HKAS 16, HKFRS 6 & Interpretation 12 October 2006

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1 HKAS 16, HKFRS 6 & Interpretation 12 October 2006 Nelson Lam 林智遠 CFA FCCA FCPA(Practising) MBA MSc BBA CPA(US) ACA Nelson 1 Today s Agenda Property, Plant and Equipment (HKAS 16) Hong Kong Interpretation 1 Hong Kong Interpretation 4 Exploration for for and Evaluation of of Mineral Resources (HKFRS 6) 6) Simple but Comprehensive Recap and key issues Real Life Cases and Examples Nelson 2 1

2 Property, Plant and Equipment (HKAS 16) Nelson 3 From SSAP 17 to HKAS 16 Summary 1. Objective and Scope 2. Definitions 3. Recognition 4. Measurement at recognition 5. Measurement after recognition 6. Derecognition 7. Disclosure Exempted entities deleted, some properties excluded Cost and residual value revised Same recognition principle applied to all costs Element of cost extended Measurement of assets from exchange of assets revised Commencement and cessation of depreciation revised Annual review of residual value needed Sections of transfer, retirements and disposals eliminated Derecognition rule introduced No exemption on disclosure of comparative figures (comparative on reconciliation needed) Nelson 4 2

3 Topics To Be Covered Definition 1. Objective and Scope 2. Definitions Recognition 3. Recognition 4. Measurement At Recognition Measurement 5. Measurement After Recognition 6. Derecognition Presentation and Disclosure 7. Disclosure 8. Transitional Provisions Nelson 5 1. Objective and Scope The objective of HKAS 16 is to prescribe the accounting treatment for property, plant and equipment (PPE) so that users of the financial statements can discern information about an entity s investment in its PPE and the changes in such investment. The principal issues in accounting for property, plant and equipment (PPE) are: a) the recognition of the assets, b) the determination of their carrying amounts and c) the depreciation charges and impairment losses to be recognised in relation to them. Definitions What are PPE? Recognition Measurement Nelson 6 3

4 1. Objective and Scope HKAS 16 shall be applied in accounting for PPE except when another standard requires or permits a different accounting treatment. HKAS 16 does not apply to: a) property, plant and equipment classified as held for sale in accordance with HKFRS 5 Non-current Assets Held for Sale and Discontinued Operations; b) biological assets related to agricultural activity (see HKAS 41 Agriculture); c) the recognition and measurement of exploration and evaluation assets (see HKFRS 6 Exploration for and Evaluation of Mineral Resources); or d) mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources. However, HKAS 16 applies to PPE used to develop or maintain the assets described in (a) and (d) Nelson 7 1. Objective and Scope Other HKFRSs/HKASs may require recognition of an item of PPE based on an approach different from that in HKAS 16. For example, HKAS 17 Leases requires an entity to evaluate its recognition of an item of leased PPE on the basis of the transfer of risks and rewards. However, in such cases other aspects of the accounting treatment for these assets, including depreciation, are prescribed by HKAS Nelson 8 4

5 1. Objective and Scope Are the following assets PPE? Example Copier acquired under an operating lease Motor vehicle acquired under finance leases Owned property used for rental purpose Investment property under re-development Property held for a currently undetermined future use Leasehold land separated from the leasehold building HKAS 17 HKAS 40 HKAS 40 HKAS 40 HKAS Nelson 9 1. Objective and Scope An entity shall apply HKAS 16 to property that is being constructed or developed for future use as investment property but does not yet satisfy the definition of investment property in HKAS 40 Investment Property. Once the construction or development is complete, the property becomes investment property and the entity is required to apply HKAS 40. HKAS 40 also applies to investment property that is being redeveloped for continued future use as investment property. An entity using the cost model for investment property in accordance with HKAS 40 shall use the cost model in HKAS Nelson 10 5

6 1. Objective and Scope Exemption for not-for-profit entities eliminated The exemption in SSAP 17 for charitable, government subvented and not-for-profit organisations was eliminated in HKAS 16 Specific transitional provisions for this elimination additionally introduced in Nov Charities, not-for-profit entities must follow Implies that all such entities are required to depreciate its PPE from the financial period beginning from 1 Jan Those entities that have previously taken advantage of the exemption under SSAP 17 are permitted to deem the carrying amount of an item of PPE immediately before applying HKAS 16 on its effective date (or earlier) as the cost of that item More to be discussed later Nelson Definitions Property, plant and equipment (PPE) are tangible items that: a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and b) are expected to be used during more than one period Nelson 12 6

7 3. Recognition The cost of an item of PPE shall be recognised as an asset if, and only if: a) it is probable that future economic benefits associated with the item will flow to the entity; and b) the cost of the item can be measured reliably. Recognition Criteria Major spare parts, servicing equipment, replacement and inspection can also be qualified as PPE. If If the the recognition criteria is is met, met, such cost cost is is recognised; the thecarrying amount of of the the replaced parts or or previous inspection is is derecognised Nelson Recognition Principle Change Recognition criteria (capitalisation) for Initial Cost Subsequent Expenditure In SSAP 17 In HKAS 16 Criteria not the same Same criteria Probable that future Probable that future economic benefit of of economic benefits in in the asset will flow to to excess of of the originally the enterprise assessed standard of of Cost measured performance of of the reliably existing asset will flow to to the entity Probable that future economic benefit of of the asset will flow to to the entity Cost measured reliably Same criteria applied to to both costs Expenditure not fulfilling the recognition criteria will be charged to income statement Clearer approach on on so-called Component Accounting Nelson 14 7

