Satisfaction of performance obligations (Step 5) D. Measurement Determining the transaction price (Step 4) Allocating the transaction price to performance obligations (Step 5) E. Contract costs F. Presentation G. Disclosure Nelson Consulting Limited 94 47

48 Scope Is the contract within HKFRS 15? For a contract within HKFRS 15, there are one or more components within other HKFRSs? Other HKFRSs specify how to separate and/or initially measure one or more part if the contract? Apply other HKFRSs First apply other HKFRSs (the separation and/or measurement requirements of other HKFRSs) Exclude from transaction price the amount measured by other HKFRSs as above Apply HKFRS 15 on the remaining part Apply the requirements in HKFRS Nelson Consulting Limited Source: Intermediate Financial Reporting 3rd (2017) by Nelson Lam and Peter Lau 95 Step 1: Identify the Contract(s) Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 1: Identifying the Contract(s) A contract is an agreement between two or more parties that creates enforceable rights and obligations. The requirements of HKFRS 15 apply to each contract that has been agreed upon with a customer and meets specified criteria. In some cases, HKFRS 15 requires an entity to combine contracts and account for them as one contract. HKFRS 15 also provides requirements for the accounting for contract modifications. (HKFRS 15.IN7) Nelson Consulting Limited 96 48

49 Step 1: Identify the Contract(s) An entity shall account for a contract with a customer that is within the scope of HKFRS 15 only when all of the following criteria (i.e. contract criteria) are met: a. the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations; b. the entity can identify each party s rights regarding the goods or services to be transferred; c. the entity can identify the payment terms for the goods or services to be transferred; d. the contract has commercial substance (i.e. the risk, timing or amount of the entity s future cash flows is expected to change as a result of the contract); and Nelson Consulting Limited 97 Step 1: Identify the Contract(s) An entity shall account for a contract with a customer that is within the scope of HKFRS 15 only when all of the following criteria (i.e. contract criteria) are met: e. it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see HKFRS 15.52) (HKFRS 15.9) Nelson Consulting Limited 98 49

50 Step 1: Identify the Contract(s) Is it a contract with a customer? Does the contract meet the contract criteria (i.e. HKFRS 15.9)? Consideration received? t within HKFRS 15 Either of the following events has occurred? The entity has no remaining obligation and all or substantial all consideration received is non refundable; or The contract has been terminated and consideration received is non refundable Consideration received recognised as liability Continue to assess whether the contract criteria are met subsequently Within HKFRS 15 continue the 5 step model of HKFRS 15 Consideration received recognised as revenue Nelson Consulting Limited Source: Intermediate Financial Reporting 3rd (2017) by Nelson Lam and Peter Lau 99 Comprehensive Example Step 1 Example Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling price of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 15 step by step Nelson Consulting Limited

51 Comprehensive Example Step 1 Example Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 1: Identify the Contract or Contracts with a Customer In Step 1, Leon determines that, prima facie, the contract with Andy meets all the contract criteria and there is only one contract Nelson Consulting Limited 101 Step 2: Identify Performance Obligations Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 2: Identifying the Performance Obligations in the Contract A contract includes promises to transfer goods or services to a customer. If those goods or services are distinct, the promises are performance obligations and are accounted for separately A good or service is distinct if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer and the entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. (HKFRS 15.IN7) Nelson Consulting Limited

52 Step 2: Identify Performance Obligations At contract inception, an entity shall assess the goods or services promised in a contract with a customer, and identify as a performance obligation each promise to transfer to the customer either: a. a good or service (or a bundle of goods or services) that is distinct; or b. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see HKFRS 15.23) (HKFRS 15.22) HKFRS 15 defines performance obligation as: Performance obligations A promise in a contract with a customer to transfer to the customer either: a. a good or service (or a bundle of goods or services) that is distinct; or b. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer Nelson Consulting Limited 103 Step 2: Identify Performance Obligations A good or service that is promised to a customer is distinct if both of the following criteria are met: a. the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and b. the entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract). (HKFRS 15.27) Performance obligations Nelson Consulting Limited

