HKAS 17 & 40 and Interpretations 10 August 2006 Nelson Lam CFA FCCA FCPA(Practising) MBA MSc BBA CPA(US) ACA 2005-06 Nelson 1 Tonight s Agenda Leases (HKAS 17) 17) Simple but Comprehensive Contentious and key issues Real Life Cases and Examples Investment Property (HKAS 40) 40) HK-Int 2 HK-Int 4 HK(IFRIC)-Int Int 4 2005-06 Nelson 2 1
Cases First Case How is this one? For year ended 31 Dec. 2004 HK$ M Turnover 1,154 Profit before tax 561% 783 2005 HK$ M 1,250 5,176 561% After crediting: Fair value changes on investment properties - 4,226 540% of 04 profit 82% of 05 profit Profit is even higher than the revenue 2005-06 Nelson 3 Cases First Case What if the latest. For 6-month ended 30 Jun. 2005 HK$ M Turnover 613 Profit before tax 3,233 2006 HK$ M 620 1,849 After crediting: Fair value changes on investment properties 2,799 1,130 43% 43% 60% 60% Profit is still higher than the revenue 2005-06 Nelson 4 2
Cases First Case What if the latest. For 6-month ended 30 Jun. 2005 HK$ M Turnover 429 Gross profit 344 Profit before tax 2,321 2006 HK$ M 2,226 430 5,948 After crediting: Fair value changes on investment properties 1,611 5,080 156% 215% 2005-06 Nelson 5 Leases (HKAS 17) For Rent 2005-06 Nelson 6 3
Leases Changes? HKAS 17 is largely the same as SSAP 14, but has just been amended to align with IAS 17 (in respect of land and buildings) by 1. Deleting one sentence, and 2. Introducing several new paragraphs In addition, 2 new interpretations were issued: HK Interpretation 4 Leases Determination of the Length of Lease Term in respect of Hong Kong Land Leases HK(IFRIC) Interpretation 4 Determining Whether an Arrangement Contains a Lease 2005-06 Nelson 7 Leases Deleting One Sentence 1. Deleting one sentence Properties in HK are leasehold interest in land Not freehold land Not a purchase but a lease In the past, SSAP 14 had an exemption: deemed all the risks and rewards incident to ownership of the leasehold property were transferred therefore, such interest was accounted for as a purchase in accordance with SSAP 13 Accounting for investment properties or SSAP 17 Property, plant and equipment, as appropriate instead of SSAP 14 2005-06 Nelson 8 4
Leases Introducing New Paragraphs 1. Deleting one sentence 2. Introducing several new paragraphs New requirements with significant impact, mainly Land and Building Separate measurement (of (of the the land land and and buildings buildings elements) elements) Land only Building only 2005-06 Nelson 9 Leases Separate Measurement As before, lease classification is made at the inception of the lease leases of land and buildings are classified as operating or finance leases in the same way as leases of other assets Land only Building only 2005-06 Nelson 10 5
Leases Separate Measurement Lease of land 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 Leasehold land without title pass Examples: Land Land purchased in in HK HK Land Land use use right right acquired in in PRC PRC Operating Lease 2005-06 Nelson 11 Leases Separate Measurement Lease of land Lease 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 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 Title passed to the lessee? Land Operating Lease Finance Lease 2005-06 Nelson 12 No Building Yes 6
Leases Separate Measurement Lease 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 2005-06 Nelson 13 Leases Separate Measurement Case The early adoption of HKAS 17 has resulted in a change in accounting policy relating to leasehold land. Leasehold land and buildings were previously carried at valuation less accumulated depreciation. In accordance with the provisions of HKAS 17, a lease of land and building should be split into a lease of land and a lease of building in proportion to the relative fair values of the leasehold interests in the land element and the building element of the lease at the inception of the lease. The lease premium for land is stated at cost and amortised over the period of the lease whereas the leasehold building is stated at valuation less accumulated depreciation. 2004 Annual Report, HKEX 2005-06 Nelson 14 7
Leases Separate Measurement Case Effect of adopting HKAS 17 Leases Increase/(Decrease) Balance sheet as at 31 December 2004 HK$ 000 Fixed assets (170,100) Lease premium for land 95,218 Deferred tax liabilities (19,139) Revaluation reserves (73,815) Retained earnings 18,072 Income statement for the year 2004 Increase in premises expenses 548 Decrease in depreciation (1,749) Increase in taxation 128 2004 Annual Report, HKEX From valuation to cost (for land) Non-current assets reduced by HK$ 75 million 2005-06 Nelson 15 Leases Separate Measurement Lease 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 2005-06 Nelson 16 8
Leases Separate Measurement Case Accounting policy on leased assets as set out in annual report 2005: Land held for own use under an operating lease where its fair value cannot be measured separately from the fair value of a building situated thereon at the inception of the lease, is accounted for as being held under a finance lease, unless the building is also clearly held under an operating lease. For these purposes, the inception of the lease is the time that the lease was first entered into by the Group, or taken over from the previous lessee, or at the date of construction of those buildings, if later. 2005-06 Nelson 17 Leases Separate Measurement Case Accounting policy on finance lease on properties (annual report 2005): On adoption of the deemed cost at the date of Merger (2001), the Group made reference to the independent property valuation conducted as at 31 Aug. 2001 for the purpose of the Merger, which did not split the values of the leasehold properties between the land and buildings elements. Any means of subsequent allocation of the valuation of the leasehold properties at the date of Merger between the land and buildings elements would be notional and therefore would not represent reliable information. It is determined that the values of the land and buildings elements of the Group s leasehold properties cannot be reliably split and the leasehold properties are treated as finance leases. The Group has also adopted the revaluation model under HKAS 16 by which assets held for own use arising under these finance leases are measured at fair value less any accumulated depreciation and impairment losses. 2005-06 Nelson 18 9
Leases Separate Measurement Lease 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 Lease Finance Lease 2005-06 Nelson 19 Leases Separate Measurement Entity A Example Lease 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 Lease Finance Lease 2005-06 Nelson 20 10