8 3. Recognition Principle Updated Case Capitalise Expense Hong Kong Aircraft Engineering Company Limited Annual Report 2005 states: Property, plant and equipment are carried at cost less accumulated depreciation and accumulated impairment losses. Cost includes expenditure that is directly attributable to the acquisition of the items. Subsequent costs are included in the asset s carrying amount or recognised as a separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measured reliably. All other repairs and maintenance are expensed in the profit and loss account during the financial period in which they are incurred Nelson Recognition Principle Updated Case Capitalise 2005 Annual Report stated its accounting policy on cost of restoring and improving PPE as follows: The plant components are depreciated over the period to overhaul. Major costs incurred in restoring the plant components to their normal working condition to allow continued use of the overall asset are capitalised and depreciated over the period to the next overhaul. Improvements are capitalised and depreciated over their expected useful lives to the Group Nelson 16 8

9 3. Recognition Principle Updated Case Capitalise Expense Hong Kong Exchange and Clearing Limited (HKEx) Consolidated financial statements of 2004 early adopted all HKFRSs issued up to 31 Dec. 2004, including HKAS 16, 17 Accounting policy on fixed assets states Subsequent costs are included in the asset s carrying amount or recognised as separate asset, as appropriate, only when it is probable that future economic benefits associated with the item will flow to the Group and the cost of the item can be measure reliably All other repairs and maintenance are charged to the profit and loss account during the year in which they are incurred Nelson Measurement at Recognition An item of PPE that qualifies for recognition as an asset shall be measured at its cost. Cost the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction, or where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other HKFRSs e.g. HKAS 39, HKFRS Nelson 18 9

10 4. Measurement at Recognition Example Entity GV buys a machine by granting share options to the supplier, who can subscribe 100 shares of Entity GV. The cash price of the machine is $200. The fair value of the options at the grant date is $300. How much should be recognised as the cost of machine? Per Per HKAS 16, 16, the the amount attributed to to the the machine should refer refer to to the the specific requirements of of HKFRS 2 Share-based Payments. Under HKFRS 2, 2, GV GV shall shall recognise an an increase in in equity if if the the machine is is received in in an an equity-settled share-based payment transaction. While the the transaction is is with with a party other than than employees and and other providing similar services, there is is a rebuttable presumption that that the the fair fair value of of goods received can can be be estimated reliably (i.e. (i.e. $200 in in this this case). In In rare rare case (if (if presumption rebutted), the the transaction is is measured by by reference to to the the fair fair value of of the the equity instruments (i.e. (i.e. share options) granted Nelson Measurement at Recognition Case In its 2005 Interim Report, full set of HKFRS was adopted. New accounting policy on property, plant and equipment Cost may include transfers from equity of any gains/losses on qualifying cash flow hedges of foreign currency purchases of property, plant and equipment. The assets residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. Hedging under HKAS Nelson 20 10

11 4. Measurement at Recognition The cost of an item of PPE comprises: a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. Purchase Price Directly Attributable Cost Dismantling Cost Nelson Measurement at Recognition Example Several same air-condition plants have been installed by GV in several leasehold properties. When the properties are returned to the landlord in 4 years, the plants should be removed. The properties include factory (3 plants installed), show room (1 plant installed) and head office (2 plants installed). The purchase cost of each plant is $1,000. The installation cost is $1,000 for each plant. Present value of removal costs of the plant include $400 resulted from installation only and $400 from the usage during the 4 years. What is the cost of each plant to be recognised? In In accordance with HKAS the the cost of of each plant installed in in the the factory should be be $2,400 (the purchase cost, installation cost and and present value of of removal cost from installation). the the cost of of each plant installed in in the the show room and and head office should be be $2,800 (including the the present value of of all all removal costs) Since the the removal costs of of such plants are are incurred as as a consequence of of having used the the machine during a particular period for for purposes, other than to to produce inventories during that that period Nelson 22 11

12 4. Measurement at Recognition Example Entity A operates an offshore oilfield where its 20-year licensing agreement requires it to remove the oil rig at the end of production and restore the seabed. Costs of removal of the oil rig and restoration of the seabed include: 75% relates to damage caused by building the oil rig 85% 10% relates to damage caused by regular maintenance of the oil rig 15% arises through the extraction of oil The cost of of the the oil oil rig rig includes the the best estimate of of 85% of of the the eventual costs a provision in in the the amount of of that that cost will will be be recognised when the the oil oil rig rig has has been constructed. removal of of the the oil oil rig rig and and restoration of of damage caused by by building it it for for purposes, other than to to produce inventories during that that period recognised as as a liability when the the oil oil is is extracted Nelson Measurement at Recognition Element of cost extended Rule on Exchange of Assets Revised Same amendment in in HKAS 38 and HKAS 40 Cost of PPE acquired in exchange is measured at fair value But not required if: Commercial Substance Fair Value of of Exchanged Asset In SSAP 17 it is an exchange for similar assets In HKAS 16 the exchange transaction lack of Commercial Substance, or the Fair Value is not reliably measurable (both asset received and given up) If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up Nelson 24 12