53 Comprehensive Example Step 2 Example Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling price of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 15 step by step Nelson Consulting Limited 105 Comprehensive Example Step 2 Example Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 2: Identify the Performance Obligations in the Contract In Step 2, Leon observes that Leon, as a franchisor, has developed a customary business practice to undertake activities such as analysing the consumers changing preferences and implementing product improvements, pricing strategies, marketing campaigns and operational efficiencies to support the franchise name. However, Leon concludes that these activities do not directly transfer goods or services to Andy because they are part of Leon s promise to grant a licence. Leon determines that it has two promises to transfer goods or services: (a) a promise to transfer equipment and (b) a promise to grant a licence Nelson Consulting Limited

54 Step 3: Determine Transaction Price Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 3: Determining the Transaction Prices The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer can be a fixed amount of customer consideration, but it may sometimes include variable consideration or consideration in a form other than cash is also adjusted for the effects of the time value of money if the contract includes a significant financing component and for any consideration payable to the customer. (HKFRS 15.IN7) Nelson Consulting Limited 107 Step 3: Determine Transaction Price Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 3: Determining the Transaction Prices If the consideration is variable, an entity estimates the amount of consideration to which it will be entitled in exchange for the promised goods or services. The estimated amount of variable consideration will be included in the transaction price only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved. (HKFRS 15.IN7) Nelson Consulting Limited

55 Step 3: Determine Transaction Price The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. When determining the transaction price, an entity shall consider the effects of all of the following: a. variable consideration (see HKFRS and 59); b. constraining estimates of variable consideration (see HKFRS ); c. the existence of a significant financing component in the contract (see HKFRS ); d. non cash consideration (see HKFRS ); and e. consideration payable to a customer (see HKFRS ). (HKFRS 15.48) Variable Consideration Constraining Estimates of Variable Con. Significant Financing Component n cash Consideration Consideration Payable to Customer Nelson Consulting Limited 109 Step 3: Determine Transaction Price Is there any variable consideration? Choose one of the two methods to estimate the variable consideration (depending on which can better predict the consideration entitled) Variable Consideration The expected value method (may be appropriate for large number of contracts with similar characteristics) The most likely amount method (may be appropriate for the contract with only two possible outcomes) Nelson Consulting Limited Source: Intermediate Financial Reporting 3rd (2017) by Nelson Lam and Peter Lau

56 Comprehensive Example Step 3 Example Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling price of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 15 step by step Nelson Consulting Limited 111 Comprehensive Example Step 3 Example Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 3: Determine the Transaction Price In Step 3, Leon is required to determine the transaction price of the contract. Based on the contract terms, Leon determines that the transaction price of Leon s contract includes a fixed consideration of $150,000 for the equipment, and a variable consideration, i.e. a sales based royalty of 5% of Andy s monthly sales Nelson Consulting Limited

57 Comprehensive Example Step 3 Step 3: Determine the Transaction Price Example Step 5: Step 3: Step 1: Step 2: Step 4: Recognise Sales based or usage based royalty Determine may result in variable consideration in Identify the Identify the Allocate the revenue when or the contract an with entity s a contract performance with a customer. transaction as performance transaction customer To account for obligations consideration in the form of a sales based price or usage based obligation is price royalty that is promised in exchange for a licence of intellectual property, satisfied Leon is specifically required to recognise revenue only when or as the later of the following events occurs: a. the subsequent sale or usage occurs; and b. the performance obligation to which some or all of the sales based or usage based royalty has been allocated has been satisfied (or partially satisfied) Nelson Consulting Limited 113 Step 4: Allocate Transaction Price to PO Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 4: Allocating the Transaction Price to Performance Obligations An entity typically allocates the transaction price to each performance obligation on the basis of the relative stand alone selling prices of each distinct good or service promised in the contract. If a stand alone selling price is not observable, an entity estimates it. HKFRS 15 specify when an entity allocates the discount or variable consideration to one or more, but not all, performance obligations (or distinct goods or services) in the contract. (HKFRS 15.IN7) Nelson Consulting Limited

58 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) Allocation of a Discount Allocation of Variable Consideration The objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. (HKFRS 15.73) Nelson Consulting Limited 115 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) Allocation of a Discount Allocation of Variable Consideration To meet the allocation objective, an entity shall allocate the transaction price to each performance obligation identified in the contract on a relative stand alone selling price basis in accordance with HKFRS , except as specified in HKFRS (for allocating discounts) and HKFRS (for allocating consideration that includes variable amounts). (HKFRS 15.74) Nelson Consulting Limited

