HKAS 16 and 17 5 March 2007 Nelson Lam 林智遠 MBA MSc BBA ACA CFA CPA(Aust) CPA(US) FCCA FCPA(Practising) 2005-07 Nelson 1 Today s Agenda Property, Plant and Equipment (HKAS 16) Simple but Comprehensive Contentious and key issues s (HKAS 17) Relevant Interpretations Over 40 real cases & examples would be shared tonight 2005-07 Nelson 2 1
Today s Agenda Property, Plant and Equipment (HKAS 16) 2005-07 Nelson 3 Agenda on Property, Plant & Equipment 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 2005-07 Nelson 4 2
Agenda on Property, Plant & Equipment 1. Objective and Scope 2005-07 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 2005-07 Nelson 6 3
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). 2005-07 Nelson 7 1. Objective and Scope What are are PPE? Are Are the the following PPE? Building acquired under an operating lease Building acquired under finance leases Freehold property used for rental purpose Investment property under re-development Property held for a currently undetermined future use hold land separated from the leasehold building HKAS 17 HKAS 40 HKAS 40 HKAS 40 HKAS 17 Example 2005-07 Nelson 8 4
1. Objective and Scope Implication 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. 2005 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. 2005 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 2005-07 Nelson 9 Agenda on Property, Plant & Equipment Definition 1. Objective and Scope 2. Definitions What are PPE? 2005-07 Nelson 10 5
2. 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. 2005-07 Nelson 11 2. Definitions Cost is 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 2 Residual value Revised but discussed later Cost extended Residual value 2005-07 Nelson 12 6
2. Definitions 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. 2005-07 Nelson 13 2. Definitions 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 39 2005-07 Nelson 14 7
Agenda on Property, Plant & Equipment Definition 1. Objective and Scope 2. Definitions Recognition 3. Recognition 2005-07 Nelson 15 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. 2005-07 Nelson 16 8
3. Recognition Principle Updated Recognition criteria (capitalisation) for Previous Now Criteria not the same Same criteria Expenditure not fulfilling the recognition criteria will be charged to income statement Improvement is no longer a threshold Subsequent Initial Cost Expenditure 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 Improvement 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 Clearer approach on on so-called Component Accounting 2005-07 Nelson 17 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. 2005-07 Nelson 18 9
Agenda on Property, Plant & Equipment Definition 1. Objective and Scope 2. Definitions Recognition Measurement 3. Recognition 4. Measurement At Recognition 2005-07 Nelson 19 4. Measurement at Recognition An item of PPE that qualifies for recognition as an asset shall be measured at its cost. The cost of an item of PPE comprises: a) its purchase price, including import duties and nonrefundable purchase taxes, after deducting trade discounts and rebates; b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period. Purchase Price Directly Attributable Cost Dismantling Cost 2005-07 Nelson 20 10
4. Measurement at Recognition Entity A leased an office for a lease term of 5 years in 2005 and incurred $500,000 million in decorating the office. The lease requires Entity A to restore the office to its original status when the lease expires. Entity A estimates that the cost of restoration will be around $60,000 at that time. Determine the cost of the decoration. IFRIC IFRIC Interpretation 1 Changes in in Existing Decommissioning, Restoration and and Similar Liabilitiesset set out out how how to to account for for the the change of of this this estimate The cost of the decoration: Cost of of decoration: Example $500,000 Initial estimate of of restoring the site: Present value of of $60,000 Assuming discount rate is 6%, PV of $60,000 is $ 44,835 Total initial cost is $ 544,835 2005-07 Nelson 21 4. 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 16 16 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 2005-07 Nelson 22 11
4. 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. 2005-07 Nelson 23 Agenda on Property, Plant & Equipment Definition 1. Objective and Scope 2. Definitions Recognition 3. Recognition 4. Measurement At Recognition Measurement 5. Measurement After Recognition 2005-07 Nelson 24 12
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. 2005-07 Nelson 25 5. 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. 2005-07 Nelson 26 13
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. 2005-07 Nelson 27 5. 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. 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. 2005-07 Nelson 28 14
5. 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 ($40,000 x 90,000 // 60,000) ($ 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 ($40,000 -- $30,000) ($ 10,000 ) 2005-07 Nelson 29 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 Class 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. Entire class To Equity directly Negative to P/L 2005-07 Nelson 30 15