13 4. Measurement at Recognition Commercial Substance To determine Commercial Substance considering the extent to which its future cash flows are expected to change as a result of the transaction Commercial Substance exists if: a) the configuration (risk, timing and amount) of the cash flows of the asset received differs from that of the asset transferred; or b) the entity-specific value of the portion of the entity s operations affected by the transaction changes as a result of the exchange; and c) the difference in (a) or (b) is significant relative to the fair value of the assets exchanged Nelson Measurement at Recognition Fair Value of of Exchanged Asset Even comparable market transactions do not exist, Fair Value of an asset is reliably measurable if a) the variability in the range of various reasonable fair value estimates is not significant for that asset, or b) the probabilities of the various estimates within the range can be reasonably assessed and used in estimating fair value. If an entity is able to determine reliably the fair value of either the asset received or the asset given up then the fair value of the asset given up is used to measure the cost of the asset received unless the fair value of the asset received is more clearly evident Nelson 26 13

14 5. Measurement after Recognition An entity shall choose either: Cost Model Revaluation Model as its accounting policy and the entity shall apply that policy to an entire class of PPE Nelson Measurement after Recognition Cost Model Revaluation Model After recognition as an asset, an item of PPE shall be carried at Its cost less any accumulated depreciation and any accumulated impairment losses After recognition as an asset, an item of PPE shall be carried at a revalued amount, being its fair value at the date of the revaluation, Less any subsequent accumulated depreciation and subsequent accumulated impairment losses Nelson 28 14

15 5. Measurement after Recognition Revaluation Model What is fair value? Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm s length transaction. All All HKFRS/HKAS have same definition on on fair value now. The fair value of land and buildings is usually determined from market-based evidence by appraisal that is normally undertaken by professionally qualified valuers. items of PPE is usually their market value determined by appraisal. If there is no market-based evidence of fair value because of the specialised nature of the item of PPE and the item is rarely sold, an entity may need to estimate fair value using an income or a depreciated replacement cost approach Nelson Measurement after Recognition Revaluation Model Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from the fair value at the balance sheet date. The frequency of revaluations depends upon the changes in fair values of the items of PPE being revalued. a) When the fair value of a revalued asset differs materially from its carrying amount, a further revaluation is required. b) Some items of PPE experience significant and volatile changes in fair value, thus necessitating annual revaluation. c) Such frequent revaluations are unnecessary for items of PPE with only insignificant changes in fair value. Instead, it may be necessary to revalue the item only every 3 or 5 years Nelson 30 15

16 5. Measurement after Recognition Revaluation Model When an item of PPE is revalued, any accumulated depreciation at the date of the revaluation is treated in one of the following ways: a) restated proportionately with the change in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount. This method is often used when an asset is revalued by means of applying an index to its depreciated replacement cost. b) eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset. This method is often used for buildings Nelson Measurement after Recognition At year end, a class of motor vehicles has: Cost of $100,000 and accumulated depreciation of $40,000 Revalued amount of that class of motor vehicles is $90,000 Show the revaluation effect Example Accumulated depreciation restated proportionately with the change in in the gross carrying amount of the asset so that the carrying amount of the asset after revaluation equals its revalued amount. Cost restated ($100,000 x 90,000 // 60,000) $ 150,000 Accumulated depreciation restated ($90,000 x 90,000 // 60,000) ($ 60,000 ) Accumulated depreciation eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount Cost $ 100,000 Accumulated depreciation eliminated ($40, $30,000) ($ 10,000 ) Nelson 32 16

17 5. Measurement after Recognition Revaluation Model If an item of property, plant and equipment is revalued, the entire class of PPE to which that asset belongs shall be revalued If an asset s carrying amount is increased as a result of a revaluation, the increase shall be credited directly to equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. If an asset s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be debited directly to equity under the heading of revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of that asset Nelson Measurement after Recognition Revaluation Model Example In 2005, an entity buys a PPE at $1,000 and adopts revaluation model. At year end of 2005, PPE s fair value rises to $1,500. At year end of 2006, PPE s fair value falls to $800. Ignore the depreciation, prepare journal for each situation above. Dr Dr PPE 1,000 Cr Cr Cash 1,000 Dr Dr PPE (1,500 1,000) Cr Cr Revaluation reserves Dr Dr Revaluation reserves Profit and and loss Cr Cr PPE (1, ) Nelson 34 17

18 5. Measurement after Recognition Revaluation Model The revaluation surplus included in equity in respect of an item of PPE may be transferred directly to retained earnings when the asset is derecognised. However, some of the surplus may be transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the asset and depreciation based on the asset s original cost. Dr Depreciation (depreciation based on the asset s original cost ) Dr Revaluation reserves (difference) Cr Acc. Depreciation (depreciation based on the revalued carrying amount) Transfers from revaluation surplus to retained earnings are not made through profit or loss Nelson Measurement after Recognition Cost Model Depreciation Revaluation Model Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Useful life is: a) the period over which an asset is expected to be available for use by an entity; or b) the number of production or similar units expected to be obtained from the asset by an entity. The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life Nelson 36 18

