Implementation of SME-FRS in HK 23 October 2006

Implementation of SME-FRS in HK 23 October 2006 Nelson Lam 林智遠 CFA FCCA FCPA(Practising) MBA MSc BBA CPA(US) ACA 2005-06 Nelson 1 Today s Agenda Overview of of SME-FRF and SME-FRS Selected Major Changes Presentation & Disclosures Leases and Investment Property Effects of of Changes in in Foreign Exchange Rates Financial Instruments SME-FRS Section 1 & 2 Section 3 & 5 Section 15 15 Section 6 Other Major Changes in in SME-FRS Real Cases and Examples Simple and Comprehensive 2005-06 Nelson 2 1

Brief Introduction: SME-FRF & FRS SME SME Financial Reporting Framework Sets out Conceptual Basis Qualifying Criteria (Qualifying Entity) Transitions and Effective Date SME Financial Reporting Standard Divided into Definitions Specific Requirements (in 17 sections) Transitions and Effective Date Appendices 2005-06 Nelson 3 Brief Introduction: SME-FRF & FRS Self-contained Historical Cost Convention Properly Present Only Not Applicable to Consol. No fallback to Main HKFRS (even if if no guidance in SME- FRS) No true and fair Only properly presented and/or true and correct Except for those Either not choose permitted or required SME-FRS, or under SME-FRS, incl. Apply to only PPE exchanged-in separate financial Finance lease statements Investment acquired by share or by asset exchange Revenue Foreign currency monetary items 2005-06 Nelson 4 2

SME Framework Users Objective Underlying Assumptions Qualitative Characteristics Elements Recognition Measurement Even SME-FRF is similar to the Framework of Main HKFRS 2 frameworks should be considered as independent framework. Conceptual Basis for the preparation of financial statements in accordance with the SME Financial Reporting Standard One of the major differences is: SME-FRF adopts Historical Cost Convention, but but further restricted that that assets: should should not not be be revalued nor nor should should future future cash cash flows flows be be discounted in in the the measurement of of assets assets and and liabilities Ruled out out Revaluation or or Fair Value Model? Value in in use? 2005-06 Nelson 5 SME Framework Qualifying Entity HK Incorporated Company Satisfies S.141D Adopted S.141D Can choose Must use No Choice Entity Non-HK Incorporated Entity Satisfies the requirements imposed by the law of the entity s place of incorporation and its constitution No Public Accountability All Owners Agreed Fulfilled Size Test Can choose SME-FRF SME-FRF and and SME-FRS SME-FRS 2005-06 Nelson 6 3

SME Framework Section 141D Satisfies S.141D In order to apply section 141D All the shareholders of a private company agree in writing that section 141D shall apply with respect to a financial year The shareholders shall not in any financial year enter into an agreement for the above purposes for more than one such financial year. But the following private companies are not allowed to apply section 141D a) a company has any subsidiary or is a subsidiary of another company formed and registered under the HK Companies Ordinance or an existing company; or b) a bank, a securities dealer, an insurance company, money lender, or a company owning and operating ships/aircraft engaged in the carriage of cargo into or out of HK All Owners Agreed in Writing Each Year Group companies under the HK Co. Ordinance Companies in Specific Industries 2005-06 Nelson 7 SME Framework Section 141D HK Incorporated Company In other word, all HK incorporated company has adopted section 141D, they must use SME-FRF and SME-FRS. Must use Adopted S.141D No Choice SME-FRF (para. 16) also clearly states that Compliance with the SME-FRF and SME-FRS is necessary in order for financial statements to give a true and correct view When a HK incorporated company prepares its financial statements in accordance with section 141D SME-FRF SME-FRF and and SME-FRS SME-FRS True and Correct = Compliance with SME-FRF and SME-FRS 2005-06 Nelson 8 4

Today s Agenda Selected Major Changes Presentation & Disclosures Leases and Investment Property Effects of of Changes in in Foreign Exchange Rates Financial Instruments SME-FRS Section 1 & 2 Section 3 & 5 Section 15 15 Section 6 2005-06 Nelson 9 Presentation and Disclosure 2005-06 Nelson 10 5