5. 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) 500 500 Cr Cr Revaluation reserves 500 500 Dr Dr Revaluation reserves 500 500 Profit and and loss 200 200 Cr Cr PPE (1,500 800) 700 700 2005-07 Nelson 31 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 Dr Depreciation (depreciation (depreciation based based on on the the asset s asset s original original cost cost )) Dr Dr Revaluation reserves (difference) Cr Cr Acc. Acc. depreciation (depreciation (depreciation based based on on the the revalued revaluedcarrying amount) amount) Transfers from revaluation surplus to retained earnings are not made through profit or loss. 2005-07 Nelson 32 16
5. Measurement after Recognition Revaluation Model CJS Limited bought a car with a cost of $50,000 on 1 Jan. 2005 and adopted the revaluation model. The estimated useful life of the car is 5 years. On 1 Jan. 2006, the car was revalued with a fair value of $48,000 at that date. Prepare the journal entries for the year ended 31 December 2005 and 31 December 2006. Year ended 31.12.2005 Example Dr Dr PPE 50,000 Cr Cr Cash 50,000 Dr Dr P/L P/L ($50K 5 years) 10,000 Cr Cr Accumulated depreciation 10,000 Dr Dr Accumulated depreciation (48K (50K 10K)) 8,000 Cr Cr Revaluation reserves 8,000 Year ended 31.12.2006 Dr Dr P/L P/L (same as as 2005) 10,000 Revaluation reserves (diff.) 2,000 Cr Cr Accumulated depreciation ($48K 4 years) 12,000 2005-07 Nelson 33 5. 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. 2005-07 Nelson 34 17
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 2005-07 Nelson 35 5. 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 500 500 hours Under usage methods of depreciation, the depreciation charges can be zero while there is no production 2005-07 Nelson 36 18
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 500 500 hours (unit of of production) zero 5 years on on a straight-line basis $2 million 2005-07 Nelson 37 5. Measurement after Recognition 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 IAS 8 Depreciation Depreciable amount 2005-07 Nelson 38 19
5. Measurement after Recognition Depreciation Residual Value Depreciable amount 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 Implication: If If estimated residual value value > carrying 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 2005-07 Nelson 39 5. 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$75 million No change in cost of a new laser head and estimated maximum useful life Shall AX revise the residual value at 31 Dec. 2005? No! AX has not changed its its usage plan and the residual value after the estimated useful live would still be be zero 2005-07 Nelson 40 20
5. Measurement after Recognition Another one At 1 Jan. 1985, Entity A bought a flat in Tai Koo Shing at HK$ 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 2005-07 Nelson 41 5. 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 2005-07 Nelson 42 21
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 2005-07 Nelson 43 5. 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 2005-07 Nelson 44 22
5. 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 2005-07 Nelson 45 Agenda on Property, Plant & Equipment Definition 1. Objective and Scope 2. Definitions Recognition 3. Recognition 4. Measurement At Recognition Measurement 5. Measurement After Recognition 6. Derecognition 2005-07 Nelson 46 23
6. 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. 2005-07 Nelson 47 6. Derecognition Derecognition on disposal The disposal of an item of PPE may occur in a variety of ways (e.g. by sale, by entering into a finance lease or by donation). In determining the date of disposal of an item, an entity applies the criteria in HKAS 18 Revenue for recognising revenue from the sale of goods. HKAS 17 s applies to disposal by a sale and leaseback. 2005-07 Nelson 48 24
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. 2005-07 Nelson 49 6. Derecognition Example Same laser machine example as before At 1 Jan. 2005, AX bought a laser At At 31 Dec. 2006, replacement printing machine of HK$50 million of of the laser head is is needed after 400 hours of of operation The machine will be used for 5 The carrying amount of of the years (maximum useful life) and laser head alone would be then dispose of at zero be HK$ 2 million at at that date value [$10M ($10M 500 x 400)] The machine s laser head can The cost of of a new laser head is is operate 500 hours, after that HK$ 8 million. replacement of a new laser head is is needed If If the laser head is is replaced Replaced laser head with HK$ 2 The cost of a new laser head million shall be be derecognised was HK$10 million at that time and New laser head of of HK$ 8 million its residual value is is zero. shall be be recognised 2005-07 Nelson 50 25
6. Derecognition Case Early adopted HKAS 16 only for 2004 Stated in 2004 Annual Report The adoption of HKAS 16 has resulted in the Group s recognition of cost of replacing concrete road surface of an expressway and the derecognition of the carrying amount of the replaced concrete road surface of the expressway 2005-07 Nelson 51 6. Derecognition Case Expense Capitalise Capitalise Capitalise Accounting policy for expenditure incurred after fixed assets have been put into operation: Ad hoc repairs and maintenance expenditures are charged to the profit and loss account in the period in which they are incurred Cost of replacing concrete road surface of expressways is recognised in the carrying amount of expressways and the carrying amount of replaced concrete road is derecognised Expenditures for upgrading asphalt road surface of an expressways are capitalised as additional costs of the expressway In other situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the fixed asset the expenditure is capitalised as an additional cost of that asset. 2005-07 Nelson 52 26