Leases Separate Measurement Example Entity A 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 Land premium assumed to to be be the fair value of of the land and accounted for for as as an an operating lease under HKAS 17 17 amortised over 50 50 years disclosed separately from the building cost as as a non-current asset Building cost accounted for for as as property, plant and equipment under HKAS 16 16 carried in in accordance with the accounting policies adopted for for that class of of assets (either Operating Finance cost Lease model or or revaluation model) Lease 2005-06 Nelson 21 Leases Separate Measurement Entity A 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 Example 10 years later, Entity B acquired the interest of the land and building for own use At At the inception of of the lease (of (of Entity B) B) allocated between the the land and and the the buildings elements in in proportion to to the the relative fair fair values of of the the leasehold interests in in the the land element and and buildings element of of the the lease If If NO recent transaction for for a similar land It It may be be impossible to to reliably identify the the relative fair fair value of of the the land Whole lease as as a finance lease If If there is is recent transaction for for a similar land The relative fair fair value of of the the land and and building may be be reliably identified Land as as operating lease under HKAS 17 17 Building as as PPE under HKAS 16 16 2005-06 Nelson 22 11
Leases Separate Measurement Example Entity A 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 10 years later, Entity B acquired the interest of the land and building for own use Assuming Entity B acquired the property at HK$20 million and A similar land has a fair value of $12M Construction cost of a similar building is $4M HK$ 20M to to be be separated in in proportion to to the relative fair values of of the land and building element at at the inception of of the lease, i.e. by by HK$ 12M to to HK$ 4M Then, the separate measurement will result in: in: Land = HK$15M ($20M $12M // $16M) Building = HK$ 5M ($20M $ 4M 4M // $16M) 2005-06 Nelson 23 Leases Separate Measurement Example Entity A 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 10 years later, Entity B acquired the interest of the land and building for own use Assuming Entity B acquired the property at HK$20 million An independent surveyor reported that: The fair value of the building elements based on depreciated replacement cost is HK$6 million The residual amount of HK$14 million is the fair value of the land elements Please discuss. 2005-06 Nelson 24 12
Leases Implementation Issues Can the lease of land and building be reliably separated? Cannot be reliably separated say, buy a flat on 2nd hand market in HK Reliably separated e.g. lease a land and then construct a building there HKEx has reliably allocated the lease payments between land and building! Can all companies do that on all leases? 2005-06 Nelson 25 Leases Implementation Issues Can the lease of land and building be reliably separated? Cannot be reliably separated Reliably separated Land and Building Finance Lease Cost Cost Revaluation Revaluation The entire lease is accounted for as a finance lease (under HKAS 17) Management can choose either one of the followings (in accordance with HKAS 16) Cost Revaluation 2005-06 Nelson 26 13
Leases Implementation Issues Can the lease of land and building be reliably separated? Cannot be reliably separated Land (no choice as under an operating lease) Prepaid lease payments (i.e. cost) amortised over lease term Building: management can choose between (in accordance with HKAS 16) Cost or Revaluation Cost Cost Building Finance Lease Reliably separated Revaluation Revaluation Land Operating Lease At At Cost Cost 2005-06 Nelson 27 Leases Implementation Issues Can the lease of land and building be reliably separated? Cannot be reliably separated Reliably separated Land and Building Building Land Finance Lease Finance Lease Operating Lease Cost Cost Revaluation Revaluation Cost Cost Revaluation Revaluation At At Cost Cost 2005-06 Nelson 28 14
Leases Implementation Issues Can the lease of land and building be reliably separated? Reliably separated Building Finance Lease How can we we revalue a building alone without considering the the land? Revaluation Revaluation 2005-06 Nelson 29 Leases Implementation Issues Case As stated previously: The lease premium for land is stated at cost and amortised over the period of the lease whereas the leasehold building is stated at valuation less accumulated depreciation. 2004 Annual Report, HKEX (28 Feb. 2005) Finance Lease Revaluation Revaluation 2005-06 Nelson 30 15
Leases Implementation Issues Case The building component of owner-occupied leasehold properties are stated at valuation less accumulated depreciation. Fair value is determined by the Directors based on independent valuations which are performed periodically. The valuations are on the basis of depreciated replacement cost. Depreciated replacement cost is used as open market value cannot be reliably allocated to the building component. 2004 Annual Report, HKEX HKAS 16 16 (para. 33) 33) states: If If there is is no no market-based evidence of of fair fair value because of of Finance the the specialised nature of of the the item of of PPE and Lease and the the item is is rarely sold, except as as part part of of a continuing business, an an entity may need to to estimate fair fair value using Revaluation Revaluation an an income or or a depreciated replacement cost approach. 2005-06 Nelson 31 Leases Implementation Issues Case Freehold land and buildings, and the building component of owner-occupied leasehold properties are stated at valuation. Independent valuations are performed every three years on an open market basis and, in the case of the building component of leasehold properties, on the basis of depreciated replacement cost. Depreciated replacement cost is used as the most reliable basis of allocating open market value to the building component. Finance Lease 2005 Annual Report, Jardines Group Revaluation Revaluation What is depreciated replacement cost? 2005-06 Nelson 32 16
Leases Depreciated Replacement Cost Replacement Cost Less: Depreciation International Valuation Guidance Note No. 8 defines Depreciated replacement cost The current cost of reproduction or replacement of an asset Less: deductions for physical deterioration and all relevant forms of obsolescence and optimisation. It is an application of the cost approach used in assessing the value of specialised assets for financial reporting purposes, where direct market evidence is limited. As an application of the cost approach, it is based on the principle of substitution. What is depreciated replacement cost? 2005-06 Nelson 33 Leases Transition The adoption of HKAS 17 represents a change in accounting policy. HKAS 17 requires: An entity that has previously applied SSAP 14 (revised 2000) shall apply the amendments made by HKAS 17 retrospectively for all leases Retrospective Application as if that policy had always been applied restate opening balance of retained earnings restate comparative figures 2005-06 Nelson 34 17