59 Step 4: Allocate Transaction Price to PO Based on Stand alone Selling Price (SASP) Suitable methods for estimating SASP of a good or service include (not limited to): a. Adjusted market assessment approach b. Expected cost plus a margin approach c. Residual approach d. Combination of the above Nelson Consulting Limited 117 Comprehensive Example Step 4 Example Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling price of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 15 step by step Nelson Consulting Limited

60 Comprehensive Example Step 4 Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Example Step 5: Recognise revenue when or as performance obligation is satisfied Step 4: Determine the Transaction Price In Step 4, Leon has to determine whether the transaction price should be allocated to the two performance obligations in the contract. Leon applies HKFRS 15 to determine whether the variable consideration should be allocated entirely to the performance obligation to transfer the franchise licence Nelson Consulting Limited 119 Comprehensive Example Step 4 Step 4: Determine the Transaction Price Example Step 5: Step 3: Step 1: Step 2: Step 4: Recognise Leon concludes that the variable Determine consideration (i.e. the sales based royalty) Identify the Identify the Allocate the revenue when or should be allocated entirely to the the franchise licence because the variable contract with a performance transaction as performance transaction customer consideration obligations relates entirely to Leon s promise to price grant the franchise obligation is licence. price satisfied In addition, Leon observes that allocating $150,000 to the equipment and the sales based royalty to the franchise licence would be consistent with an allocation based on Leon s relative stand alone selling prices in similar contracts. Since Leon s stand alone selling price of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy s sales. Consequently, Leon concludes that the variable consideration (i.e. the salesbased royalty) should be allocated entirely to the performance obligation to grant the franchise licence Nelson Consulting Limited

61 Step 5: Satisfy Performance Obligations Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 5: Satisfaction of performance obligations A an entity recognises revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer which is when the customer obtains control of that good or service. The amount of revenue recognised is the amount allocated to the satisfied performance obligation. (HKFRS 15.IN7) Nelson Consulting Limited 121 Step 5: Satisfy Performance Obligations Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied Step 5: Satisfaction of performance obligations A performance obligation may be satisfied at a point in time (typically for promises to transfer goods to a customer) or over time (typically for promises to transfer services to a customer). For performance obligations satisfied over time, an entity recognises revenue over time by selecting an appropriate method for measuring the entity s progress towards complete satisfaction of that performance obligation. (HKFRS 15.IN7) Nelson Consulting Limited

62 Step 5: Satisfy Performance Obligations An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset (HKFRS 15.31) Nelson Consulting Limited 123 Step 5: Satisfy Performance Obligations For each performance obligation identified in accordance with HKFRS , an entity shall determine at contract inception whether it satisfies the performance obligation over time (in accordance with HKFRS ) or satisfies the performance obligation at a point in time (in accordance with HKFRS 15.38). If an entity does not satisfy a performance obligation over time, the performance obligation is satisfied at a point in time. (HKFRS 15.32) Over Time At a Point in Time Nelson Consulting Limited

63 Step 5: Satisfy Performance Obligations Goods and services are assets, even if only momentarily, when they are received and used (as in the case of many services). Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. When evaluating whether a customer obtains control of an asset, an entity shall consider any agreement to repurchase the asset (see HKFRS 15.B64 B76). (HKFRS 15.33) Over Time At a Point in Time Nelson Consulting Limited 125 Step 5: Satisfy Performance Obligations An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met: Over Time a. the customer simultaneously receives and consumes the benefits provided by the entity s performance as the entity performs (see HKFRS 15.B3 B4); b. the entity s performance creates or enhances an asset (e.g. work in progress) that the customer controls as the asset is created or enhanced (see HKFRS 15.B5); or c. the entity s performance does not create an asset with an alternative use to the entity (see HKFRS 15.36) and the entity has an enforceable right to payment for performance completed to date (see HKFRS 15.37). (HKFRS 15.35) Nelson Consulting Limited