Agenda on Property, Plant & Equipment 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 2005-07 Nelson 53 7. 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 2005-07 Nelson 54 27
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 2005-07 Nelson 55 7. Disclosure Information include: i) additions; ii) disposals; iii) acquisitions through business combinations; iv) increases or decreases resulting from revaluations and from impairment losses recognised or reversed directly in equity in accordance with HKAS 36; v) impairment losses recognised in profit or loss in accordance with HKAS 36; vi) impairment losses reversed in profit or loss in accordance with HKAS 36; vii) depreciation; viii) the net exchange differences arising on the translation of the financial statements from the functional currency into a different presentation currency, including the translation of a foreign operation into the presentation currency of the reporting entity; and ix) other changes. 2005-07 Nelson 56 28
7. Disclosure Case hold improvements, furniture, equipment and hold 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) 117,000 444,232 105,304 71,572 738,108 effect of adopting HKAS 17 (98,500) (98,500) as restated (note i) 18,500 444,232 105,304 71,572 639,608 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) 548 548 Net book value at 31 Dec 2003 18,300 344,679 75,717 44,231 482,927 At 31 Dec 2003 At cost 1,345,403 347,385 231,519 1,924,307 At valuation 18,300 18,300 Accumulated depreciation (1,000,724) (271,668) (187,288) (1,459,680) Net book value 18,300 344,679 75,717 44,231 482,927 2005-07 Nelson 57 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 hold land and buildings HK$ 5,040,000 - - 5,040,000 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 1,204,170 485,770 (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 3,364,170 565,770 (878,000) 3,051,940 5,270,300 4,104,010 2005-07 Nelson 58 29
7. Disclosure Case Melco Development Limited (2005 Annual Report) 2005-07 Nelson 59 7. 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. Other disclosures 2005-07 Nelson 60 30
Agenda on Property, Plant & Equipment 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 2005-07 Nelson 61 8. 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. 2005-07 Nelson 62 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. 2005-07 Nelson 63 8. 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 2005. All the costs of PPE of an notfor-profit entity had not been depreciated before 2005. 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 2005 2005 to to follow follow HKAS HKAS 16 16 from from 2005 2005 The The entity is is permitted to to begin begin depreciation from from 2005 2005 to to follow follow HKAS HKAS 16 16 from from 2005 2005 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. 2005-07 Nelson 64 32
Today s Agenda s (HKAS 17) 2005-07 Nelson 65 s New requirements with significant impact, mainly Separate measurement (of (of the the land land and and buildings buildings elements) elements) Land and Building Land only Building only 2005-07 Nelson 66 33
Agenda on s 1. Objective and Scope 2. Classification of s Classification of Land and Buildings 3. Lessees Financial Statements 4. Lessors Financial Statements 5. Sale and back Transactions 6. Transitional Provisions 2005-07 Nelson 67 1. Objective and Scope The objective of HKAS 17 s is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases. A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. 2005-07 Nelson 68 34
1. Objective and Scope HKAS 17 shall be applied in accounting for all leases other than: a) leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources; and b) licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights. HKAS 17 shall not be applied as the basis of measurement for: a) property held by lessees that is accounted for as investment property (see HKAS 40), b) investment property provided by lessors under operating leases (see HKAS 40), c) biological assets held by lessees under finance leases (see HKAS 41), or d) biological assets provided by lessors under operating leases (see HKAS 41). 2005-07 Nelson 69 Agenda on s 1. Objective and Scope 2. Classification of s Classification of Land and Buildings 2005-07 Nelson 70 35
2. Classification of s The classification of leases adopted in HKAS 17 Is based on the extent to which risks and rewards incidental to ownership of a leased asset lie the the lessor or the leseee. Risks and Rewards Finance Operating A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. An operating lease is a lease other than a finance lease 2005-07 Nelson 71 2. Classification of s Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return because of changing economic conditions. Rewards may be represented by the expectation of of profitable operation over the asset s economic life and of gain from appreciation in value or realisation of a residual value. Risks and Rewards Finance A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. Operating A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. 2005-07 Nelson 72 36
