Annual Accounting Update 2008 4 October 2008 Nelson Lam 林智遠 MBA MSc BBA ACA ACS CFA CPA(Aust.) CPA(US) FCCA FCPA(Practising) FHKIoD MSCA 2007-08 Nelson 1 Amendment Effective After 1.1.2008 Selected new interpretations and amendments to HKFRSs issued in 2007 to 2008 HK(IFRIC )12 Service Concession Arrangements (2007) HK(IFRIC) 13 Customer Loyalty Programmes (2007) HK(IFRIC) 14 HKAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction (2007) HK(IFRIC) 15 Agreements for the Construction of Real Estate (2008) HK(IFRIC) 16 Hedges of a Net Investment in a Foreign Operation (2008) HKFRS 8 Operating Segments (2007) HKFRS 23 Borrowing Costs (2007) HKAS 1 Presentation of Financial Statements (2007) HKAS 27 Consolidated and Separate Financial Statements (2008) HKFRS 3 Business Combination (2008) Amendments to HKAS 32 and HKAS 1 Puttable Financial Instruments and Obligations Arising on Liquidation (2008) Effective for periods beginning on/after 1 Jan. 2008 1 Jul. 2008 1 Jan. 2008 1 Jan. 2009 1 Oct. 2008 1Jan Jan. 2009 1 Jan. 2009 1 Jan. 2009 1 Jul. 2009 1 Jul. 2009 1 Jan. 2009 2007-08 Nelson 2 1
Service Concession Arrangements (HK(IFRIC) Interpretation 12) 2006-07 Nelson 3 Scope of HK(IFRIC)-Int 12 HK(IFRIC) Interpretation 12 gives guidance on the accounting by operators for public-to-private private service concession arrangements The interpretation applies to public-to-private service concession arrangements if a) the grantor controls or regulates what service the operator must provide with the infrastructure, to whom it must provide them, and at what price; and b) the grantor controls through ownership, beneficial entitlement or otherwise any significant residual interest in the infrastructure at the end of the term of arrangement. No need to have complete control Sufficient for the price to be regulated, say by capping mechanism 2006-07 Nelson 4 2
Summary of HK(IFRIC)-Int 12 a) Treatment of operator s rights over the infrastructure; b) Recognition & measurement of FV to be used arrangement consideration; c) Construction or upgrade services; d) Operation services; e) Borrowing costs; f) Subsequent accounting treatment of a financial asset and an intangible asset; and g) Items provided to the operator by the grantor. Shall not be recognised as PPE Construction ti or Upgrade Services HKAS 11 HKAS 23 Financial Asset HKAS 39 Intangible Asset HKAS 38 Operation Services HKAS 18 Unconditional contractual right to receive cash or other FA A right (a licence) to charge users Use only or as part of the consideration 2006-07 Nelson 5 Consensus Recognition and Measurement of Arrangement Consideration Under the terms of contractual arrangements within the scope of this Interpretation, the operator acts as a service provider. The operator constructs or upgrades infrastructure (construction or upgrade services) used to provide a public service and operates and maintains that infrastructure (operation services) for a specified period of time. The operator shall recognise and measure revenue in accordance with HKAS 11 and 18 for the services it performs. Operator = Service Provider Construction or Upgrade Services Operation Services 2006-07 Nelson 6 3
Consensus Recognition and Measurement of Arrangement Consideration The operator shall account for revenue and costs relating to construction or upgrade services in accordance with HKAS 11. The operator shall account for revenue and costs relating to operation services in accordance with HKAS 18. Operator = Service Provider Construction or Upgrade Services Operation Services HKAS 11 HKAS 18 2006-07 Nelson 7 Consensus Construction or Upgrade Services If the operator provides construction or upgrade services the consideration received or receivable by the operator shall be recognised at its fair value. The consideration may be rights to: a) a financial asset, or b) an intangible asset. Operator = Service Provider Construction or Upgrade Services An unconditional contractual right to receive cash or another financial asset A right (a licence) to charge users of the public service. Financial Asset Intangible Asset 2006-07 Nelson 8 4
Consensus If the operator is paid for the construction services partly by a financial asset and partly by an intangible asset it is necessary to account separately for each component of the operator's consideration. The consideration received or receivable for both components shall be recognised initially at the fair value of the consideration received or receivable. The nature of the consideration given by the grantor to the operator shall be determined by reference to the contract terms and, when it exists, relevant contract law. Operator = Service Provider Construction or Upgrade Services Financial Asset Intangible Asset 2006-07 Nelson 9 Consensus Case China Communications Construction Company Ltd. Annual Report of 2006 IFRIC 12, Service Concession Arrangements, effective for annual periods beginning on or after 1 January 2008, was early adopted in 2006. The Group is engaged in certain service concession arrangements in which the Group carries out the construction work (e.g. toll highways and bridges) for the granting authority and receives in exchange a right to operate the asset concerned in accordance with pre-established conditions set by the granting authority. In accordance with the IFRIC Interpretation 12 Service Concession Arrangement (IFRIC 12), the assets under the concession arrangements may be classified as intangible assets or financial assets. 2006-07 Nelson 10 5