Section 1 Presentation Component of Financial Statements Overall Consideration Structure and Content Balance Sheet Income Statement Changes in Equity Accounting Policies and Notes SME-FRS Section 1 HK SSAP 1 HKAS 1 2005-06 Nelson 11 Section 1 Presentation Component of Financial Statements Under SME-FRF, a complete set of separate financial statements for the entity includes the following components: a) a balance sheet; b) an income statement; and c) accounting policies and explanatory notes. Difference from HKAS 1 Cash flow statement is not required Changes in equity can be presented either in the notes or as a separate statement. Implication Section 1 clearly states that the SME-FRS does NOT apply to the preparation and presentation of consolidated financial statements. If the entity is required or chooses to prepare group account, it cannot use SME-FRS to prepare the consolidated financial statements. 2005-06 Nelson 12 6

Section 1 Presentation Overall Consideration Under SME-FRS, financial statements should properly present the financial In In HKAS HKAS 1, 1, financial statements position and financial performance of an shall shall give give a true true and and fair fair view viewof of the the financial entity. position, financial performance Explicitly, compliance with SME-FRF and and and cash cash flows flows of of an an entity. entity. SME-FRS would only result in financial statements that achieve a proper presentation appropriate for SMEs. An An entity whose financial statements comply with with the the SME-FRS should disclose that that fact. fact. Such financial statements should not not be be described as as complying with with Main HKFRS. 2005-06 Nelson 13 Section 1 Presentation Overall Consideration In the event that the SME-FRS does not cover an event or a transaction undertaken by an entity, management may consider the SME-FRF for guidance on developing an appropriate accounting policy, consistent with the historical cost convention, for that particular event or transaction. In In HKAS HKAS 8, 8, reference will will be be made made to to relevance and and reliability requirements in in similar similar item item the the Framework and and the the pronouncements of of other other standard-setting bodies bodies adopted similar similar Framework Historical Cost Convention 2005-06 Nelson 14 7

Section 1 Presentation HK Incorporated Entity Notes to the financial statements Overall Consideration Example Basis of preparation and accounting policies The company qualifies under the HK Companies Ordinance to prepare and present its financial statements in accordance with section 141D of that Ordinance. The company s shareholders have unanimously agreed in writing to apply section 141D with respect to the company s financial statements for the year ended 31 December 2005. These financial statements comply with the Small and Medium-sized Entity Financial Reporting Standard issued by the Hong Kong Institute of Certified Public Accountants and have been prepared under the accrual basis of accounting and on the basis that the company is a going concern. The measurement base adopted is the historical cost convention. 2005-06 Nelson 15 Section 1 Presentation HK Incorporated Entity Overall Consideration Example Unqualified auditors report (per ED on PN 900) Opinion In our opinion the financial statements have been properly prepared, in all material respects, in accordance with the SME-FRS. In addition, we report that we have obtained all the information and explanations which we have required and in our opinion the balance sheet together with the notes thereon is properly drawn up so as to exhibit a true and correct view of the state of the company s affairs as at 31 December 2005 according to the best of our information and explanations given to us, and as shown by the books of the company. Non-HK Incorporated Entity This is not required for non-hk incorporated co. 2005-06 Nelson 16 8

Section 1 Presentation Overall Consideration Structure and Content Going concern basis, accrual basis, consistency of presentation and classification, offsetting guideline, and comparative requirements are largely the same as HKAS 1. Same as SSAP 1 and HKAS 1 Each component of the financial statements should be clearly identified Financial statements should be presented at least annually 2005-06 Nelson 17 Section 1 Presentation Balance Sheet Definitions of current assets and current liabilities follow the improved definitions in HKAS 1, some amendments different from HK SSAP 1 include: Current assets do not include Cash or cash equivalent restricted from being exchanged or used to settle a liability for at least 12 months after the balance sheet date Current liabilities must include Liabilities in which the entity has no unconditional right to defer settlement for at least 12 months after the balance sheet date Financial liabilities when they are due to be settled within 12 months after the balance sheet date, even if: a) the original term was for a period longer than 12 months; and b) an agreement to refinance, or to reschedule payments, on a longterm basis is completed after the balance sheet date and before the financial statements are authorised for issue. 2005-06 Nelson 18 9

Section 1 Presentation Balance Sheet Example Can the following be classified as current assets? 3-month fixed deposits pledged to a bank to secure a mortgage loan of 5 years 2-year fixed deposits with a bank Can the following be classified as non-current liabilities? 5-year term loan matured after year end but renewed for another 5 years after year end (before the issuance of the financial statements) 2-year term loan to be matured with 12 months and the entity has a right to renew for another 2 years 2005-06 Nelson 19 Section 1 Presentation Income Statement The face of the income statement should include, where applicable, line items that present the following amounts: a) Revenue b) Finance costs c) Tax expense, and d) Profit or loss for the period Turnover required for HK incorporated company? No such requirement under S.141D and the Eleventh Schedule of the HK Companies Ordinance. 2005-06 Nelson 20 10