Leases Transition Case Retrospective Application Annual report 2005: In the current year, the Group has applied HKAS 17 Leases the leasehold interests in land are reclassified to prepaid lease payments under operating leases which are carried at cost and amortised over the lease term on a straight-line basis. The surplus on revaluation in respect of the land interests accounted for as property, plant and equipment previously recognised in the asset revaluation reserve was adjusted retrospectively. Comparative figures for 2004 have been restated. 2005-06 Nelson 35 Leases Separation Exemption Exemption from separation measurement of land and building if the leasehold land and buildings is classified as an investment property (if fulfils HKAS 40), and the fair value model is adopted. Such property interest so classified even under an operating lease is accounted for as if it were a finance lease the fair value model is used In addition, such lease shall still be accounted for as a finance lease continuously, even if a subsequent event changes the nature of the lessee s property interest so that it is no longer classified as investment property, examples include transferred from investment property to owneroccupied property (at a deemed cost equal to its fair value at the date of change in use); or grants a finance lease (sublease) to an unrelated third party. 2005-06 Nelson 36 18
Leases HK Interpretation 4 2005-06 Nelson 37 Leases HK Interpretation 4 A new locally developed interpretations was also issued in May 2005 HK Interpretation 4, Leases Determination of the Length of Lease Term in respect of Hong Kong Land Leases (HK-Int. 4) 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 2005-06 Nelson 38 19
Leases 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 2005-06 Nelson 39 Leases HK Interpretation 4 In 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 2005-06 Nelson 40 20
Leases 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 Lessee and has the option it is reasonably certain at the inception of the lease that the lessee will exercise the option. At the Further inception Options for extending the lease term that are not at at the discretion of of the lessee shall not be taken into account by the lessee in in determining the lease term. 2005-06 Nelson 41 Leases HK Interpretation 4 As a result (HK-Int. 4 also specifically stated) Lessees shall not assume that the lease term of a HK land lease will be extended for a further 50 years, or any other period while the HKSAR Government retains the sole discretion as to whether to renew Any general intention to renew certain types of property leases expressed by the HKSAR Government is not sufficient grounds for a lessee to include such Lessee has extensions in the determination of the lease term for the option amortisation At the inception Options for extending the lease term that are not at at the discretion of of the lessee shall not be taken into account by the lessee in in determining the lease term. 2005-06 Nelson 42 21
Leases 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. 2005-06 Nelson 43 Leases HK Interpretation 4 Example Entity ABC has a property bought in 1980 and it is located in Cheung Sha Wan. According to the land search, the lease term with the HK SAR government should expire in 30 June 1997. Based on SSAP 14 and 17, the land and building had been depreciated over 50 years previously. Please discuss the implication under HKAS 17. 2005-06 Nelson 44 22
HK(IFRIC) Interpretations 4 Determining Whether an an Arrangement Contains a Lease 2005-06 Nelson 45 1. Background and Scope An entity may enter into an arrangement (comprising a transaction or a series of related transactions) that does not take the legal form of a lease but conveys a right to use an asset in return for a payment or series of payments. 2005-06 Nelson 46 23
1. Background and Scope Example Examples of arrangements in in which one entity (the supplier) may convey such a right to use an asset to another entity (the purchaser), often together with related services, Right Right to to use use include: an an asset + Services asset 1. outsourcing arrangements e.g. the outsourcing of the data processing functions of an entity (IT system plus support services) 2. arrangements in the telecommunications industry in which suppliers of network capacity enter into contracts to provide purchasers with rights to capacity (telecommunication facilities plus services) 3. take-or-pay and similar contracts in which purchasers must make specified payments regardless of whether they take delivery of the contracted products or services e.g. a take-or-pay contract to acquire substantially all of the output of a supplier s power generator (power generator plus related services) 2005-06 Nelson 47 1. Background and Scope HK(IFRIC) Interpretation 4 provides guidance for determining whether such arrangements are, or Right contain, leases that should be Right to to use use an accounted for in accordance with an asset asset HKAS 17 But it does not provide guidance for determining how such a lease should be classified under HKAS 17 address how to determine when a portion of a larger asset is itself the underlying asset for the purposes of applying HKAS 17. apply to arrangements that are, or contain, leases excluded from the scope of HKAS 17. + Services 2005-06 Nelson 48 24
1. Background and Scope Case 7 Right to use an asset as leases Royal Dutch/Shell Early adopted IFRIC Interpretation 4 in 2005 Explained its group accounting policies under IFRS in respect of leases as follows: Agreements under which Group companies make payments to owners in return for the right to use an asset for a period are accounted for as leases. Leases that transfer substantially all the risks and benefits of ownership are recorded at inception as finance leases within property, plant and equipment and debt. All other leases are recorded as operating leases and the costs are charged to income as incurred. How How do do we we determine whether there there is is a right right to to use use an an asset asset in in a contract? 2005-06 Nelson 49 2. Issue Right Right to to use use an an asset asset + Services How to to Determine When to to Determine How to to Separate The issues addressed in HK(IFRIC) Interpretation 4 are: a) how to determine whether an arrangement is, or contains, a lease as defined in HKAS 17; b) when the assessment or a reassessment of whether an arrangement is, or contains, a lease should be made; and c) if an arrangement is, or contains, a lease, how the payments for the lease should be separated from payments for any other elements in the arrangement. 2005-06 Nelson 50 25
3. Conclusions How to to Determine Determining whether an arrangement is, or contains, a lease shall be based on the substance of the arrangement and requires an assessment of whether: Dependent on specific asset Convey an asset use right a) Fulfilment of the arrangement is dependent on the use of a specific asset or assets (the asset); and b) The arrangement conveys a right to use the asset. 2005-06 Nelson 51 3. Conclusions How to to Determine Dependent on specific asset Even a specific asset may be explicitly identified in an arrangement, it is not the subject of a lease if fulfilment of the arrangement is not dependent on the use of the specified asset. In addition, a contractual provision permitting or requiring the supplier to substitute other assets for any reason on or after a specified date does not preclude lease treatment before the date of substitution. Even no explicit statement, an asset might has been implicitly specified if, for example the supplier owns or leases only one asset with which to fulfil the obligation, and it is not economically feasible or practicable for the supplier to perform its obligation through the use of alternative assets. 2005-06 Nelson 52 26