19 5. Measurement after Recognition Depreciation Each part of an item of PPE with a cost that is significant in relation to the total cost of the item shall be depreciated separately. e.g. it may be appropriate to depreciate separately the airframe and engines of an aircraft The depreciation charge for each period shall be recognised in profit or loss unless it is included in the carrying amount of another asset. Each significant component shall be depreciated separately (not clearly required in the past) Clearer approach on on so-called Component Accounting Nelson Measurement after Recognition Example Depreciation At 1 Jan. 2005, AX bought a laser printing machine of HK$50 million The machine will be used for 5 years (maximum useful life) and then dispose of at zero value The machine s laser head can operate 500 hours, after that replacement of a new laser head is is needed The cost of a new laser head was HK$10 million at that time and its residual value is is zero. Cost of of each part is is significant in in relation to to the the total cost of of the the parts Each part should be be depreciated separately Laser machine other than laser head is is depreciated over 5 years Laser head is is depreciated over hours Under usage methods of depreciation, the depreciation charges can be zero while there is no production Nelson 38 19

20 5. Measurement after Recognition At 1 Jan. 2005, AX bought a laser printing machine of HK$50 million The machine will be used for 5 years (maximum useful life) and then dispose of at zero value The machine s laser head can operate 500 hours, after that replacement of a new laser head is is needed The cost of a new laser head was HK$10 million at that time and its residual value is is zero. Example Depreciation Assume the laser head can operate 500 hours or 5 years, which is shorter. If the machine has not been used in the 2nd year, calculate depreciation on the laser head under different depreciation methods Depreciation for for 2nd 2nd year If If the the laser head is is depreciated over hours (unit of of production) zero 5 years on on a straight-line basis $2 million Nelson Measurement after Recognition Case Annual Report 2005 Where an item of property and equipment comprises major components having different useful lives, they are accounted for as separate items of property and equipment. Depreciation is calculated to write off the cost or deemed cost, less residual value if applicable, of property and equipment and is charged to the income statement on a straight-line basis over the estimated useful lives of each part of an item of property and equipment Nelson 40 20

21 5. Measurement after Recognition Depreciation Residual Value Depreciable amount The depreciable amount of an asset shall be allocated on a systematic basis over its useful life. The residual value and the useful life of an asset shall be reviewed at least at each financial year-end if expectations differ from previous estimates, the change shall be accounted for as a change in an accounting estimate in accordance with HKAS Nelson Measurement after Recognition Depreciation Residual Value Depreciable amount As stated before, definition of Residual Value is revised as the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life Inflation may be incorporated in residual value New requirements (on both residual value and useful life) shall be reviewed at least at each financial year end if expectations differ from previous estimates, the change shall be accounted for as a change in an accounting estimate in accordance with HKAS 8 No such requirement in SSAP Nelson 42 21

22 5. Measurement after Recognition PPE s residual value may increase to an amount equal to or greater than the asset s carrying amount If it does, the depreciation charge is zero unless and until its residual value subsequently decreases to an amount below the asset s carrying amount Be careful By referring to the definition of residual value It is still limited to the estimates that it would receive currently for the asset if the asset were already of the age and in the condition expected at the end of its useful life Implication: If If estimated residual value value > carrying amount amount no no depreciation is is required But But feasible only only if if the the management clearly clearly intends intends to to dispose of of the the PPE PPE before before the the end end of of its its physical usage usage life life otherwise, the the estimated residual value value is is minimal or or even even zero zero Nelson Measurement after Recognition Same laser machine example as before At 1 Jan. 2005, AX bought a laser printing machine of HK$50 million The machine will be used for 5 years (maximum useful life) and then dispose of at zero value The machine s laser head can operate 500 hours, after that replacement of a new laser head is is needed The cost of a new laser head was HK$10 million at that time and its residual value is is zero. Example At 31 Dec. 2005, the price of a new laser machine increases to HK$75 million No change in cost of a new laser head and estimated maximum useful life Shall AX revise the residual value at 31 Dec. 2005? No! AX has not changed its its usage plan and the residual value after the estimated useful live would still be be zero Nelson 44 22

23 5. Measurement after Recognition Another one At 1 Jan. 1985, Entity A bought a flat in Tai Koo Shing at HK$ 500,000. Entity A aimed to use it for 50 years until the end of its estimated useful life The original estimated residual value is zero Depreciation is calculated on a straight-line basis At 31 Dec. 2004, the depreciated historical cost (and carrying amount) of the property was HK$0.3 million Now, the price of a similar flat in Tai Koo is about HK$ 3M Shall A revise the residual value? Example No! A has has not not changed its its usage plan and and the the residual value after the the estimated useful live live would still still be be around zero If A changes its intention and aims to dispose of the flat in 10 years (i.e. 2015) Shall A revise the residual value? Yes! If If A can can demonstrate that that it it has has an an intention to to dispose of of it it before the the end end of of its its economic life life Nelson Measurement after Recognition Depreciation Depreciation of an asset begins when it is available for use i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with HKFRS 5 and the date that the asset is derecognised Land and buildings are separable assets and are accounted for separately, even when they are acquired together. Depreciable amount Implied that depreciation still required even PPE becomes idle or is retired from active use Nelson 46 23