64 Step 5: Satisfy Performance Obligations Determine at contract inception Does the customer receive and consume the benefits provided by the entity as the entity performs? Does the customer control the asset being created or enhanced by the entity? Does the entity s performance create an asset with an alternative use to the entity? Does the entity have an enforceable right to payment for performance completed to date? Performance obligation satisfied over time Performance obligations satisfied at a point in time Measuring progress towards complete satisfaction of that performance Nelson Consulting Limited Source: Intermediate Financial Reporting 3rd (2017) by Nelson Lam and Peter Lau 127 Step 5: Satisfy Performance Obligations Methods for Measuring Progress Measuring Progress Appropriate methods of measuring progress include output methods and input methods (HKFRS 15.B14 B19 provide guidance) In determining the appropriate method for measuring Over Time progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer. (HKFRS 15.41) When applying a method for measuring progress, an entity shall exclude from the measure of progress any goods or services for which the entity does not transfer control to a customer. Conversely, an entity shall include in the measure of progress any goods or services for which the entity does transfer control to a customer when satisfying that performance obligation. (HKFRS 15.42) Nelson Consulting Limited

65 Step 5: Satisfy Performance Obligations If a performance obligation is not satisfied over time in accordance with HKFRS , an entity satisfies the performance obligation at a point in time. To determine the point in time at which a customer obtains control of a promised asset and the entity satisfies a performance obligation, the entity shall consider the requirements for control in HKFRS (HKFRS 15.38) At a Point in Time Nelson Consulting Limited 129 Step 5: Satisfy Performance Obligations In addition, an entity shall consider indicators of the transfer of control, which include, but are not limited to, the following: a. The entity has a present right to payment for the asset b. The customer has legal title to the asset c. The entity has transferred physical possession of the asset d. The customer has the significant risks and rewards of ownership of the asset e. The customer has accepted the asset At a Point in Time Nelson Consulting Limited

66 5 Steps: Recognition and Measurement Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Step 5: Recognise revenue when or as performance obligation is satisfied When (or as) a performance obligation is satisfied, an entity shall recognise as revenue the amount of the transaction price (which excludes estimates of variable consideration that are constrained in accordance with HKFRS ) that is allocated to that performance obligation. (HKFRS 15.46) Nelson Consulting Limited 131 Comprehensive Example Step 5 Example Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling price of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 15 step by step Nelson Consulting Limited

67 Comprehensive Example Step 5 Step 1: Identify the contract with a customer Step 2: Identify the performance obligations Step 3: Determine the transaction price Step 4: Allocate the transaction price Example Step 5: Recognise revenue when or as performance obligation is satisfied Step 5: Recognise Revenue When the Entity Satisfies a Performance Obligation In Step 5, Leon is required to recognise revenue when or as it satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to the customer, Andy. An asset is transferred when or as the customer obtains control of that asset. The amount of revenue recognised is the amount allocated to the satisfied performance obligation. A performance obligation may be satisfied at a point in time or over time Nelson Consulting Limited 133 Comprehensive Example Step 5 Step 5: Recognise Revenue When the Entity Satisfies a Step 3: Step 1: Step 2: Step 4: Performance Obligation Determine Identify the Identify the Allocate the the contract Leon with identifies a performance two performance obligations: transaction transaction customer (a) a promise obligations to transfer equipment price price and Example Step 5: Recognise revenue when or as performance obligation is satisfied (b) a promise to grant a franchise licence. For a promise of transfer equipment, the performance obligation is satisfied at a point in time as the three criteria for performance obligation satisfied over time are not met. While the allocated transaction price to it is the fixed consideration of $150,000, Leon finally recognises the fixed consideration when that promise is satisfied by delivering the equipment to Andy (i.e. control transferred) Nelson Consulting Limited

68 Comprehensive Example Step 5 Step 5: Recognise Revenue When the Entity Satisfies a Example Step 5: Step 3: Step 1: Step 2: Step 4: Recognise Performance Obligation Determine Identify the Identify the Allocate the revenue when or the contract For with a promise a performance of transfer a franchise licence, the transaction variable consideration, as performance i.e. transaction customer in the form of obligations the sales based royalty, is allocated price entirely to the obligation franchise price licence. satisfied Then, the final step in recognised the allocated transaction price is to determine whether the performance obligation in licence transfer is satisfied at a point in time or over time. HKFRS 15 has a specific application guidance for licensing, which also includes sales based or usage based royalty Nelson Consulting Limited 135 Revenue Contract Costs Incremental Costs of Obtaining a Contract An entity shall recognise as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. (HKFRS 15.91) The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (e.g. a sales commission). (HKFRS 15.92) Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained shall be recognised as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained. (HKFRS 15.93) As a practical expedient, an entity may recognise the incremental costs of obtaining a contract as an expense when incurred if the amortisation period of the asset that the entity otherwise would have recognised is one year or less. (HKFRS 15.94) Nelson Consulting Limited