3. Conclusions How to to Determine Example Entity OB contracted with a toy manufacturer, Jedi China Inc. The contract required Jedi to use its plastic machine, Premium Toy No.1, to produce and deliver 20,000 sets of premium toys to Entity OB. If the toys can be produced with the same quality, Jedi can choose to produce the toys by using other machine not specified in the contract. Is it a lease under HKAS 17? No Although a specific asset is is explicitly identified in in the contract, it it is is not the subject of a lease. Since the fulfilment of the arrangement is is not dependent on the specified asset and Jedi has the right and ability to provide those toys by using other machines not specified in in the contact. 2005-06 Nelson 53 3. Conclusions How to to Determine An arrangement conveys the right to use the asset if the arrangement conveys to the purchaser (lessee) the right to control the use of the underlying asset. The right to control is conveyed if any one of the following conditions is met: a) The purchaser has the ability (or direct others) to operate the asset (while obtaining more than an Convey insignificant amount of the asset output). an asset use right b) The purchaser has the ability to control physical access to the asset (while obtaining more than an insignificant amount of the asset output). c) It is remote that other parties will take more than an insignificant amount of the asset output, and the unit price of output that the purchaser will pay is neither fixed nor equal to the current market price at the time of delivery. 2005-06 Nelson 54 27
3. Conclusions How to to Determine Example ABC signed a contract with UX to supply minimum quantity of electricity needed in its production process for 10 years. UX builds a power generator adjacent to ABC s plant Dependent on to produce the electricity and maintains ownership and specific asset control over it. The contract terms include: Asset explicitly The generator is explicitly identified in the identified and arrangement. fulfillment depend on on the UX has a right to supply the generator s power generator electricity to other customers but ABC has The purchaser has the ability to control physical access to the the ability to to control generator physical access to to the UX is responsible for repairs, maintenance, asset and capital expenditures and must stand Convey an ready to deliver a minimum quantity of asset use right electricity each month. The The contract contains a lease within the the scope of of HKAS 17 17 Leases 2005-06 Nelson 55 3. Conclusions When to to Determine When to assess and reassess Dependent on specific asset Convey an asset use right The assessment of whether an arrangement contains a lease shall be made at the inception of the arrangement, being the earlier of the date of the arrangement and the date of commitment by the parties to the principal terms of the arrangement, on the basis of all of the facts and circumstances. 2005-06 Nelson 56 28
3. Conclusions When to to Determine When to assess and reassess Such Dependent on Such reassessment shall shall be specific asset be based based on on the the facts facts and and circumstances as Convey as of an of the the date date of asset of reassessment, use right including the the remaining term term of of the the arrangement. Changes in estimate would not trigger a reassessment. e.g. estimated amount of output to be delivered to the purchaser A reassessment of whether the arrangement contains a lease after the inception of the arrangement shall be made only if any one of the following conditions is met: a) A renewal option is exercised or an extension is agreed to by the parties to the arrangement, unless the term of the renewal or extension had initially been included in the lease term. b) There is a substantial change to the asset, for example, a substantial physical change to property, plant or equipment. c) There is a change in the determination of whether fulfilment is dependent on a specified asset. d) There is a change in the contractual terms, unless the change only renews or extends the arrangement. 2005-06 Nelson 57 3. Conclusions When to to Determine If an arrangement is reassessed and is determined to contain a lease (or not to contain a lease), lease accounting shall be applied (or cease to apply) from In case of (a), from the inception of the renewal or extension period In case of other conditions, from when the change in circumstances giving rise to the reassessment occurs a) A renewal option is exercised or an extension is agreed to by the parties to the arrangement, unless the term of the renewal or extension had initially been included in the lease term. b) There is a substantial change to the asset, for example, a substantial physical change to property, plant or equipment. c) There is a change in the determination of whether fulfilment is dependent on a specified asset. d) There is a change in the contractual terms, unless the change only renews or extends the arrangement. 2005-06 Nelson 58 29
3. Conclusions How to to Separate If an arrangement contains a lease the parties to the arrangement shall apply the requirements of HKAS 17 to the lease element of the arrangement, unless exempted from those requirements in accordance with HKAS 17. that lease shall be classified as a finance lease, or an operating lease in accordance with HKAS 17. Right Right to to use use an an asset asset + Services Other elements of the arrangement not within the scope of HKAS 17 shall be accounted for in accordance with other standards. 2005-06 Nelson 59 3. Conclusions How to to Separate For the purpose of applying the requirements of HKAS 17, payments and other consideration required by the arrangement shall be separated at the inception of the arrangement or upon a reassessment of the arrangement into those for the lease, and those for other elements on the basis of their relative fair values. Right Right to to use use an an asset asset Fair value of lease + Services Fair value of others The The minimum lease payments as as defined in in HKAS 17 17 include includeonly payments for for the the lease lease (i.e. (i.e. the the right right to to use use the the asset) asset) and and exclude payments for for other other elements in in the the arrangement (e.g. (e.g. for for services and and the the cost cost of of inputs). inputs). 2005-06 Nelson 60 30
3. Conclusions In some cases, separating the payments for the lease from payments for other elements in the arrangement will require the purchaser to use an estimation technique, for example: Right Right to to use use an an asset asset How to to Separate Example + Services 1. 1. Estimate the the lease lease payments by by reference to to a lease lease agreement for for a comparable asset assetthat that contains no no other other elements Fair value of lease Fair value of others 2. 2. Estimate the the payments for for the the other other elements in in the the arrangement by by reference to to comparable agreements and and Then, Then, deducting these these payments from from the the total total payments under under the the arrangement. 2005-06 Nelson 61 3. Conclusions As stated in the previous example, ABC signed a contract with UX to supply minimum quantity of electricity needed in its production process for 10 years. UX builds a power generator adjacent to ABC s plant to produce the electricity and maintains ownership and control over it. In addition to the terms stated in the previous example, the contract terms also include: UX is responsible for repairs, maintenance, and capital expenditures and must stand ready to deliver a minimum quantity of gas each month. Each month, ABC will pay a fixed capacity charge (irrespective of whether it takes any electricity from the generator) and a variable charge based on actual production taken (incl. the generator s actual energy costs, which amount to about 90% of the generator s total variable costs). How to to Separate Example Service element Element of the right to use the asset Service element 2005-06 Nelson 62 31