24 5. Measurement after Recognition The depreciation method used shall reflect the pattern in which the asset s future economic benefits are expected to be consumed by the entity shall be reviewed at least at each financial year-end and such a change shall be accounted for as a change in an accounting estimate in accordance with HKAS 8 Other than the above, that method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. Depreciation Depreciable amount Depreciation method Nelson Measurement after Recognition HKAS 16 states that: Depreciation A variety of depreciation methods Depreciable amount can be used to allocate the depreciable amount of an asset on Depreciation method a systematic basis over its useful life. These methods include: results in in a constant charge over the the useful Straight Line life life if if the the asset s residual value does not not change Diminishing Balance Units of Production results in in a decreasing charge over the the useful life life results in in a charge based on on the the expected use use or or output Nelson 48 24

25 5. Measurement after Recognition 2 broad schools of thought on the meaning of consumption of economic benefits of an Supporters argue infrastructure asset: for for the the component approach and and primarily Time straight-line depreciation method Based View as as they consider the the passage of of time determines the the consumption of of economic benefits for for most components of of toll toll roads. Usage Based View Supporters argue for for the the integral asset approach and and units-ofusage depreciation method as as they consider the the usage or or traffic flow determines the the consumption of of economic benefits for for entire toll toll roads Nelson Measurement after Recognition To determine whether an item of PPE is impaired, an entity applies HKAS 36 Compensation from third parties for items of property, plant and equipment that were impaired, lost or given up shall be included in profit or loss when the compensation becomes receivable Depreciation Depreciable amount Depreciation method Impairment Nelson 50 25

26 5. Measurement Impairment Triggering events Recoverable Amount Impairment Loss At each reporting date, an entity shall assess whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset. It is the higher of an asset s Fair value less costs to sell and Value in Use If, and only if, the recoverable amount of an asset is less than its carrying amount The carrying amount of the asset shall be reduced to its recoverable amount. That reduction is an impairment loss Nelson Derecognition The carrying amount of an item of PPE shall be derecognised: a) on disposal; or b) when no future economic benefits are expected from its use or disposal. The gain or loss arising from the derecognition of an item of PPE shall be included in profit or loss when the item is derecognised (unless HKAS 17 requires otherwise on a sale and leaseback). Gains shall not be classified as revenue Nelson 52 26

27 6. Derecognition Derecognition on replacement If, under the initial recognition principle, an entity recognises in the carrying amount of an item of PPE the cost of a replacement for part of the item, then it derecognises the carrying amount of the replaced part regardless of whether the replaced part had been depreciated separately. The gain or loss arising from the derecognition of an item of PPE shall be determined as the difference between the net disposal proceeds, if any, and the carrying amount of the item Nelson Disclosure The financial statements shall disclose, for each class of PPE: a) the measurement bases used for determining the gross carrying amount; b) the depreciation methods used; c) the useful lives or the depreciation rates used; d) the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; and Nelson 54 27

28 7. Disclosure Detailed information and reconciliation of the carrying amount of PPE are required The reconciliation of the carrying amount of PPE for prior period, i.e. comparative reconciliation is now required The carrying amount of the PPE net book value of PPE In HK SSAP 17, the requirement is a reconciliation of the gross carrying amount and the accumulated depreciation at the beginning and end of the period Nelson Disclosure Case Leasehold improvements, furniture, equipment and Leasehold buildings Computer trading and clearing systems Other computer hardware and software motor vehicles Total $ 000 $ 000 $ 000 $ 000 $ 000 Net book value at 1 Jan 2003 as previously reported (note ii) 117, , ,304 71, ,108 effect of adopting HKAS 17 (98,500) (98,500) as restated (note i) 18, , ,304 71, ,608 Additions 13,431 16,775 6,041 36,247 Disposals (3,474) (6,659) (1,604) (11,737) Depreciation (748) (109,510) (39,703) (31,778) (181,739) Revaluation (note 34) Net book value at 31 Dec , ,679 75,717 44, ,927 At 31 Dec 2003 At cost 1,345, , ,519 1,924,307 At valuation 18,300 18,300 Accumulated depreciation (1,000,724) (271,668) (187,288) (1,459,680) Net book value 18, ,679 75,717 44, , Nelson 56 28