Consensus Case China Communications Construction Company Ltd. Annual Report of 2006 The assets are classified as intangibles if the operator receives a right (a license) to charge users of the public service or as financial assets if paid by the granting authority. The Group classified the non-current assets linked to the long-term investment in these concession arrangements as concession assets within intangible assets classification on the balance sheet if the intangible ibl asset model is adopted. d Once the underlying infrastructure of the concession arrangements is completed, the concession assets will be amortised over the term of the concession on a straight-line basis under the intangible asset model. 2006-07 Nelson 11 Customer Loyalty Programmes (HK(IFRIC) Interpretation 13) 2007-08 Nelson 12 6
Scope HK(IFRIC) Interpretation 13 applies to customer loyalty award credits that: a) an entity grants to its customers as part of a sales transaction, i.e. a sale of goods, rendering of services or use by a customer of entity assets; and b) subject to meeting any further qualifying conditions, the customers can redeem in the future for free or discounted goods or services. The Interpretation addresses accounting by the entity that grants award credits to its customers. 2007-08 Nelson 13 Issues Whether the entity s obligation to provide free or discounted goods or services ("awards") in the future should be recognised and measured by: i) allocating some of the consideration received or receivable from the sales transaction to the award credits and deferring the recognition of revenue (applying HKAS 18.13); or ii) providing for the estimated future costs of supplying the awards (applying HKAS 18.19); and If consideration is allocated to the award credits: i) how much should be allocated to them; ii) when revenue should be recognised; and iii) if a third party supplies the awards, how revenue should be measured. 2007-08 Nelson 14 7
Conclusions Separation An entity shall apply HKAS 18.13 and account for award credits as a separately identifiable component of the sales transaction(s) in which they are granted (the "initial sale"). The fair value of the consideration received or receivable in respect of the initial sale shall be allocated between the award credits and the other components of the sale. Separately Identifiable Component Fair Value Award Credit Other Components Supplied by the Entity Itself Supplied by the Third Party 2007-08 Nelson 15 Conclusions Recognition If the entity supplies the awards itself, it shall recognise the consideration allocated to award credits as revenue when award credits are redeemed and it fulfils its obligations to supply awards. The amount of revenue recognised shall be based on the number of award credits that have been redeemed in exchange for awards, relative to the total number expected to be redeemed. No. of Award Credits Redeemed in Exchange Total No. of Award Credits Expected to be Redeemed Supplied by the Entity Itself 2007-08 Nelson 16 8
Conclusions Recognition Example A grocery retailer operates a customer loyalty programme. It grants programme members loyalty points when they spend a specified amount on groceries. Programme members can redeem the points for further groceries. The points have no expiry date. In one period, the entity grants 100 points (assume sales of $2,000). Management expects 80 of these points to be redeemed. Management estimates the fair value of each loyalty point to be one currency unit ($1), and defers revenue of $100. Dr Cash $ 2,000 Cr Revenue $ 1,900 Deferred income 100 2007-08 Nelson 17 Conclusions Recognition Example Year 1 At the end of the first year, 40 points (pts) have been redeemed in exchange for groceries, i.e. half of those expected to be redeemed. The entity recognises revenue of (40 / 80 pts) $100 = $50. Dr Deferred income $ 50 Cr Revenue $ 50 Year 2 In the second year, management revises its expectations and now expects 90 points to be redeemed altogether. During the second year, 41 points are redeemed, bringing g the total number redeemed to 40 + 41 = 81 points. The cumulative revenue that the entity recognises is (81 / 90 pts) $100 = $90. The entity has recognised revenue of $50 in the first year, so it recognises $40 in the second year. Dr Deferred income $ 40 Cr Revenue $ 40 2007-08 Nelson 18 9
Conclusions Recognition Example Year 3 In the third year, a further nine points are redeemed, taking the total number of points redeemed to 81 + 9 = 90 points. Management continues to expect that only 90 points will ever be redeemed, ie that no more points will be redeemed after the third year. So the cumulative revenue to date is (90 points / 90 points) $100 = $100. The entity has already recognised $90 of revenue ($50 in the first year and $40 in the second year). So it recognises the remaining $10 in the third year. All of the revenue initially deferred has now been recognised. Dr Deferred income $ 10 Cr Revenue $ 10 2007-08 Nelson 19 Conclusions Recognition If a third party supplies the awards, the entity shall assess whether it is collecting the consideration allocated to the award credits on its own account (i.e. as the principal in the transaction) or on behalf of the third party (i.e. as an agent for the third party). On its Own Account On Behalf of the Third Party Supplied by the Third Party 2007-08 Nelson 20 10