3. Conclusions As stated in previous examples, ABC signed a contract with UX to supply minimum quantity of electricity needed in its production process for 10 Separate the the elements based on on years. their their relative fair fair values and and UX builds a power generator adjacent to ABC s plant to produce Recognise the electricity the the and element maintains of of the the ownership and control over right it. In addition to the terms stated in the right to to use use the the asset in in previous accordance example, the contract terms also include: with with HKAS 17 17 UX is responsible for repairs, maintenance, and capital expenditures and must stand ready to deliver a minimum quantity of gas each month. Each month, ABC will pay Alternatively, estimate a fixed capacity the charge the lease (irrespective of payments whether it by by takes reference any electricity to to a lease from the agreement generator) for and for a comparable power a variable generator charge that that based contains actual no no service production elements taken (and (incl. (and the recognise generator s in in actual accordance energy with costs, with HKAS which 17, amount 17, too) too) to about 90% of the generator s total variable costs). How to to Separate Example Service element Element of the right to use the asset Service element 2005-06 Nelson 63 3. Conclusions How to to Separate How if it is impracticable to separate the payments reliably? a) In the case of a finance lease the purchaser shall recognise an asset and a liability at an amount equal to the fair value of the underlying asset that was identified as the subject of the lease. subsequently the liability shall be reduced as payments are made and an imputed finance charge on the liability recognised using the purchaser s incremental borrowing rate of interest. b) In the case of an operating lease the purchase shall treat all payments under the arrangement as lease payments for the purpose of complying with the disclosure requirements of HKAS 17, but i) disclose those payments separately from minimum lease payments of other arrangements that do not include payments for non-lease elements, and ii) state that the disclosed payments also include payments for non-lease elements in the arrangement. 2005-06 Nelson 64 32
4. Effective Date and Transition An entity shall apply HK(IFRIC) Interpretation 4 for annual periods beginning on or after 1 January 2006. Earlier application is encouraged. If an entity applies this Interpretation for a period beginning before 1 January 2006, it shall disclose that fact. 2005-06 Nelson 65 4. Effective Date and Transition HKAS 8 specifies how an entity applies a change in accounting policy resulting from the initial application of an Interpretation. An entity is not required to comply with those requirements when first applying HK(IFRIC) Interpretation 4. If an entity uses this exemption, it shall apply the requirements of this Interpretation to arrangements existing at the start of the earliest period for which comparative information under HKFRSs is presented on the basis of facts and circumstances existing at the start of that period. 2005-06 Nelson 66 33
Investment Property (HKAS 40) 2005-06 Nelson 67 From SSAP 13 to HKAS 40 Summary 1. Scope 2. Definitions 3. Recognition and Measurement at Recognition 4. Measurement after recognition 5. Transfers 6. Disposals 7. Disclosure Exemption to certain companies removed Redefine investment property Introduce owner-occupied property Same recognition principle applied to all costs (aligned with HKAS 16) Measurement of assets from exchange of assets introduced (aligned with HKAS 16) Introduce cost model, chosen between fair value model Fair value model refined Transfer requirements are similar to those in SSAP 17 PPE before Introduce new requirements Detailed disclosure required, including fair value of investment property 2005-06 Nelson 68 34
1. Scope Exemption Removed Exemption for some entities eliminated The exemption in SSAP 13 for certain insurance companies and charitable, government subvented and not-for-profit organisations was eliminated in HKAS 40 Insurance co., not-forprofit entities must follow Implies that all these entities are required to apply HKAS 40 from the financial period beginning from 1 Jan. 2005 Specific transitional provisions for this elimination additionally introduced in Nov. 2005 More to be discussed later. 2005-06 Nelson 69 2. Definitions Revised Amended and clearer definition on an investment property SSAP 13 An investment property is an interest in land and/or buildings: a) in respect of which construction work and development have been completed; and b) which is held for its investment potential, any rental income being negotiated at arm s length HKAS 40 Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: a) use in the production or supply of goods or services or for administrative purposes; or b) sale in the ordinary course of business 2005-06 Nelson 70 35
2. Definitions Revised Example Amended and clearer definition on an investment property SSAP Examples 13 of investment property under HKAS 40 include: An Property investment leased property out under is an operating interest leases in land and/or buildings: Property a) in respect held for of long-term which construction capital appreciation work and development have been completed; and Property held for a currently undetermined future use b) which is held for its investment potential, any rental income Vacant being property negotiated to be leased at arm s out length under operating leases HKAS 40 Investment property is property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: a) use in the production or supply of goods or services or for administrative purposes; or b) sale in the ordinary course of business How s about property held by the lessee under an operating lease? 2005-06 Nelson 71 2. Definitions Extend to Operating Leases A property interest that is held by a lessee under an operating lease may be classified and accounted for as An entity has a choice investment property if, and only if the property would otherwise meet the definition of an investment property and the lessee uses the Fair Value This classification alternative is available on a property-by-property basis However, once this classification alternative is selected for one such property interest held under an operating lease, all properties classified as investment property shall be accounted for using the Fair Value Simple? How s about Let s property term this held classification by the lessee as under an operating Operating lease? Lease IP Alternative 2005-06 Nelson 72 36