29 7. Disclosure However, in SME FRS, the requirement is the same (except no comparative requirement), but it it gives the following illustrative e notes: Property, plant and equipment Cost: At 1 January 20X5 Additions Disposals At 31 December 20X5 Accumulated depreciation and impairment losses: At 1 January 20X5 Depreciation for the year Written back on disposal At 31 December 20x5 Net carrying amount: At 31 December 20X5 At 31 December 20x4 Leasehold land and buildings HK$ 5,040, ,040,000 2,160,000 80,000-2,240,000 2,800,000 2,880,000 Furniture, fixtures and equipment HK$ 2,428,180 2,381,530 (1,527,470) 3,282,240 1,204, ,770 (878,000) 811,940 2,470,300 1,224,010 Example Total HK$ 7,468,180 2,381,530 (1,527,470) 8,322,240 3,364, ,770 (878,000) 3,051,940 5,270,300 4,104, Nelson Disclosure The financial statements shall also disclose: a) the existence and amounts of restrictions on title, and PPE pledged as security for liabilities; b) the amount of expenditures recognised in the carrying amount of an item of PPE in the course of its construction; c) the amount of contractual commitments for the acquisition of PPE; and d) if it is not disclosed separately on the face of the income statement, the amount of compensation from third parties for items of PPE that were impaired, lost or given up that is included in profit or loss. Similar disclosures are required on the PPE measured by using Revaluation Model Nelson 58 29

30 Topics To Be Covered Definition 1. Objective and Scope 2. Definitions Recognition 3. Recognition 4. Measurement At Recognition Measurement 5. Measurement After Recognition 6. Derecognition Presentation and Disclosure 7. Disclosure 8. Transitional Provisions Nelson Transitional Provisions For exchange of assets The requirements regarding the initial measurement of an item of PPE acquired in an exchange of assets transaction shall be applied prospectively to future transactions Nelson 60 30

31 8. Transitional Provisions For those entities (charities and not-for-profit entities) that have previously taken advantage of the exemption under SSAP 17 They are permitted to deem the carrying amount of an item of PPE immediately before applying HKAS 16 on its effective date (or earlier) as the cost of that item. Depreciation on the deemed cost of an item of property, plant and equipment commences from the time at which HKAS 17 is first applied. In the case where a carrying amount is used as a deemed cost for subsequent accounting, this fact and the aggregate of the carrying amounts for each class of property, plant and equipment presented shall be disclosed Nelson Transitional Provisions What is the implication on the following cases when HKAS 16 is adopted? Example All the costs of PPE of an notfor-profit entity had been written off to income and expenditure statement before All the costs of PPE of an notfor-profit entity had not been depreciated before The The entity is is permitted not not to to restate restate the the costs costs of of PPE PPE to to carry carry zero zero beginning balance on on PPE PPE in in to to follow follow HKAS HKAS from from The The entity is is permitted to to begin begin depreciation from from to to follow follow HKAS HKAS from from For For both both cases, the the fact fact and and the the aggregate of of the the carrying amounts for for each class of of PPE PPE presented shall shall be be disclosed Nelson 62 31

32 HK Interpretation 1 The Appropriate Policies for Infrastructure Facilities Nelson 63 HK Interpretation 1 Sinking Fund Some companies in HK have adopted Sinking Fund Method in depreciating their infrastructure facilities, in particular toll roads, in their financial statements purporting to be in compliance with HKFRSs. Such companies disclosed an accounting policy that the capital cost of an infrastructure asset was allocated by applying a sinking fund method whereby the aggregate annual depreciation amounts, compounded at certain rates of return, up to the expiry of the infrastructure asset (e.g. toll road) concession periods, will be equal to the total cost of the asset Nelson 64 32

33 HK Interpretation 1 Sinking Fund Example A machine costs HK$600,000 with an estimated useful life of 3 years? Calculate deprecation for the years under difference depreciation methods. Year 1 Year 2 Year 3 Total Straight-line basis Reducing balance (at 70%) Sum-of-year-digit Sinking fund (compounded at 23.2%) (160 x 123.2%) (197 x 123.2%) Sinking fund method allocates more depreciation to the later years. It is different from most depreciation methods (as above) Nelson 65 HK Interpretation 1 Sinking Fund Case Some listed companies stated that they had used a sinking fund method Nelson 66 33

34 Conclusion by HK Interpretation 1 HK Int. 1 concludes that: The Sinking Fund Method is NOT an appropriate method of depreciating or amortising infrastructure assets, regardless of whether the asset (or components thereof) is classified as property, plant and equipment, intangible assets or operating lease prepayments. By definition, the sinking fund method neither supports the view that consumption of economic benefits (such as in a Build- Operate-Transfer franchise) is determined by either the passage of time and/or usage. Sinking Fund Nelson 67 HK Interpretation 4 Leases Determination of the Length of Lease Term in respect of Hong Kong Land Leases Nelson 68 34

35 HK Interpretation 4 Leases Determination of the Length of Lease Term in respect of Hong Kong Land Leases A locally developed interpretations issued in May 2005 Clarified how the length of the lease term of a HK land lease should be determined for the purpose of applying the amortisation requirements under HKAS 16 and 17 Have a review on such requirement on HKAS 16 and 17 first Nelson 69 HK Interpretation 4 In HKAS 16 In the case where the entire lease is classified as a finance lease the related leasehold property interest can be accounted for using the cost or valuation model under HKAS 16 if such property interest meets the definition of PPE under HKAS 16. Under the cost or valuation model in HKAS 16, the depreciable amount of that leasehold property interest should be allocated on a systematic basis over its useful life Lease Term would normally provide an indication of the useful life of that property interest Nelson 70 35