Construction of Real Estate (HK(IFRIC) Interpretation 15) 2007-08 Nelson 21 Before 2005 Before 2005, property developers in HK adopted various policies for recognising revenue arising from pre-completion contracts for the sale of fdevelopment properties. The stage of completion method was a commonly used policy. Full completion method was another one used by some companies. Stage of Completion Full Completion 2007-08 Nelson 22 11
HK Interpretation 3 HK Interpretation 3 (effective in 2005) concluded that pre-completion contracts for the sale of development properties do not meet the definition of construction contracts, if the contracts in question are not specifically negotiated for the construction of the properties. Accordingly, these contracts fall outside the scope of HKAS 11 and, as a result, the stage of completion method as required under HKAS 11 shall not be used to recognise revenue arising i from such contracts. t HK(IFRIC) 15 sets out the same conclusion but gives guidance on other types of presale transactions. 2007-08 Nelson 23 Scope and Issue of HK(IFRIC) 15 Scope HK(IFRIC) 15 applies to the accounting for revenue and associated expenses by entities that undertake the construction of real estate directly or through subcontractors. Agreements in the scope of this Interpretation are: agreements for the construction of real estate such agreements may include the delivery of other goods or services. Issues HK(IFRIC) 15 addresses two issues: 1. Is the agreement within the scope of HKAS 11 or HKAS 18? 2. When should revenue from the construction of real estate be recognised? 2007-08 Nelson 24 12
1. Within Scope of HKAS 11 or 18 Determination depends on the terms of each agreement and all the surrounding facts and circumstances HKAS 11 HKAS 11 Construction Contracts applies when the agreement meets the definition of a construction contract set out in HKAS 11.3 (i.e. contract specifically negotiated) HKAS 18 Meets the definition when the buyer is able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether or not it exercises that ability). When HKAS 11 applies, the construction contract also includes any contracts or components for the rendering of services in accordance with HKAS 11.5(a) and HKAS 18.4 2007-08 Nelson 25 1. Within Scope of HKAS 11 or 18 Determination depends on the terms of each agreement and all the surrounding facts and circumstances HKAS 11 HKAS 18 Revenue applies (i.e. an agreement for the sale of goods), HKAS 18 When an agreement for the construction of real estate in which buyers have only limited ability to influence the design of the real estate, e.g. to select a design from a range of options specified by the entity, or to specify only minor variations to the basic design 2007-08 Nelson 26 13
2. When is Revenue Recognised? Construction Contract Rendering of Services Sale of Goods When the agreement is within the scope of HKAS 11 and its outcome can be estimated reliably, the entity shall recognise revenue by reference to the stage of completion of the contract activity in accordance with HKAS 11. The agreement may not meet the definition of a construction contract and therefore be within the scope of HKAS 18. In this case, the entity shall determine whether the agreement is for the rendering of services or for the sale of goods. 2007-08 Nelson 27 2. When is Revenue Recognised? Rendering of Services If the entity is not required to acquire and supply construction materials, the agreement may be only an agreement for the rendering of services in accordance with HKAS 18. In this case, if the criteria in HKAS 18.20 are met, HKAS 18 requires revenue to be recognised by reference to the stage of completion of the transaction using the percentage of completion method. The requirements of HKAS 11 are generally applicable to the recognition of revenue and the associated expenses for such a transaction (HKAS 18.21). 2007-08 Nelson 28 14
2. When is Revenue Recognised? If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver the real estate to the buyer, the agreement is an agreement for the sale of goods and the criteria for recognition of revenue set out in HKAS 18.14 apply. The entity may transfer to the buyer control and the significant risks and rewards of ownership of the WIP in its current state as construction progresses, or of the real estate in its entirely at a single time. Sale of Goods Transfer WIP as construction progress Transfer entirely at a single time 2007-08 Nelson 29 2. When is Revenue Recognised? Transfers in its current state as construction progresses (and if all the criteria in HKAS 18.14 are met continuously as construction progresses) the entity shall recognise revenue by reference to the stage of completion using the percentage of completion method. The requirements of HKAS 11 are generally applicable to the recognition of revenue and the associated expenses for such a transaction. Sale of Goods Transfer WIP as construction progress 2007-08 Nelson 30 15