Section 1 Presentation Changes in Equity Accounting Policies and Notes There is is a choice Should disclose An entity should present changes in equity either in the notes to the financial statements, or as a separate component of the financial statements. An entity should disclose the following, if the information is not disclosed elsewhere in information published with the financial statements: a) the domicile and legal form of the entity, its place of incorporation and the address of the registered office (or principal place of business, if different from the registered office); and b) a description of the nature of the entity s operations and its principal activities. 2005-06 Nelson 21 Section 1 Presentation Changes in Equity Example Accounting Policies and Notes Note to the financial statements ABC Limited is a company incorporated in Hong Kong with limited liability. The company s registered office is located at Unit 1808, 50 Bonham Strand, Hong Kong. The principal activity of the company is trading of clothes. The company has adopted a trade name Clofashion for its business. 2005-06 Nelson 22 11

Section 2 Accounting Policies SME-FRS Section 2 HK SSAP HKAS 1 and 2 8??? 2005-06 Nelson 23 Section 2 Accounting Policies Select and Apply Accounting Policy Change in Accounting Policy Change in Accounting Estimate Correction of Errors Management should use its judgment in developing an accounting policy resulting in information that is relevant to the needs of users of the financial statements and is reliable in nature. Management should select and apply an entity s accounting policies so that the financial statements comply with all the requirements of the SME-FRS and are consistent with the historical cost convention. Further emphasis 2005-06 Nelson 24 12

Section 2 Accounting Policies Change in Accounting Policy SME-FRS requires that a change in accounting policy should be made only if 1. it is required by the SME-FRS or 2. if it results in a more relevant and reliable presentation in the financial statements of the effects of transactions or other events on the entity s financial position or financial performance. It is similar to HKAS 8 However, more relevant and reliable presentation is indeed the wordings of the Exposure Draft (ED) of IAS 8 (or HKAS 8) issued in 2002. HKAS 8 has finally replaced it by using reliable and more relevant information Any difference? 2005-06 Nelson 25 Section 2 Accounting Policies Change in Accounting Policy HKAS 8 adopts retrospective application (or applied retrospectively ) in accounting for a change in accounting policy unless there is a transitional provision if the change is resulted from a new HKFRS SME-FRS adopts a similar approach but the disclosure is simplified as compared with HKAS 8. As if the new policy had always been in used Adjust opening balance of reserves for the earlier period presented Adjust all comparatives The The simplified disclosure in in SME-FRS is is the the wordings of of the the ED ED of of IAS IAS 8 in in 2002. 2002. IAS IAS 8 (or (or HKAS HKAS 8) 8) has has finally finally adopted different wordings in in the the final final standard. 2005-06 Nelson 26 13

Section 2 Accounting Policies Undue Undue cost cost or or effort effort not not defined defined in in SME-FRS Even Even not not in in Main Main HKFRS How to apply undue cost or effort? Change in Accounting Policy In addition, SME-FRS introduce a criterion of exemption undue cost or effort Restating comparative information is not required if it requires undue cost or effort Such Such undue undue cost cost or or effort effort exemption criterion had had been been proposed by by IASB IASB in in its its Exposure Draft Draft for for IAS IAS 8 but but was was finally finally abolished. IASB IASB decided that that an an exemption based based on on management s assessment of of undue undue cost cost or or effort effort is is too too subjective to to be be applied applied consistently by by different entities. In In consequence, IASB IASB abolished the the proposed undue undue cost cost or or effort effort criterion and and still still follow follow the the impracticability criterion in in IAS IAS 8. 8. But now SME-FRS still have it 2005-06 Nelson 27 Section 2 Accounting Policies How to apply undue cost or effort? Change in Accounting Policy The ED clarified that it is the cases in which the cost or effort of restating comparative information exceed the resulting benefits to be derived by users of financial statements. The ED set out an example that data may not have been collected in the prior periods in a way that allows restatement, and recreating the information would require undue cost or effort. When comparative information for a particular prior period is not restated the new accounting policy should be applied to the balances of assets and liabilities as at the beginning of the next period, and a corresponding adjustment should be made to the opening balance of reserves for the next period. 2005-06 Nelson 28 14