69 Revenue Contract Costs Costs to Fulfil a Contract If the costs incurred in fulfilling a contract with a customer are not within the scope of another Standard (e.g. HKAS 2, HKAS 16 or HKAS 38), an entity shall recognise an asset from the costs incurred to fulfil a contract only if those costs meet all of the following criteria: a. the costs relate directly to a contract or to an anticipated contract that the entity can specifically identify (e.g. costs relating to services to be provided under renewal of an existing contract or costs of designing an asset to be transferred under a specific contract that has not yet been approved); b. the costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future; and c. the costs are expected to be recovered. (HKFRS 15.95) Nelson Consulting Limited 137 Revenue Contract Costs Costs to Fulfil a Contract For costs incurred in fulfilling a contract with a customer that are within the scope of another Standard, an entity shall account for those costs in accordance with those other Standards. (HKFRS 15.96) Nelson Consulting Limited

70 Revenue Contract Costs Amortisation and Impairment An asset recognised in accordance with HKFRS or 95 shall be amortised on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. The asset may relate to goods or services to be transferred under a specific anticipated contract (as described in HKFRS 15.95(a)). (HKFRS 15.99) An entity shall update the amortisation to reflect a significant change in the entity s expected timing of transfer to the customer of the goods or services to which the asset relates. Such a change shall be accounted for as a change in accounting estimate in accordance with HKAS 8. (HKFRS ) Nelson Consulting Limited 139 Revenue Contract Costs Amortisation and Impairment An entity shall recognise an impairment loss in profit or loss to the extent that the carrying amount of an asset recognised in accordance with HKFRS or 95 exceeds: a. the remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates; less b. the costs that relate directly to providing those goods or services and that have not been recognised as expenses (see HKFRS 15.97). (HKFRS ) Nelson Consulting Limited

71 Effective Date and Transition An entity shall apply HKFSR 15 for annual reporting periods beginning on or after 1 January Earlier application is permitted. If an entity applies HKFRS 15 earlier, it shall disclose that fact. (HKFRS 15.C1) Nelson Consulting Limited 141 Effective Date and Transition For the purposes of the transition requirements in paragraphs C3 C8A: a. the date of initial application is the start of the reporting period in which an entity first applies HKFRS 15; and b. a completed contract is a contract for which the entity has transferred all of the goods or services identified in accordance with HKAS 11 Construction Contracts, HKAS 18 Revenue and related Interpretations. (HKFRS 15.C2) Nelson Consulting Limited

72 Effective Date and Transition An entity shall apply HKFRS 15 using one of the following two methods: a) retrospectively to each prior reporting period presented in accordance with HKAS 8, subject to the expedients in para. C5; or b) retrospectively with the cumulative effect of initially applying HKFRS 15 recognised at the date of initial application in accordance with para. C7 C8. (HKFRS 15.C3) Practical expedients are available The date of initial application is the start of the reporting period in which an entity first applies HKFRS Nelson Consulting Limited 143 Effective Date and Transition An entity may use one or more of the following practical expedients when applying HKFRS 15 retrospectively in accordance with para.c3(a): a. for completed contracts, an entity need not restate contracts that: i. begin and end within the same annual reporting period; or ii. are completed contracts at the beginning of the earliest period presented. b. for completed contracts that have variable consideration, an entity may use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods Nelson Consulting Limited

73 Effective Date and Transition c. for contracts that were modified before the beginning of the earliest period presented, an entity need not retrospectively restate the contract for those contract modifications in accordance with para Instead, an entity shall reflect the aggregate effect of all of the modifications that occur before the beginning of the earliest period presented when: i. identifying the satisfied and unsatisfied performance obligations; ii. determining the transaction price; and iii.allocating the transaction price to the satisfied and unsatisfied performance obligations. d. for all reporting periods presented before the date of initial application, an entity need not disclose the amount of the transaction price allocated to the remaining performance obligations and an explanation of when the entity expects to recognise that amount as revenue (see para. 120). (HKFRS 15.C5) Nelson Consulting Limited 145 SNAI, Shanghai China Consulting Limited Photo taken by Stephanie and Nelson