2. Definitions Extend to Operating Leases Entity GV has 3 properties as follows: Leasehold property A Leasehold property B Freehold property C All the properties are held to earn rental. What is the implication of HKAS 40 on its properties? Example Property C is is an an investment property under HKAS 40 40 and and GV GV must use use HKAS 40 40 to to account for for it it Property A and and B are are not not investment property under HKAS 40. 40. However, GV GV can can choose to to account for for either A or or B or or both both as as investment property under HKAS 40. 40. If If Property A and and B are are not not accounted for for under HKAS 40, 40, they they will will be be accounted for for under HKAS 17. 17. Measurement under HKAS 40 40. to to be be discussed later. 2005-06 Nelson 73 2. Definitions Owner-Occupied Property Introduce a new term, owner-occupied property Defined as a property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods or services or for administrative purposes In substance, a property under HKAS 16 Being one of the examples that is NOT an investment property 2005-06 Nelson 74 37
2. Definitions Owner-Occupied Property Example How do we account for the following property? Owner-occupied property Property (completed or under development) intended for sale in the ordinary course of business Property being constructed or developed for third parties Property leased out under finance lease Property that is being constructed or developed for future use as investment property How s the classification for existing investment property being redeveloped for continued future use as investment property? Which HKAS? HKAS 16 & 17 HKAS 2 HKAS 11 HKAS 17 HKAS 16 & 17 Still Investment Property 2005-06 Nelson 75 2. Definitions Owner-Occupied Property Refer back to HKAS 16 for definition of property, plant and equipment Property, plant and equipment 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. Both for rental, how to distinguish? For example, how to distinguish: A flat leased out for rental A hotel Cash Flow Extent of Ancillary Services Investment Property Owner-occupied Property 2005-06 Nelson 76 38
2. Definitions Owner-Occupied Property Cash Flow One of the key indicators in determining the classification between investment property and owner-occupied property Investment Property Owner-occupied property held to earn rentals or for capital appreciation or both therefore, generates cash flows largely independently of the other assets held by an entity. the production or supply of goods or services (or the use of property for administrative purposes) generates cash flows that are attributable not only to property, but also to other assets used in the production or supply process 2005-06 Nelson 77 2. Definitions Owner-Occupied Property Cash Flow Ancillary Investment services not Property significant Extent of Ancillary Services investment property owner-occupied property provided by an entity to the occupants of a property it holds is also considered e.g. a owner-managed hotel is not an investment property Significant Owner-occupied ancillary services property provided If owner-managed hotel was classified as investment property before 2005, it should be reclassified as property, plant and equipment (HKAS 16) or lease (HKAS 17) Significant impact on hotel group 2005-06 Nelson 78 39
2. Definitions Owner-Occupied Property It may be difficult to determine whether ancillary services are so significant that a property does not qualify as investment property for example, there may be a spectrum from one end to another: Ancillary services not significant Passive investor Investment property Use HKAS 40 How to determine those in between these 2 ends? Then, judgement is required to determine Entities should develop consistent criteria for use in exercising the judgement Significant impact on hotel group Significant ancillary services provided Significant exposure to variation in the cash flows Owner-occupied Use HKAS 16 2005-06 Nelson 79 2. Definitions Owner-Occupied Property Case Shangri-La Asia Ltd. (extracted from 2003 Annual Report and Announcement of 17 Dec. 2004) Before 2005, its hotel properties are classified as investment properties, which are stated at annual professional valuations at the balance sheet date It announced on 17 Dec. 2004 that its hotel properties will no longer be accounted for as investment properties from 2005 It will adopt the following accounting policies retroactively: 1. The underlying buildings and integral plant and machinery will be stated at cost less accumulated depreciation and impairment 2. The underlying freehold land will be stated at cost less impairment 3. The underlying leasehold land will be stated at cost and subject to annual operating lease rental charge (amortization of land cost) Owner-managed hotels cannot be classified as Significant investment property impact on They hotel can group be classified as property, plant and equipment (HKAS 16) and/or leases (HKAS 17) 2005-06 Nelson 80 40
2. Definitions Owner-Occupied Property Case Shangri-La Asia Ltd. 2004 Final Results Announcement of 31 Mar. 2005 further stated that, from 1 Jan. 2005: Adoption of these new accounting policies will have the following significant consequences: a) The net book value of fixed assets, the overall provision for deferred tax liabilities and the net asset value of the Group will be reduced b) The annual depreciation and lease rental charges will increase and this will reduce the profit after tax attributable to the shareholders ( PAT ) and the earnings per share ( EPS ) of the Group. Owner-managed hotels cannot be classified as investment property They can be classified as property, plant and equipment (HKAS 16) and/or leases (HKAS 17) 2005-06 Nelson 81 2. Definitions Owner-Occupied Property Case Shangri-La Asia Ltd. Let s do some comparison for 2004 (in US$ 000) Net assets at 31.12.2004 as reported in 2004 Annual Report 3,109 23% 23% as announced on 26 Aug. 2005 2,379 Depreciation for the year ended 31.12.2004 as reported in 2004 Annual Report 39,038 as announced on 26 Aug. 2005 21% 21% 47,410 2005-06 Nelson 82 41
2. Definitions Partially Used Only Some properties comprise a portion held as investment property and another portion NOT held as investment property. If these portions: Could be sold separately Could not be sold separately or leased out separately under a finance lease an entity accounts for the portions separately the property is investment property only if an insignificant portion is NOT held as investment property 2005-06 Nelson 83 2. Definitions Partially Used Only Case Accounting policy (2004/05) on buildings: The cost of construction of the Duke of Windsor Social Service Building the Building has been written down to a nominal value of HK$1. The Council hires out meeting rooms and auditorium in the Building to third parties and lease out some portion of usable floor area to certain bodies approved by the Government. Income derived from hiring meeting rooms and auditorium and leasing out usable floor area have been accounted for in the statement of operations as hiring fees, rental and management fee income. Point for consideration: Fulfil the definition of investment property? Generate passive cash flow or owner-occupied? Separable under HKAS 40? If not, significant portion for rental? 2005-06 Nelson 84 42