Section 2 Accounting Policies Undue cost or effort exemption criterion introduced in SME-FRS has replaced the impracticability exemption criterion in HKAS 8 Change in Accounting Policy Change in Accounting Estimate Correction of Errors Except for the replaced exemption criterion, other areas are simplified from HKAS 8 the effect of a change in an accounting estimate is still recognised prospectively the amount of the correction of a material prior period error is till accounted for retrospectively no fundamental error any more and definition of error consistent with HKAS 8 the disclosure requirements are similar to HKAS 8 2005-06 Nelson 29 Section 2 Accounting Policies In short, Section 2 of SME-FRS emphasises the consistency to historical cost convention simplifies the disclosure (followed the wordings of ED of IAS 8) replaces impracticability by undue cost or effort exemption criterion has NO requirement to disclose the fact and estimated effect on new standard issued but not yet become effective Select and Apply Accounting Policy Change in Accounting Policy Change in Accounting Estimate Correction of Errors SME-FRS Section 2 HK SSAP HKAS 1 and 2 8 Most interesting is is. ED to to?? IAS 8 2005-06 Nelson 30 15

Property, Plant and Equipment 2005-06 Nelson 31 SME-FRS Section 3: PPE Mainly fallback to the requirements of HK SSAP 17 Extended to investment property and leasehold interest in land Follow some simple approaches SME-FRS Section 3 HK SSAP 17 2005-06 Nelson 32 16

SME-FRS Section 3: PPE Definition Property, plant and equipment are tangible assets that: a) are held by an entity for use in the production or supply of goods or services, for rental to others, Assets held for investment for investment potential, or potential (including investment for administrative purposes; and property) are included b) are expected to be used during more than one period. 2005-06 Nelson 33 SME-FRS Section 3: PPE Recognition Recognition criteria for In SME-FRS In HKAS 16 Criteria not the same Same criteria Initial Cost Probable that future economic benefit of of the asset will flow to to the enterprise Cost measured reliably Subsequent Expenditure Probable that future economic benefits in in excess of of the originally assessed standard of of performance of of the existing asset will flow to to the entity Probable that future economic benefit of of the asset will flow to to the entity Cost measured reliably Same criteria applied to to both costs 2005-06 Nelson 34 17

SME-FRS Section 3: PPE Measurement after recognition No revaluation model can be used i.e. PPE should be carried at cost less any accumulated depreciation and any accumulated impairment losses Definitions of useful life and residual value are updated to the same definitions as in HKAS 16 Implies depreciation begins from available for use depreciation is still required even the asset is retired from active use Annual review is required on useful life but there is no such annual review requirement on residual value Consistent with Historical Cost Convention No revaluation is is allowed Useful life is is defined as: a) a) the period of of time over which an an asset is is expected to to be be available for for use by by an an entity; or or b) b) the no. of of production or or similar units expected to to be be obtained from the asset by by an an entity. 2005-06 Nelson 35 SME-FRS Section 3: PPE Application on leasehold interest in land Land and buildings are separable assets and are dealt with separately for accounting purposes. Leasehold interest in land from the HKSAR In In HKAS 17 Leases, such Government or elsewhere with similar features interest is is accounted for as an are also accounted for as PPE operating lease Leasehold land is to be depreciated over the lease term. Lease term defined as Buildings the same as HKAS 17 have a limited life and therefore, are depreciable assets. Separation or or Separate Measurement of of Land Land and and Building is is Can Can we we use use useful useful life, life, compulsorily required? instead of of lease lease term term in in amortisation? 2005-06 Nelson 36 18

Lease Term Defined in SME-FRS While HKAS 17 17 and and SME-FRS have the the same definition on on lease term, can can HK HK Interpretation 4 be be referred to to in in analysing the the implication? Lease Term is the non-cancellable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option. Lessee has the option At the inception 2005-06 Nelson 37 Leases HK Interpretation 4 HK-Int. 4 (applicable to HKFRS only) interprets that: For the purpose of applying the amortisation requirements under HKAS 16 and 17 the lease term of a HK land lease shall be determined by reference to the legal form and status of the lease renewal of a lease is assumed only when the lessee has a renewal option and it is reasonably certain at the inception of the lease that the lessee will exercise the option. Further Lessee has the option At the inception Options for extending the lease term that are not at at the discretion of of the lessee shall not be taken into account by the lessee in in determining the lease term. 2005-06 Nelson 38 19