74 Today s Agenda New or Revised HKFRS Effective for and after 2019 Full presentation can be found in: Nelson Consulting Limited 147 HKFRS 16 Leases Heidelberg Nelson Castle GermanyLimited Photo taken by Stephanie and Nelson

75 Introduction HKFRS 16 supersedes the following Standards and Interpretations: (a) HKAS 17 Leases; (b) HKFRIC 4 Determining whether an Arrangement contains a Lease; (c) HK(SIC) 15 Operating Leases Incentives; and (d) HK(SIC) 27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease Nelson Consulting Limited 149 HKFRS 16 Contents 1. Objective 2. Scope 3. Recognition Exemptions Today s 4. Identifying a Lease update 5. Lease Term 6. Lessee 7. Lessor 8. Sales and Leaseback Transactions 9. Effective Date and Transition Nelson Consulting Limited

76 HKFRS 16 Assess a contract whether it is a lease or contains a lease? t within HKFRS 16 Determining lease term Lessee accounting Lessor accounting Reporting exemption is applicable and elected? Recognise assets and liabilities for all leases Recognise lease payments as an expense Sale and leaseback transactions Nelson Consulting Limited Source: Intermediate Financial Reporting 3rd (2017) by Nelson Lam and Peter Lau Reporting Exemptions A lessee may elect not to apply the requirements in HKFRS 16 (HKFRS ) to: (a) short term leases; and (b) leases for which the underlying asset is of low value (as described in HKFRS 16.B3 B8). HKFRS 16 defines short term lease as: A lease that, at the commencement date, has a lease term of 12 months or less. A lease that contains a purchase option is not a shortterm lease Nelson Consulting Limited

77 3. Reporting Exemptions Leases for which the underlying asset is of low value A lessee shall assess the value of an underlying asset based on the value of the asset when it is new, regardless of the age of the asset being leased. (HKFRS 16.B3) The assessment of whether an underlying asset is of low value is performed on an absolute basis. Leases of low value assets qualify for the accounting treatment in HKFRS 16.6 regardless of whether those leases are material to the lessee. The assessment is not affected by the size, nature or circumstances of the lessee. Accordingly, different lessees are expected to reach the same conclusions about whether a particular underlying asset is of low value. (HKFRS 16.B4) Nelson Consulting Limited Reporting Exemptions Example Leases for which the underlying asset is of low value A lease of an underlying asset does not qualify as a lease of a low value asset if the nature of the asset is such that, when new, the asset is typically not of low value. For example, leases of cars would not qualify as leases of low value assets because a new car would typically not be of low value. (HKFRS 16.B6) If a lessee subleases an asset, or expects to sublease an asset, the head lease does not qualify as a lease of a low value asset. (HKFRS 16.B7) Examples of low value underlying assets can include tablet and personal computers, small items of office furniture and telephones. (HKFRS 16.B8) Nelson Consulting Limited

78 4. Identifying a Lease HKFRS 16 defines lease as: A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. (HKFRS 16.9) Nelson Consulting Limited Identifying a Lease To assess whether a contract conveys the right to control the use of an identified asset (see HKFRS 16.B13 B20) for a period of time, an entity shall assess whether, throughout the period of use, the customer has both of the following: a. the right to obtain substantially all of the economic benefits from use of the identified asset (as described in HKFRS 16.B21 B23); and b. the right to direct the use of the identified asset (as described in HKFRS 16.B24 B30) (HKFRS 16.B9) Nelson Consulting Limited

79 4. Identifying a Lease HKFRS 16 illustrates how an entity makes the assessment of whether a contract is a lease or contains a lease, or the right to control the use of an identified asset for a period of time, as follows: Is there an identified asset? Does the lessee have the right to obtain substantially all of the economic benefits from use of the identified asset throughout the period of use? Does the lessee have the right to direct how and for what purpose the asset is used throughout the period of use? Contract contains a lease Contract does not contain a lease Nelson Consulting Limited Identifying a Lease Simple Case In simple case, a lessee has the right to direct the use of an identified asset throughout the period of use when the lessee has the right to direct how and for what purpose the asset is used throughout the period of use. Contract contains a lease Contract does not contain a lease Nelson Consulting Limited