2. Definitions Partially Used Only An entity owns property that is leased to, and occupied by, its parent or another subsidiary The property does not qualify as investment property in the consolidated financial statements, because the property is owner-occupied from the perspective of the group But, from the perspective of the entity that owns it, the property is investment property if it meets the definition of investment property The lessor treats the property as investment property in its individual financial statements. Consolidated Individual Changed from SSAP 13 15% benchmark is removed Property leased to group companies is still investment property in an entity s individual financial statements 2005-06 Nelson 85 2. Definitions Partially Used Only Example Can the following freehold properties be classified as investment property in individual level and in consolidation? Parent A s property leased to Subsidiary B Subsidiary C s property leased to Parent D Subsidiary E s property leased to Subsidiary F Parent G s property leased to Associate H Individual Yes Yes Yes Yes Consolidation No No No Yes 2005-06 Nelson 86 43
3. Recognition and Measurement Recognition principles Same as HKAS 16 Property, Plant and Equipment Component accounting is also introduced No such details in SSAP 13 Measurement at Recognition Introduce the measurement base for investment property acquired from exchange Same as HKAS 16 Property, Plant and Equipment Clarify that measurement of property interest held under a lease and classified as investment property shall be aligned with HKAS 17, i.e. recognised at lower of the fair value of the property, and the present value of the minimum lease payments 2005-06 Nelson 87 4. Measurement after Recognition Introduce Cost and choose either and Fair Value Cost HKAS 40 implicitly implies that the choice can only be elected on the first-time adoption of HKAS 40 The model chosen should be applied to all investment properties, except for 1. Property held under operating lease classified as investment properties 2. Investment property backing liabilities that pay a return linked directly to the fair value of, or returns from specific assets including that investment property 3. Investment property with a fair value that cannot be reliably determinable on a continuing basis (i.e. inability to determine No choice, only fair value model Choose a model for all such properties No choice, only cost model fair value reliably) 2005-06 Nelson 88 44
4. Measurement after Recognition Introduce Cost and choose either and Fair Value Cost However, even Cost is adopted, HKAS 40 still requires all entities to determine the fair value of investment property For disclosure purpose, the fair value of the investment property has to be disclosed in notes to the financial statement! In determining the fair value of investment property for both cost model and fair value model an entity is only encouraged, but not required, to rely on a professional valuer s valuation More Flexible? 2005-06 Nelson 89 4. Measurement after Recognition After initial recognition, an entity that chooses Fair Value shall measure all of its investment property at fair value, except in the cases that 1. the fair value cannot be determined reliably, or 2. the cost model is chosen for the investment property backing liabilities that pay a return linked directly to the fair value of, or returns from specific assets including that investment property When a property interest held by a lessee under an operating lease is classified as an investment property the fair value model must be applied for all investment properties A gain or loss arising from a change in the fair value of investment property shall be recognised in profit or loss for the period in which it arises Depreciation? Tax Implication? 2005-06 Nelson 90 45
4. Measurement after Recognition Example Entity GV has 3 properties, leasehold property A, leasehold property B and freehold property C All the properties are held to earn rental. What is the implication of HKAS 40 if GV chooses to account for A as investment property? Then, GV GV has has no no choice in in accounting for for the the investment property. It It must adopt fair fair value model in in accounting for for all all investment properties including property A and and C (subject to to specific exceptions) While property A is is accounted for for at at fair fair value model under HKAS 40, 40, property B can can still still be be accounted for for under HKAS 17. 17. 2005-06 Nelson 91 4. Measurement after Recognition HKAS 40 Fair Value Uses fair value, instead of open market value but in substance, they are similar not the same as SSAP 13, HKAS 40 only encourages, but not requires, a profession valuation on a fair value Fair value is defined as the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm s length transaction Same definition used in other HKFRSs and HKASs But HKAS 40 provides more explanations unique for a fair value of a property The fair value of investment property shall reflect market conditions at the balance sheet date No depreciation required in HKAS 40 Depreciation? Tax Implication? Not our concern this time! 2005-06 Nelson 92 46
4. Measurement after Recognition Case Interim Report 2005 clearly stated that: The directors consider it inappropriate for the company to adopt two particular aspects of the new/revised HKFRSs as these would result in the financial statements, in the view of the directors, either: not reflecting the commercial substance of the business or being subject to significant potential short-term volatility, as explained below. 2005-06 Nelson 93 4. Measurement after Recognition Case Interim Report 2005 clearly stated that: HKAS 40 Investment property requires an assessment of the fair value of investment properties. The group intends to follow the same accounting treatment as adopted in 2004, which is to value such investment properties on an annual basis. Accordingly, the investment properties were not revalued at 30 June 2005, since the directors consider that such change of practice could introduce a significant element of shortterm volatility into the income statement in respect of assets which are being held on a long-term basis by the group It is not practicable to estimate the financial effect of this non-compliance as no interim valuation of the properties has been conducted. At At year-end, revaluation would would still still be be conducted. 2005-06 Nelson 94 47