Leases HK Interpretation 4 As a result (HK-Int. 4 also specifically stated) Lessees shall not assume that the lease term of a HK land lease will be extended for a further 50 years, or any other period while the HKSAR Government retains the sole discretion as to whether to renew Any general intention to renew certain types of property leases expressed by the HKSAR Government is not sufficient grounds for a lessee to include such Lessee has extensions in the determination of the lease term for the option amortisation At the inception Options for extending the lease term that are not at at the discretion of of the lessee shall not be taken into account by the lessee in in determining the lease term. 2005-06 Nelson 39 Leases HK Interpretation 4 Example Entity ABC has a property bought in 1980 and it is located in Cheung Sha Wan. According to the land search, the lease term with the HK SAR government should expire in 30 June 1997. Based on SSAP 14 and 17, the land and building had been depreciated over 50 years previously. Please discuss the implication under HKAS 17. Then, an an auditor issued a letter to to ABC ABC as as follows: Dear Dear Raymond, for for the the amortisation issue issue we we discussed, we we consider that that the the estimated useful useful life life of of the the land land should should be be 2047 2047 but but it it should should not not be be 1997. 1997. Therefore, the the land land cost cost should should be be amortised until until 2047. 2047. Our Our judgement is is based based on on the the HKSA s the the accounting guideline issued issued on on 1990s 1990s for for the the treatment of of land land title title in in the the new new Kowloon area. area. In In fact, fact, the the land land use use right right should should have have been been already already automatically extended to to 2047. 2047. Please comment. 2005-06 Nelson 40 20

Effects of Changes in Foreign Exchange Rates 2005-06 Nelson 41 SME-FRS Section 15: F. Exchange Rate Mainly fallback to to the requirements of HK SSAP 11 with resulting major difference from HKAS 21 SME-FRS Section 15 HK SSAP 11 2005-06 Nelson 42 21

SME-FRS Section 15: F. Exchange Rate The concept and approach of functional currency in HKAS 21 has not been adopted in SME-FRS Foreign currency In In HKAS 21, foreign follows the definition in HK SSAP 11, and currency is is a currency is re-defined as a currency other than other than the functional the reporting currency of an entity. currency of of the entity. Is there significant impact? 2005-06 Nelson 43 SME-FRS Section 15: F. Exchange Rate Translation of foreign currency transactions Initial recognition at the exchange rate at the date of transactions At each balance sheet date foreign currency monetary items retranslated by using the closing rate Translation of a foreign branch Follows the superseded Closing Rate/Net Investment Method in the superseded HK SSAP 11 a) assets and liabilities for each balance sheet presented (i.e. including comparatives) should be translated at the closing rate at the date of that balance sheet; b) income and expenses for each income statement (i.e. including comparatives) should be translated at average rate for the period, or closing rate at that balance sheet date; and c) all resulting exchange differences should be recognised as a separate component of equity. 2005-06 Nelson 44 22

SME-FRS Section 15: F. Exchange Rate The accounting for forward foreign contracts is largely based on HK SSAP 11 Accounting treatment depends on whether the forward contract is speculative or non-speculative Difference and calculation should be derived in respect of gain/loss and premium/discount on the contracts In In Main HKFRS, such accounting treatment is is set out in in HKAS 39 However, gain/loss and premium/discount on the contracts are not defined in in SME-FRS 2005-06 Nelson 45 SME-FRS Section 15: F. Exchange Rate Where a non-speculative forward contract is used as a hedge of a net monetary asset or liability the gain or loss on the contract should be taken to the income statement and the discount or premium may be either amortised over the period of the contract or taken to the income statement. Where a non-speculative forward contract is used as a hedge of a firm commitment no gain or loss need normally be recognised during the commitment period. at the end of that period any gain or loss will be added to, or deducted from, the amount of the relevant transaction. the discount or premium should be either amortised over the period of the contract or deferred with the gain or loss. Where a forward contract is speculative the gain or loss should be credited or charged to the income statement. 2005-06 Nelson 46 23

Associates and Joint Ventures 2005-06 Nelson 47 Associates and Joint Ventures SME-FRS has definitions on associate and joint venture but no specific requirements are set out Section 6 of SME-FRS (Investments) clarifies that: This Section should be applied in accounting for investments in subsidiaries, associates, joint ventures and other investments in securities Associate and joint venture would be accounted for in the same manner as other investments 2005-06 Nelson 48 24

Financial Instrument or Investment New practice Significantly difference from HK SSAP 24 and HKAS 39 2005-06 Nelson 49 SME-FRS Section 6: Investments Scope with less coverage SME-FRS addresses only investments, including investments in subsidiaries, associates, joint ventures and other investments in securities extension to derivative is uncertain Financial liability, equity instrument and derivatives are not explicitly covered New practice Significantly difference from HK SSAP 24 and HKAS 39 2005-06 Nelson 50 25