80 4. Identifying a Lease Simple Case Customer Is there an identified asset? (HKFRS 16.B13 B20) Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use? (HKFRS 16.B21 B23) Does the customer, the supplier or neither party have the right to direct how and for what purpose the asset is used throughout the period of use? (HKFRS 16.B25 B30) Supplier Contract contains a lease Contract does not contain a lease Nelson Consulting Limited Adapted from HKFRS 16.B Identifying a Lease Complicated Case In more complicated situations, a lessee (or customer) has the right to direct the use of an identified asset throughout the period of use if either: a. the customer has the right to direct how and for what purpose the asset is used throughout the period of use; or b. the relevant decisions about how and for what purpose the asset is used are predetermined and: i. the customer has the right (or to direct others) to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions; or ii. the customer designed the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use. Contract contains a lease Contract does not contain a lease Nelson Consulting Limited

81 4. Identifying a Lease Complicated Case Customer Is there an identified asset? (HKFRS 16.B13 B20) Does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use? (HKFRS 16.B21 B23) Does the customer, the supplier or neither party have the right Supplier to direct how and for what purpose the asset is used throughout the period of use? (HKFRS 16.B25 B30) Neither; how and for what purpose the asset will be used is predetermined Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions? (HKFRS 16.B24(b)(i)) Did the customer design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use? (HKFRS 16.B24(b)(ii)) Contract contains a lease Contract does not contain a lease Nelson Consulting Limited Adapted from HKFRS 16.B Lease Term An entity shall determine the lease term as the non cancellable period of a lease, together with both: (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and (b) periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option. In assessing whether a lessee is reasonably certain to exercise an option to extend a lease, or not to exercise an option to terminate a lease, an entity shall consider all relevant facts and circumstances that create an economic incentive for the lessee to exercise the option to extend the lease, or not to exercise the option to terminate the lease, as described in HKFRS 16.B37 B Nelson Consulting Limited

82 6. Lessee Recognition Recognition At the commencement date, a lessee shall recognise a right of use asset, and a lease liability. (HKFRS 16.22) HKFRS 16 defines right of use asset as: An asset that represents a lessee s right to use an underlying asset for the lease term. Right of Use Asset Lease Liability Nelson Consulting Limited Lessee Initial Measurement Initial Measurement of the Right of Use Asset At the commencement date, a lessee shall measure the right of use asset at cost. (HKFRS 16.23) Right of Use Asset HKFRS 16 defines commencement date of a lease as: The date on which a lessor makes an underlying asset available for use by a lessee Nelson Consulting Limited

83 6. Lessee Initial Measurement The cost of the right of use asset shall comprise: (a) the amount of the initial measurement of the lease liability, as described in HKFRS 16.26; (b) any lease payments made at or before the commencement date, less any lease incentives received; (c) any initial direct costs incurred by the lessee; and (d) an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories. The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying asset during a particular period. (HKFRS 16.24) Lease liab. amount Incl. rental incentives excl. rental deposits Incl. costs in restoring Similar to HKAS 16 PPE Nelson Consulting Limited Lessee Initial Measurement Initial Measurement of the Lease Liability At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, If that rate (i.e. the interest rate implicit in the lease) can be readily determined, the lessee shall use that rate If that rate cannot be readily determined, the lessee shall use the lessee s incremental borrowing rate. (HKFRS 16.26) Lease Liability Use that rate first Affected by, e.g. the credit rating Nelson Consulting Limited

84 6. Lessee Initial Measurement At the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date: (a) fixed payments (including in substance fixed payments as described in HKFRS 16.B42), less any lease incentives receivable; (b) variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date (as described in HKFRS 16.28); (c) amounts expected to be payable by the lessee under residual value guarantees; (d) the exercise price of a purchase option if the lessee is reasonably certain to exercise that option (assessed considering the factors described in HKFRS 16.B37 B40); and (e) payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease Nelson Consulting Limited Lessee Initial Measurement Melody Investment Inc. entered into a lease of a floor of a building with the following terms: A lease of 10 year, with an option to extend for five years Lease payments were $50,000 per year during the initial term and $55,000 per year during the optional period, all payable at the beginning of each year. For the lease, Melody incurred initial direct costs of $20,000, incl. Example $15,000 relates to a payment to a former tenant of the lease, & $5,000 relates to a commission paid to the real estate agent that arranged the lease. As an incentive to Melody for entering into the lease, Singapore Landlord Company (SLC) agreed to reimburse to Melody the real estate commission of $5,000 and Melody s leasehold improvements of $7, Nelson Consulting Limited