36 HK Interpretation 4 In accordance HKAS 17 Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the Lease Term ( unless another systematic basis is more representative of the time pattern of the user s benefit) Lease Term is defined as the non-cancellable period for which the lessee has contracted to lease the asset together with any further terms Lessee has for which the lessee has the option to continue to the option lease the asset, with or without further payment, when at the inception of the lease it is reasonably At the certain that the lessee will exercise the option. inception Nelson 71 HK Interpretation 4 HK-Int. 4 further 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 Nelson 72 36

37 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 Nelson 73 HK Interpretation 4 Example For the leases in the New Territories expiring shortly before 30 June 2047 The legal limit in these leases shall be assumed to be the maximum lease term For those leases which extend beyond 30 June 2047 (e.g. those with an original lease term of 999 years) Lessees shall assume that any legal rights under the leases that extend the lease term to beyond 30 June 2047 will be protected for the full duration of the lease in the absence of any indication to the contrary HK Interpretation 4 becomes effective on 24 May 2005 Options for for extending the lease term that are not at at the discretion of of the lessee shall not be be taken into account by by the lessee in in determining the lease term Nelson 74 37

38 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 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 but but it it should should not not be be Therefore, the the land land cost cost should should be be amortised until until Our Our judgement is is based based on on the the HKSA s (HKICPA?) 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 Please comment Nelson 75 Exploration for and Evaluation of Mineral Resources (HKFRS 6) Nelson 76 38

39 Exploration for and Evaluation of Mineral Resources Sharing Points 1. Objective of HKFRS 6 2. Scope of HKFRS 6 3. Limited Improvements a. Recognition of exploration and evaluation assets b. Measurement of exploration and evaluation assets c. Presentation classification and reclassification 4. Impairment 5. Disclosure 6. Effective date and transition Nelson Objective of HKFRS 6 The objective of HKFRS 6 is to specify the financial reporting for the exploration for and evaluation of mineral resources What are mineral resources? What are the exploration for and evaluation of mineral resources? Nelson 78 39

40 1. Objective of HKFRS 6 The objective of HKFRS 6 is to specify the financial reporting for the exploration for and evaluation of mineral resources Intended not to define in HKFRS 6 but include minerals, oil, natural gas and similar non-regenerative resources What are mineral resources? affected companies include: oil, gas, mining.. What are the exploration for and evaluation of mineral resources? the search for mineral resources after the entity has obtained legal rights to explore in a specific area the determination of the technical feasibility and commercial viability of extracting the mineral resource Nelson Objective of HKFRS 6 (Summary) In particular, the HKFRS requires: a.limited improvements to existing accounting practices for exploration and evaluation expenditures. b.entities that recognise exploration and evaluation assets to assess such assets for impairment in accordance with HKFRS 6, and measure any impairment in accordance with HKAS 36 Impairment of Assets. c. disclosures that identify and explain the amounts in the entity s financial statements arising from the exploration for and evaluation of mineral resources and help users of those financial statements understand the amount, timing and certainty of future cash flows from any exploration and evaluation assets recognised. Limited Improvements Impairment Disclosure Nelson 80 40

41 2. Scope of HKFRS 6 Pre-Production Stage of Mineral Resources From SEED Study & acquire Exploration Evaluation Development To Harvest Mineral resources value chain Exploration and Production Transportation Distribution and Selling Upstream Downstream Nelson Scope of HKFRS 6 Pre-Production Stage of Mineral Resources From SEED Study & acquire Exploration Evaluation Development To Harvest Study a site or Explore the prospect site Acquire the legal Search in right to explore greater detail Determine technical feasibility and commercial viability Build the necessary infrastructure to extract Which stage(s) does HKFRS 6 cover? Nelson 82 41

42 2. Scope of HKFRS 6 An entity shall apply HKFRS 6 to Exploration and Evaluation (E&E) Expenditures that it incurs. Pre-E&E Exploration Evaluation Post E&E HKFRS 6 does not address other aspects of accounting by entities engaged in the exploration for and evaluation of mineral resources. An entity shall not apply HKFRS 6 to expenditures incurred: a) Pre-E&E before the exploration for and evaluation of mineral resources, such as expenditures incurred before the entity has obtained the legal rights to explore a specific area b) Post E&E after the technical feasibility and commercial viability of extracting a mineral resource are demonstrable Nelson Scope of HKFRS 6 Case An entity shall apply HKFRS 6 to Exploration and Evaluation (E&E) Expenditures that it incurs. Exploration Evaluation Why do we concern E&E? Success Not success BASF, the largest chemical co., explained its exploration risk as follows: In the oil and gas segment, future growth in exploration and production is largely based on the success of exploration activities. When searching for new reserves of crude oil and natural gas there are geological risks with regard to the presence, quantity and quality of hydrocarbons Nelson 84 42