SME-FRS Section 6: Investments Definition Investment (in a Security) is defined as a financial asset (such as a bond or share or other negotiable instrument evidencing debt or ownership) held by an entity for trading, the accretion of wealth through distribution (such as interest and dividends), for capital appreciation or for other benefits to the investing entity such as those obtained through trading relationships. Current investments are those that would satisfy the criteria for being classified as current in accordance with SME-FRS. Financial asset asset not not properly defined defined in in SME-FRS, which which sets sets out out such such examples only only Included derivatives? - Strictly speaking, some derivatives are also not included - As they cannot be evidencing debt or ownership 2005-06 Nelson 51 SME-FRS Section 6: Investments Recognition simplified Same recognition criteria as other assets an investment should be recognised as an asset when: a) it is probable that future economic benefits associated with the asset will flow to the entity; and b) the cost of the asset can be measured reliably. In In HKAS 39, the approach is is when the entity becomes a party to to the contractual provisions of of the instrument. Derivative is thus recognised in HKAS 39 Can derivatives, say option or swap, be demonstrated that there is probable future economic benefits flowing to the entity? No! 2005-06 Nelson 52 26

SME-FRS Section 6: Investments Initial measurement An investment that qualified for recognition as an asset should initially be measured at its cost Cost of investments includes acquisition charges such as brokerages, fess, duties and taxes In In HKAS 39, measurement is is initially at at fair value plus transaction cost If an investment is acquired, or partly acquired, by the issue of shares or other securities the acquisition cost is the fair value of the securities issued and not their nominal or par value. If an investment is acquired in exchange, or part exchange, for another asset the acquisition cost of the investment is determined by reference to the fair value of the asset given up. In In cases where such fair value is is not reliably determinable, the acquisition cost should be the fair value of of the investment acquired. 2005-06 Nelson 53 SME-FRS Section 6: Investments Subsequent measurement simplified as compared with HKAS 39 Investment cannot be carried at fair value In SME-FRS, investments are divided into the following 3 categories for subsequent measurement Current investment Long-term investment Held-to-maturity debt security What s the effect if it refers heldto-maturity definition in HKAS 39? Current investment is the investment that would satisfy the criteria for being classified as current in SME-FRS (refer to Section 1) Except for current investment, no specific definitions are given to long-term investment and held-to maturity debt security HK SSAP 24 can be referred to ascertain what held-to-maturity debt security is Long-term investment may be regarded as the investment not classified as current investment and held-to-maturity debt security 2005-06 Nelson 54 27

SME-FRS Section 6: Investments If referred to HK SSAP 24 for reference Investments in debt securities should be classified as held-to-maturity if, and only if, the reporting enterprise has the expressed intention and ability to hold those securities to maturity If referred to HKAS 39 for reference Held to maturity investment is Non-derivative financial assets with fixed or determinable payments and fixed maturity that the entity has the positive intention and ability to hold to maturity Subject to strict tainting rule An entity shall not classify any financial assets as held to maturity if the entity has, What s the effect if it refers heldto-maturity definition in HKAS 39? Example - during the current financial year or - during the two preceding financial years, sold or reclassified more than an insignificant amount of held-to-maturity investments before maturity 2005-06 Nelson 55 SME-FRS Section 6: Investments Subsequent measurement simplified as compared with HKAS 39 Investment cannot be carried at fair value Current investment Long-term investment Held-to-maturity debt security It is carried at amortised cost, and the amortisation is calculated by the entity on a systematic basis over the period from acquisition to maturity either by way of the straight-line method, or a method whereby a constant yield is earned on the investment. The resulting carrying amount is then regarded as cost. at the lower of cost and net realisable value at cost less accumulated impairment losses for long-term investments any changes in the carrying amount recognised in the income statement. 2005-06 Nelson 56 28

Today s Agenda Selected Major Changes in in SME-FRS Section 4 Intangible assets Section 9 Impairment of of assets Section 14 14 Income taxes Section 16 16 Related party disclosures SME-FRF Transitional provisions and effective date Other Major Changes in in SME-FRS 2005-06 Nelson 57 SME-FRS Section 4: Intangible Assets Mainly fallback to the requirements of HK SSAP 29 and simplified the requirements relating to measurement SME-FRS Section 4 HK SSAP 29 2005-06 Nelson 58 29