85 6. Lessee Initial Measurement Example At the commencement date, Melody concluded and performed the following: It would not be reasonably certain to exercise the option to extend the lease and, therefore, determined that the lease term is 10 years. The interest rate implicit in the lease was not readily determinable. Melody s incremental borrowing rate was 5 per cent per annum, which reflected the fixed rate at which Melody could borrow an amount similar to the value of the right of use asset, in the same currency, for a 10 year term, and with similar collateral. It made the lease payment for the first year, incurred initial direct costs, received lease incentives from SLC It measured the lease liability at the present value of the remaining nine payments of $50,000, discounted at the interest rate of 5 per cent per annum, which was $355, Nelson Consulting Limited Lessee Initial Measurement Example In consequence, Melody initially recognised assets and liabilities in relation to the lease as follows. Dr Right of use asset $405,391 Cr Lease liability $355,391 Cash (lease payment for the first year) $50,000 Dr Right of use asset $20,000 Cr Cash (initial direct costs) $20,000 Dr Cash (lease incentive) $5,000 Cr Right of use asset $5,000 In case Melody applied HKAS 17 (which did not address the accounting for initial direct cost for operating lease), it might account for the lease as follows: Dr Profit or loss rental expenses $50,000 Cr Cash (lease payment for the first year) $50,000 Dr Profit or loss 20,000 Cr Cash (initial direct cost) $20, Nelson Consulting Limited

86 6. Lessee Initial Measurement Example Melody accounted for the reimbursement of leasehold improvements from SLC applying other relevant IFRS and not as a lease incentive applying IFRS 16. This is because costs incurred on leasehold improvements by Melody are not included within the cost of the right ofuse asset. Thus, the initial cost of the right of use asset was $420,391 while the initial measurement of the lease liability was $355, Nelson Consulting Limited Lessee Subsequent Measurement Subsequent Measurement of the Right of Use Asset After the commencement date, a lessee shall measure the right of use asset applying a cost model, Right of Use Asset unless it applies either of the measurement models described in HKFRS and 35. (HKFRS 16.29) Cost Model Measurement Models Nelson Consulting Limited

87 6. Lessee Subsequent Measurement To apply a cost model, a lessee shall measure the right of use asset at cost: (a) less any accumulated depreciation and any accumulated impairment losses; and (b) adjusted for any remeasurement of the lease liability specified in HKFRS 16.36(c). Right of Use Asset Cost Model Nelson Consulting Limited Lessee Subsequent Measurement If a lessee applies the fair value model in HKAS 40 Investment Property to its investment property, the lessee shall also apply that fair value model to right of use Right of Use Asset assets that meet the definition of investment property in HKAS 40. If right of use assets relate to a class of property, plant and equipment to which the lessee applies the revaluation model in HKAS 16, a lessee may elect to apply that revaluation model to all of the right of use assets that relate to that class of property, plant and equipment. Measurement Models Nelson Consulting Limited

88 6. Lessee Subsequent Measurement Subsequent Measurement of the Lease Liability After the commencement date, a lessee shall measure the lease liability by: (a) increasing the carrying amount to reflect interest on the lease liability; (b) reducing the carrying amount to reflect the lease payments made; and (c) remeasuring the carrying amount Lease Liability to reflect any reassessment or lease modifications specified in HKFRS , or to reflect revised in substance fixed lease payments (see HKFRS 16.B42). (HKFRS 16.36) Nelson Consulting Limited 175 Summary Effect on Fin. Position Nelson Consulting Limited The IASB s Effect Analysis on IFRS 16 of January

89 Summary Effect on Profit or Loss Nelson Consulting Limited The IASB s Effect Analysis on IFRS 16 of January Rundale 2013 Nelson Latvia Consulting Limited Photo taken by Stephanie and Nelson