43 2. Scope of HKFRS 6 An entity shall apply HKFRS 6 to Exploration and Evaluation (E&E) Expenditures that it incurs. Exploration and evaluation expenditures E&E expenditures Expenditures incurred by an entity in in connection with the exploration for and evaluation of of mineral resources before the technical feasibility and commercial viability of of extracting a mineral resource are demonstrable. Exploration and evaluation assets E&E assets E&E expenditures recognised as assets in in accordance with the entity s accounting policy. Success Not success Nelson Scope of HKFRS 6 Case In oil exploration and production industry While a few companies adopted Full Cost Method most companies follow Successful Efforts Method in accounting for exploration and development expenditure Including the Big Annual Report of BP plc, the largest integrated oil co., stated: Oil and natural gas exploration and development expenditure is accounted for using the successful efforts method of accounting. Its accounting policy sets out 3 kinds of exploration and development expenditure as follows: 1. Licence and property acquisition costs 2. Exploration expenditure 3. Development expenditure Which is/are within the scope of HKFRS 6? Nelson 86 43

44 2. Scope of HKFRS 6 Case What s the situation in HK? 2004 Annual Report of PetroChina stated: The successful efforts method of accounting is used for oil and gas exploration and production activities. Under this method, all costs for development wells, support equipment and facilities, and proved mineral interests in oil and gas properties are capitalised What are the details of successful efforts method discussed later! Nelson Limited Improvements a. Recognition of E&E assets b. Measurement of E&E assets c. Presentation classification and reclassification Limited Improvements Nelson 88 44

45 3a. E&E Assets Recognition HKFRS 6 has Has no new specific criteria But provides some exemptions from HKAS 8 Requires that when developing its accounting policies an entity recognising E&E assets shall apply para. 10 of HKAS 8 Exempts, subject to the requirements in HKFRS 6, an entity from applying para. 11 & 12 of HKAS 8 to its accounting policies for the recognition & measurement of E&E assets. Temporary exemption from HKAS 8 para. 11 and 12 Thus, an entity adopting HKFRS 6 may continue to use the accounting policies applied immediately before adopting the HKFRS Nelson 89 3a. E&E Assets Recognition Similar requirements in SSAP 1 No significant impact Para. Para of of HKAS HKAS 8 requires that, that, in in the the absence of of a HKFRS or or Interpretation that that specifically apples apples to to a transaction, other other event event or or condition Requires that when developing its accounting policies an entity recognising E&E assets shall apply para. 10 of HKAS 8 Management shall shall use use its its judgement in in developing and and applying an an accounting policy policy that that results results in in information that that is: is: a) a) Relevant to to the the economic decisionmaking needs needs of of users; users; and and making b) b) Reliable Reliable information in in that that the the financial statements: i) i) represent faithfully the the financial position, financial performance and and cash cash flows flows of of the the entity; entity; ii) ii) reflect reflect the the economic substance of of transactions, other other events events and and conditions, and and not not merely merely the the legal legal form; form; iii) iii) are are neutral, neutral, i.e. i.e. free free from from bias; bias; iv) iv) are are prudent; and and v) v) are are complete in in all all material respects.` Nelson 90 45

46 3a. E&E Assets Recognition Paragraph and and of of HKAS HKAS 8 specify specify sources of of authoritative requirements and and guidance and and states states that that In In making making judgement in in developing and and applying an an accounting policy policy that that results results in in relevant and and reliable reliable information 1) 1) management shall shall consider the the applicability of, of, the the following sources in in descending order: order: a) a) the the requirements and and guidance in in HKFRS and and Interpretations dealing dealing with with similar similar and and related related issues; issues; and and b) b) the the definitions, recognition criteria criteria and and measurement concepts for for elements in in the the Framework. Exempts, subject to the 2) 2) management may may also also consider the the requirements in HKFRS 6, most most recent recent pronouncements of of other other standard-setting an entity from applying bodies bodies (subject to to limitations para. 11 & 12 of HKAS 8 to and and not not conflict conflict with with the the sources in in point point 1 above). above). its accounting policies for the recognition & measurement of E&E assets. If no such exemption Nelson 91 3a. E&E Assets Recognition Let s revisit the Framework Definition Asset is defined as a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise Recognition If based on this, can E&E expenditure be capitalised? Recognition is the process of incorporating in the balance sheet or income statement an item that 1. meets the definition of an element and 2. satisfies the criteria for recognition Criteria for recognition an item that meets the definition of an element should be recognised if: 1. it is probable that any future economic benefit associated with the item will flow to or from the enterprise; and 2. the item has a cost or value that can be measured with reliability. If no such exemption Nelson 92 46

47 3a. E&E Assets Recognition Case Royal Dutch/Shell elaborated successful efforts method for its exploration costs in 2004 Annual Report as follows: Exploration costs are charged to income when incurred, except that Can such cost be capitalised? exploratory drilling costs are included in Is inflow of future economic tangible fixed assets, pending determination benefit really probable? of proved reserves. If no such exemption Nelson 93 3a. E&E Assets Recognition Case Can such cost be capitalised? Is inflow of future economic benefit really probable? Sinopec also elaborated successful efforts method as follows: Under this method, costs of development wells and the related support equipment are capitalised. The cost of exploratory well is initially capitalised as construction in progress pending determination of whether the well has found proved reserves. If no such exemption Nelson 94 47