2. Classification of s Case Accounting policy on leases (annual report 2005): s of property, plant and equipment where the Group assumes substantially all the benefits and risks of ownership are classified as finance leases. Accounting policy on operating lease (annual report 2005): s in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. 2005-07 Nelson 73 2. Classification of s Is a hire purchase contract a lease? Example The definition of of a lease includes contracts for for the the hire hire of of an an asset that that contain a provision giving the the hirer an an option to to acquire title titleto to the the asset upon the the fulfilment of of agreed conditions. These contracts are are sometimes known as as hire hire purchase contracts. Finance Operating Is a hire purchase contract classified as a finance lease or an operating lease? 2005-07 Nelson 74 37
2. Classification of s Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Indicators of a finance lease include: Finance Operating a) the lease transfers ownership of the asset to the lessee by the end of the lease term; b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised; c) the lease term is for the major part of the economic life of the asset even if title is not transferred; d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and e) the leased assets are of such a specialised nature that only the lessee can use them without major modifications. 2005-07 Nelson 75 2. Classification of s Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Indicators of a finance lease include: What is term? Economic life? Inception of a lease? Minimum lease payment Finance Operating Major part? c) the lease term is for the major part of the economic life of the asset even if title is not transferred; d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and Substantially all? 2005-07 Nelson 76 38
2. Classification of s Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Finance Operating Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are: a) if the lessee can cancel the lease, the lessor s losses associated with the cancellation are borne by the lessee; b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent. 2005-07 Nelson 77 2. Classification of s classification is made at the inception of the lease. What is is inception of of the the lease? Finance Operating The The inception of of the the lease is is the the earlier of of the the date date of of the the lease lease agreement and and the the date date of of commitment by by the the parties parties to to the the principal provisions of of the the lease. lease. As As at at this this date: a) a) a lease lease is is classified as as either either or or a finance financeor or an an operating lease; lease; and and b) b) in in the the case case of of a finance finance lease, lease, the the amounts to to be be recognised at at the the commencement of of the the lease lease term term are are determined. 2005-07 Nelson 78 39
2. Classification of s Finance Operating The The lease term termis is the the non-cancellable period periodfor for which which the the lessee lessee has has contracted to to lease lease the the asset asset together with with any any further further terms terms for for which which the the lessee lessee has has the the option option to to continue to to lease lease the the asset, asset, with with or or without without further further payment, when when at at the the inception of of the the lease leaseit it is is reasonably certain certainthat that the the lessee lessee will will exercise the the option. option. The The commencement of of the the lease term term is is the the date date from from which which the the lessee lessee is is entitled entitled to to exercise its its right right to to use usethe the leased leased asset. asset. It It is is the the date date of of initial initial recognition of of the the lease lease (i.e. (i.e. the the recognition of of the the assets, assets, liabilities, income income or or expenses resulting from from the the lease, lease, as as appropriate). 2005-07 Nelson 79 2. Classification of s Determine the lease term of the following leases: 1. A lease with 2-year initial term and another 2-year further term. The lessor has an option to cancel the further term. 2. A lease with 2-year initial term. The lessee has the right to extend 2- year further term but he had not decided to take this term at the inception of the lease. 3. A lease with the same term as the above term but the lessee has decided to take the further term at the inception of the lease. Example term: 2 years The lessee has no discretionary right to renew term: 2 years It It is is not reasonably certain that the lessee will exercise the option term: 4 years It It is is not reasonably certain that the lessee will exercise the option 2005-07 Nelson 80 40