SME-FRS Section 4: Intangible Assets Definition of intangible asset Updated to that of HKAS 38 an intangible asset is an identifiable non-monetary asset without physical substance. In In SSAP SSAP 29, 29, an an intangible asset asset is is defined defined as as an an identifiable non-monetary asset asset without without physical substance held held for for use use in in the the production or or supply supply of of goods goods or or services, for for rental rental to to others, others, or or for for administrative purposes. Now, the use of the intangible asset is irrelevant. Recognition and initial measurement are similar to HK SSAP 29 and HKAS 38 2005-06 Nelson 59 SME-FRS Section 4: Intangible Assets Measurement after recognition After initial recognition, an intangible asset should be carried at its cost less any accumulated amortisation and any accumulated impairment losses. No revaluation model can be used Amortisation with a rebuttable presumption that the useful life of an intangible asset will not exceed 20 years from the date when the asset is available for use. Definitions of useful life and residual value are updated to the same definitions as in HKAS 38. However, there is no annual review requirement on residual value. Consistent with Historical Cost Convention No revaluation is is allowed The approach of of finite and indefinite useful life in in HKAS 38 38 has not been adopted 2005-06 Nelson 60 30

SME-FRS Section 4: Intangible Assets Disclosure Simplified as compared with HKAS 38 A reconciliation of the carrying amount of the PPE at the beginning and end of the period is still required. However, comparative information is not required. HKAS 38 38 has no no such exemption and comparative information is is still required 2005-06 Nelson 61 SME-FRS Section 9: Impairment Mainly fallback to the requirements of HK SSAP 31 Provide less guidance Discounting would be permitted but not required SME-FRS Section 9 HK SSAP 31 2005-06 Nelson 62 31

SME-FRS Section 9: Impairment SME-FRS on impairment of assets is simplified from HK SSAP 31 At each balance sheet date an entity should consider whether there exists any indications of impairment and if so, estimate the recoverable amount of all assets Impairment requirements covers all assets including property, plant and equipment, intangible assets and investments in securities but excluding inventories, construction contracts and current investments 2005-06 Nelson 63 SME-FRS Section 9: Impairment Recoverable amount is the greater of an asset s net selling price (not defined!) and future net cash flow expected from the continued use of that asset. Not updated to fair value less costs to sell in in HKAS 36 (intentionally?) Discounting would be permitted but not required. HKAS 36 s lengthy explanation in explaining how to derive future cash flow is not provided in SME-FRS Good or bad? The effect of time value of money is quite substantial in some cases! 2005-06 Nelson 64 32

SME-FRS Section 9: Impairment Example An asset has a carrying amount of $100,000 It can provide a rental income of $10,000 in next 10 years end At the end of 10 years, there is no residual value Normal discount rate is 5%. Calculate the future cash flow with and without discounting Future cash flow in in total is is $100,000 Discounted future cash flow is is $77,217 Difference is is $22,783 (23% of the carrying amount) The effect of time value of money is quite substantial in some cases! 2005-06 Nelson 65 SME-FRS Section 9: Impairment No separate disclosure requirements are set out in Section 9 for impairment of assets! The concept of cash-generating unit is not provided in SME-FRS It may involve more cost and effort! Implicitly, impairment test shall be performed on individual asset level Cost or effort saved or increased? 2005-06 Nelson 66 33

SME-FRS Section 14: Income Taxes Simplified from HKAS 12 and made a significant amendment Provision for deferred tax is not allowed 2005-06 Nelson 67 SME-FRS Section 14: Income Taxes SME-FRS prohibits the recognition of deferred tax liabilities or assets It clearly states that deferred tax liabilities (assets) should not be recognised. Tax expense (income) is only composed of current tax It is defined as the aggregate amount included in the determination of profit or loss for the period in respect of current tax. Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period e.g. representing only those payables to the tax authorities, like 2005-06 Nelson 68 34

SME-FRS Section 14: Income Taxes Illustrative financial statements in the Appendix to SME-FRS - Accounting Policies and Explanatory Notes to the Financial Statements Example Taxation Income tax expense represents current tax expense. The income tax payable represents the amounts expected to be paid to the taxation authority, using the tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date. Deferred tax is not provided. 2005-06 Nelson 69 SME-FRS Section 16: Related Party Simplified from HKAS 24 and similar to HKAS 24 Definition of related party is updated to the definition in HKAS 24 except for a minor difference in the definition of close member of the family SME-FRS Section 16 HKAS 24 2005-06 Nelson 70 35