2. When is Revenue Recognised? Transfers the real estate in its entirety at a single time (e.g. at completion, upon or after delivery) the entity shall recognise revenue only when all the criteria in HKAS 18.14 are satisfied. Sale of Goods Transfer entirely at a single time 2007-08 Nelson 31 Hedges of Foreign Operation (HK(IFRIC) Interpretation 16) 2007-08 Nelson 32 16
Scope of HK(IFRIC) 16 Scope HK(IFRIC) 16 applies to an entity that hedges the foreign currency risk arising from its net investments in foreign operations and wishes to qualify for hedge accounting in accordance with HKAS 39. HK(IFRIC) 16 applies only to hedges of net investments in foreign operations; it should not be applied by analogy to other types of hedge accounting. 2007-08 Nelson 33 Conclusions: Hedged Risk Hedge accounting may be applied only to the foreign exchange differences arising between the functional currency of the foreign operation and the parent entity s functional currency The hedged risk may be designated as the foreign currency exposure arising between the functional currency of the foreign operation and the functional currency of any parent entity (the immediate, intermediate or ultimate parent entity) of that foreign operation. Not applied to presentation currency Net investment is held through an intermediate parent does not affect it 2007-08 Nelson 34 17
Conclusions: Hedged Risk An exposure to foreign currency risk arising from a net investment in a foreign operation may yqualify for hedge accounting only once in the consolidated financial statements. The hedge accounting applied by the lower level parent must be reversed before the higher level parent s hedge accounting is recognised. 2007-08 Nelson 35 Conclusions: Where H.I. Held? The hedging instrument(s) (H.I.) may be held by any entity or entities within the group (except the foreign operation that itself is being hedged), as long as the designation, documentation and effectiveness requirements are satisfied. The assessment of effectiveness is not affected by whether the hedging instrument t is a derivative or a non-derivative instrument or by the method of consolidation. 2007-08 Nelson 36 18
Conclusions: Disposal When a foreign operation that was hedged is disposed of, the amount reclassified to profit or loss as a reclassification adjustment from the foreign currency translation reserve in the consolidated financial statements of the parent in respect of the hedging instrument is: the cumulative gain or loss on the hedging instrument that was determined to be an effective hedge. The amount reclassified to profit or loss from the foreign currency translation reserve is not affected by the consolidation method. 2007-08 Nelson 37 HKFRS 8 Operating Segments 2007-08 Nelson 38 19
Background HKFRS 8 arises from the IASB s consideration of FASB Statement No. 131 Disclosures about Segments of an Enterprise and Related Information (SFAS 131 of United States) issued in 1997, compared with IAS 14 Segment Reporting, which is similar to HKAS 14. HKFRS 8 achieves convergence with the requirements of SFAS 131. The wording of HKFRS 8 is the same as that of SFAS 131 except for changes necessary to make the terminology consistent with that in other HKFRSs. Adopted the Management Approach 2007-08 Nelson 39 Core Principle and Scope Core Principle An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates. Scope HKFRS 8 applies to: the separate or individual financial statements of an entity with listed debt and equity the consolidated financial statements of a group with a parent with listed debt and equity The segment information of an entity which chooses to follow HKFRS 8 If a financial report contains both the parent s consolidated financial statements and separate financial statements, segment information is required only in the consolidated financial statements. 2007-08 Nelson 40 20
Operating Segments An operating segment is a component of an entity: a) that engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity), b) whose operating results are regularly reviewed by the entity s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and c) for which discrete financial information is available. A business activity might have not yet earned any revenue For example: CEO, COO, or a group of executive directors Not necessary be geographical areas or products Operating Segments Not every part of an entity is necessarily an operating segment or part of an operating segment, say corporate headquarter 2007-08 Nelson 41 Reporting Segments Reportable Segment Operating Segments Aggregation Criteria Quantitative Thresholds Other Situations An entity shall report separately information about each operating segment that a) has been identified as operating segment or results from aggregating two or more of those segments under the aggregation criteria, and b) exceeds the quantitative thresholds ( 10% or more test ). There are also other situations in which separate information about an operating segment shall be reported. 2007-08 Nelson 42 21