2. Classification of s Finance Operating Minimum lease payments are are the the payments over over the the lease lease term termthat that the the lessee lessee is is or or can can be be required to to make, make, excluding contingent rent, rent, costs costs for for services and and taxes taxes to to be be paid paid by by and and reimbursed to to the the lessor, lessor, together with: with: a) a) for for a lessee, lessee, any any amounts guaranteed by by the the lessee lessee or or by by a party party related related to to the the lessee; lessee; or or b) b) for for a lessor, lessor, any any residual value value guaranteed to to the the lessor lessorby: by: i) i) the the lessee; lessee; ii) ii) a party party related related to to the the lessee; lessee; or or iii) iii) a third third party party unrelated to to the the lessor lessorthat is is financially capable of of discharging the the obligations under under the the guarantee. 2005-07 Nelson 81 2. Classification of s Determine the minimum lease payment (MLP) of the following lease to the lessee and the lessor: AJS Ltd. has a 5-year lease to rent its office with an annual payment of $10,000. It makes a guarantee to the lessor, C & P Inc., that the office should have a value not less than $10,000. It s parent, AJS Holding Inc., also makes a further guarantee of $10,000 C & P Inc. in turn has obtained an additional guarantee of $5,000 from the property agent. Example For the lessee, AJS Ltd., the MLP is: is: Payments over the the lease term $10,000 5 $50,000 Guarantee (incl. the the one one from parent) $10,000 + $10,000 20,000 $70,000 For the lessor, C& P, P, the MLP is: is: MPL as as above $70,000 Guarantee from agent 5,000 $75,000 2005-07 Nelson 82 41
2. Classification of s with provision to adjust lease payments the effect of any such changes shall be deemed to have taken place at the inception of the lease for the purposes of HKAS 17. Finance Change of provision of a lease, other than by renewing the lease in a manner that would have resulted in a different classification of the lease, the revised agreement is regarded as a new agreement over its term. Operating 2005-07 Nelson 83 2. Classification of L&B of land of land and buildings of land and of buildings are classified as operating or finance leases in the same way as leases of other assets but Critical change and and problematic area area in in HK HK Land only Building only 2005-07 Nelson 84 42
2. Classification of Land of land of land is classified in the same way as leases of other assets However, as land normally has an indefinite economic life If title of leasehold land is not expected to pass to the lessee Lessee normally does not receive substantially all of the risks and rewards incidental to the ownership In which case the lease of land will be an operating lease payment acquiring such leasehold represents prepaid lease payments amortised over the lease term in accordance with the pattern of benefits provided Land only hold land without title pass Operating 2005-07 Nelson 85 2. Classification of Land Case Annual Report 2005 Accounting policy on lease prepayments prepayments represent land use rights paid to the PRC s land bureau. Land use rights are carried at cost less accumulated amortisation and impairment losses. Amortisation is provided to write off the cost of lease prepayments on a straight-line basis over the respective periods of the rights which range from 20 years to 70 years. 2005-07 Nelson 86 43
2. Classification of L&B of land of land and buildings Land and Building Separate measurement (of (of the the land land and and buildings buildings elements) elements) Land only Building only 2005-07 Nelson 87 2. Classification of L&B of land and buildings If a lease contains land and buildings elements 2 elements are considered separately for lease classification If title of both elements is expected to pass to the lessee Both elements are classified as finance lease Title passed to the lessee? No Yes If title of land or both elements is NOT expected to pass to the lessee The land element alone is normally classified as an operating lease The building element is considered separately Land Operating Building Finance 2005-07 Nelson 88 44
2. Classification of L&B of land and buildings To classify and account for a lease of land and buildings the minimum lease payments (including any lump-sum upfront payments) are allocated between the land and the buildings elements Relative Fair Fair Value in proportion to the relative fair values of the leasehold interests in the land element and buildings element of the lease at the inception of the lease Land only Building only 2005-07 Nelson 89 2. Classification of L&B of land and buildings Minimum lease payment allocated in in proportion to to the the relative fair fair values of of land and and building elements Title passed to the lessee? No Can land and building be reliably separated? Yes Yes No Land Building Operating Finance 2005-07 Nelson 90 45
2. Classification of L&B of land and buildings If the lease payments cannot be allocated reliably between the 2 elements the entire lease is classified as a finance lease unless it is clear that both elements are operating leases, in which case the entire lease is classified as an operating lease For a lease of land and building if the land is immaterial The lease may be treated as a single unit and classified as finance or operating leases Land only Building only 2005-07 Nelson 91 2. Classification of L&B Entity A Example of land and buildings paid a land premium to lease a land from the HKSAR government for 50 years then, constructed a building on the land for own use Title passed to the lessee? No Can land and building be reliably separated? Yes Land Building Operating Finance 2005-07 Nelson 92 46