SME-FRS Section 16: Related Party Similar definition adopted in in HKAS 24 24 Related party: a party is related to an entity if: a) directly, or indirectly through one or more intermediaries, the party: i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries); ii) has an interest in the entity that gives it significant influence over the entity; or iii) has joint control over the entity; b) the party is an associate of the entity; c) the party is a joint venture in which the entity is a venturer; d) the party is a member of the key management personnel of the entity or its parent; e) the party is a close member of the family of any Definition? individual referred to in (a) or (d); or f) the party is an entity that is controlled, jointly controlled or significantly influenced by, or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e). 2005-06 Nelson 71 SME-FRS Section 16: Related Party Similar definition adopted in in HKAS 24 24 Close members of the family of an individual are those family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity they may include: a) the individual s spouse and children; b) children of the individual s spouse; and c) dependants of the individual or the individual s spouse. HKAS HKAS 24 24 uses uses domestic partner, instead instead of of spouse 2005-06 Nelson 72 36

SME-FRS Section 16: Related Party Related party disclosures are required under the SME-FRS In the past, HK SSAP 20 implicitly gave exemption to those financial statements prepared under section 141D of the HK Companies Ordinance. Now, even under SME-FRS, disclosures are required, including Name of the entity s parent or ultimate controlling company Total remuneration of key management personnel If there have been transactions between related parties, an entity should disclose the nature of the related party relationships, and at a minimum, disclosures should include: a) the amount of the transactions; b) the amount of outstanding balances c) provisions for doubtful debts related to the amount of outstanding balances; and d) the expense recognised during the period in respect of bad or doubtful debts due from related parties. 2005-06 Nelson 73 SME-FRF Transitional Provisions HKFRS (Main (Main HKFRS) SME-FRS The transition to the SME-FRF and SME-FRS is accounted for as follows: a) All items recognised previously under a different GAAP which do not meet the recognition criteria under the SME-FRF and SME-FRS are to be derecognised and dealt with as a change of accounting policy under the SME-FRS. b) All items not recognised previously under a different GAAP which do meet the recognition criteria under the SME-FRF and SME-FRS are to be recognised in accordance with the relevant section of the SME-FRS and dealt with as a change of accounting policy under the SME-FRS. c) All items recognised previously under a different GAAP, which do meet the recognition criteria under the SME-FRF and SME-FRS, but which were previously measured on a basis inconsistent with the SME-FRF and SME-FRS are to be re-measured in accordance with the relevant section of the SME- FRS and dealt with as a change of accounting policy under the SME-FRS. 2005-06 Nelson 74 37

SME-FRF Transitional Provisions Suggest any items that: a) Not meeting the recognition criteria under the SME-FRF and SME-FRS to be derecognised b) Not recognised previously but meeting the recognition criteria under the SME- FRF and SME-FRS to be recognised c) Recognised previously but required to be re-measured in accordance with SME-FRS More discussion on on individual items later Example Derivatives Deferred tax Component replacement of property, plant and equipment Long leasehold interest in land without title pass Intangible asset not meeting the previous definition Decommissioning cost Property, plant and equipment remeasured to cost Intangible asset re-measured to cost Investments re-measured to cost Value in use fallback to expected future cash flow 2005-06 Nelson 75 SME-FRF Transitional Provisions Example Transition to Small and Medium-sized Entity Financial Reporting Standard In pursuant to the adoption of the Small and Medium-sized Entity Financial Reporting Standard (SME-FRS), the company has dealt with the following changes as a change of accounting policy under the SME- FRS. 1. Items (including.) recognised previously which do not meet the recognition criteria under the SME-FRS have been derecognised. 2. Items (including.) not recognised previously under a different GAAP which do meet the recognition criteria under the SME-FRF and SME-FRS are to be recognised 3. Items (including.) previously measured on a basis inconsistent with the SME-FRS have been re-measured in accordance the SME-FRS Except for those set out below, such changes have no significant impact to the company s performance and financial position. 2005-06 Nelson 76 38

SME-FRF Transitional Provisions HKFRS (Main (Main HKFRS) SME-FRS The transition from the SME-FRF and SME-FRS is not explicitly stated in the SME-FRF and SME- FRS. HKFRS 1 imposes some additional requirements during transition But it it also provides some exemptions not available in SME-FRS However, HKICPA clarifies in its set of Questions and Answers that when an entity no longer qualifies for reporting under the SME-FRS, the entity has to apply HKFRS 1 First-time Adoption of HK Financial Reporting Standards for its first HKFRS financial statements 2005-06 Nelson 77 Implementation of SME-FRS in HK 23 October 2006 Full set of slides can be found in www.nelsoncpa.com.hk Q&A Session Nelson Lam 林智遠 nelson@nelsoncpa.com.hk www.nelsoncpa.com.hk 2005-06 Nelson 78 39