Reporting Segments Aggregation Criteria Operating segments often exhibit similar long-term financial performance if they have similar economic characteristics. For example, similar long-term average gross margins for two operating segments would be expected if their economic characteristics were similar. 2007-08 Nelson 43 Reporting Segments Aggregation Criteria Aggregate segments if desired Two or more operating segments may be aggregated into a single operating segment if aggregation is consistent with the core principle of HKFRS 8, the segments have similar economic characteristics, and the segments are similar in each of the following respects: a) the nature of the products and services; b) the nature of the production processes; c) the type or class of customer for their products and services; d) the methods used to distribute their products or provide their services; and e) if applicable, the nature of the regulatory environment, e.g., banking or public utilities. 2007-08 Nelson 44 22
Disclosure To give effect to the core principle, an entity shall disclose the following for each period for which an income statement is presented: a) general information as described in HKFRS 8; b) information about General Information reported segment profit or loss, including specified revenues and expenses included in reported segment profit or loss, segment assets, and Other Information the basis of measurement; and c) reconciliations of fthe totalst of segment revenues, reported segment profit or loss, segment assets, and other material segment items to corresponding entity amounts. Reconciliations 2007-08 Nelson 45 Disclosure An entity shall report a measure of profit or loss and total assets for each reportable segment. An entity shall report a measure of liabilities for each reportable segment if such an amount is regularly provided to the chief operating decision maker. Other Information 2007-08 Nelson 46 23
Measurement The amount of each segment item reported shall be the measure reported to the chief operating decision maker for the purposes of making decisions about allocating resources to the segment and assessing its performance. Compared with HKAS 14, HKAS 14 required segment information to be prepared in conformity with the accounting policies adopted for preparing and presenting the financial statements of the consolidated group or entity. HKAS 14 defines segment revenue, segment expense, segment result, segment assets and segment liabilities HKFRS 8 does not define these terms but requires an explanation of how segment profit or loss, segment assets and segment liabilities are measured for each reportable segment. 2007-08 Nelson 47 Measurement Adjustments and eliminations made in preparing an entity s financial statements and allocations of revenues, expenses, and gains or losses shall be included in determining reported segment profit or loss only if they are included in the measure of the segment s profit or loss that is used by the chief operating decision maker. Similarly, only those assets and liabilities that are included in the measures of the segment s assets and segment s liabilities that are used by the chief operating decision maker shall be reported for that segment. If amounts are allocated to reported segment profit or loss, assets or liabilities, those amounts shall be allocated on a reasonable basis. 2007-08 Nelson 48 24
Amendment Effective After 1.1.2008 Selected new interpretations and amendments to HKFRSs issued in 2007 to 2008 HK(IFRIC )12 Service Concession Arrangements (2007) HK(IFRIC) 13 Customer Loyalty Programmes (2007) HK(IFRIC) 14 HKAS 19 The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction (2007) HK(IFRIC) 15 Agreements for the Construction of Real Estate (2008) HK(IFRIC) 16 Hedges of a Net Investment in a Foreign Operation (2008) HKFRS 8 Operating Segments (2007) HKFRS 23 Borrowing Costs (2007) HKAS 1 Presentation of Financial Statements (2007) HKAS 27 Consolidated and Separate Financial Statements (2008) HKFRS 3 Business Combination (2008) Amendments to HKAS 32 and HKAS 1 Puttable Financial Instruments and Obligations Arising on Liquidation (2008) Effective for periods beginning on/after 1 Jan. 2008 1 Jul. 2008 1 Jan. 2008 1 Jan. 2009 1 Oct. 2008 1Jan Jan. 2009 1 Jan. 2009 1 Jan. 2009 1 Jul. 2009 1 Jul. 2009 1 Jan. 2009 2007-08 Nelson 49 Global Development of IFRSs Canada (2011) Russia 2014 U.S. Korea (2011) China Japan (2011) Hong Kong India (2011) 2007-08 Nelson 50 25
Global Development in U.S. The US FASB and the IASB reaffirmed their commitment in 2005 to the convergence of US GAAP and IFRSs In Nov. 2007 the US SEC approved the financial statements from foreign private issuers in the US will be accepted without reconciliation to US GAAP only if they are prepared using IFRSs In 2008 The AICPA proposed incorporating IFRS elements in its Uniform CPA Examination The AICPA launched a designated website for its members and public, www.ifrs.com On 27 August 2008, US SEC voted to publish for public comment a proposed roadmap that could lead to the use of IFRS by U.S. issuers beginning in 2014 2007-08 Nelson 51 Future Development There is a long road, we keep on search here and there. Li Sao of Qu Yuan (340-278 B.C.) 2007-08 Nelson 52 26
Annual Accounting Update 2008 4 October 2008 Full set of slides in PDF can be found in www.nelsoncpa.com.hk Nelson Lam 林智遠 nelson@nelsoncpa.com.hk www.nelsoncpa.com.hk 2007-08 Nelson 53 27