However, 4. Measurement after 2005 Recognition 2005 Final Final Results Case Interim Report 2005 clearly stated that: Announcement disclosed that that provision for for deferred tax tax was was finally finally made made with with regard regard to to revaluation of of the the HK HK investment properties (total (total HK$2.2 HK$2.2 billion) billion) at at 2005 2005 year-end. end. HKAS 12 Income Taxes, together with HKAS-INT 21 Income Taxes Recovery of Revalued Non-Depreciable Assets, requires deferred taxation to be recognised on any revaluation movements on investment properties. It is further provided that any such deferred tax liability should be calculated at the profits tax rate in the case of assets which the management has no definite intention to sell. The company has not made such provision in respect of its HK investment properties since the directors consider that such provision would result in the financial statements not reflecting the commercial substance of the business since, should any such sale eventuate, any gain would be regarded as capital in nature and would not be subject to any tax in HK. Should this aspect of HKAS 12 have been adopted, deferred tax liabilities amounting to HK$2,008 million on the revaluation surpluses arising from revaluation of HK investment properties would have been provided. (estimate - over 12% of the net assets at 30 June 2005) 2005-06 Nelson 95 4. Measurement after Recognition Fair Value Under HKAS 40 Fair value has the following attributes: No deduction for transaction costs it may incur on sale or other disposal Time-specific as of a given date Reflects rental income from current leases and from future leases in light of current conditions (with reasonable and supportable assumption) Refers to knowledgeable, willing parties Refers to an arm s length transaction What are are the the differences between fair fair value and and value in in use? 2005-06 Nelson 96 48
4. Measurement after Recognition Fair Value Value in in use use consists of of the the following attributes which are are not not found in in fair fair value: a) a) additional value value derived derived from from creation of of a portfolio of of properties; b) b) synergies between investment property and and other other assets; assets; c) c) legal legal rights rights or or restrictions that that are are specific specific only only to to the the current current owner; owner; and and d) d) tax tax benefits or or tax tax burdens that that are are specific specific to to the the current current owner. owner. What are are the the differences between fair fair value and and value in in use? 2005-06 Nelson 97 4. Measurement after Recognition Fair Value The best evidence of fair value is given by current prices in an active market For similar property in the same location and condition and Subject to similar lease and other contracts. An entity takes care to identify any differences in the nature, location or condition of the property, or in the contractual terms of the leases and other contracts relating to the property 2005-06 Nelson 98 49
4. Measurement after Recognition Fair Value If NO current prices in an active market, an entity considers the information from a variety of sources, including a) current prices in an active market for properties of different nature, condition or location (or subject to different lease or other contracts), adjusted to reflect those differences; b) recent prices of similar properties on less active markets, with adjustments to reflect any changes in economic conditions since the date of the transactions that occurred at those prices; and c) discounted cash flow projections (based on reliable estimates of future cash flows, and using discount rate with appropriate adjustments and assumptions) Considers difference conclusions to arrive reliable estimate of fair value within a range of reasonable fair value estimates 2005-06 Nelson 99 4. Measurement after Recognition There is a rebuttable presumption that an entity can reliably determine the fair value of an investment property on a continuing basis. Fair Value However, in exceptional cases and in initial recognition of investment property, there is clear evidence that the fair value of the investment property is not reliably determinable on a continuing basis. This arises when, and only when, comparable market transactions are infrequent and alternative reliable estimates of fair value (for example, based on discounted cash flow projections) are not available. In such cases, an entity shall measure that investment property (alone) using the cost model in HKAS 16 residual value shall be assumed to be zero apply HKAS 16 until disposal of the investment property shall continue to account for other investment properties using the fair value model 2005-06 Nelson 100 50
4. Measurement after Recognition Fair Value If an entity has previously measured an investment property at fair value it shall continue to measure the property at fair value until disposal or cessation to be investment property, even if comparable market transactions become less frequent or market prices become less readily available. Once you you chose Fair Fair Value, you you cannot fall fall back to to Cost 2005-06 Nelson 101 4. Measurement after Recognition Fair Value After initial recognition, an entity that chooses Cost shall measure all of its investment properties in accordance with the requirements of HKAS 16 for that cost model other than those that meet the criteria to be classified as held for sale (or are included in a disposal group that is classified as held for sale) in accordance with HKFRS 5 Non-current Assets Held for Sale and Discontinued Operations then, those investment properties shall be measured in accordance with HKFRS 5 Once you you chose Fair Fair Value, you you cannot fall fall back to to Cost 2005-06 Nelson 102 51
5. Transfer Introduce transfer section (but is similar to those in SSAP 17 before) Transfers to, or from, investment property shall be made when, and only when, there is a change in use, evidenced by: Change in use Transfer from investment property a) Commencement of owneroccupation b) Commencement of development with a view to sale Change in use a) End of owner-occupation b) Commencement of an operating lease to another party c) End of construction or development Measurement at at transfer? Owner-Occupied Property Inventories Transfer to investment property Owner-Occupied Property Inventories End of construction Investment Property Investment Property Depend on the model the entity is using 2005-06 Nelson 103 5. Transfer When an entity uses Cost transfers DO NOT change the carrying amount of the property transferred and they DO NOT change the cost of that property for measurement or disclosure purposes. Measurement at at transfer? 2005-06 Nelson 104 52
5. Transfer For a transfer from investment property (i.e. the following cases) carried at fair value Fair Value Change in use a) Commencement of owneroccupation b) Commencement of development with a view to sale Transfer from investment property Owner-Occupied Property Inventories Investment Property the property s deemed cost for subsequent accounting in accordance with HKAS 16 or HKAS 2 shall be its fair value at the date of change in use. Measurement at at transfer? 2005-06 Nelson 105 5. Transfer Example GV has adopted HKAS 40 and stated its investment properties at fair value even the properties are held under operating leases. On 1 Jan. 2005, GV s investment property A held under operating lease was stated at fair value of $1,000. Its original cost was $800. On 10 Feb. 2005, the lease of property A expired and GV decided and began to hold it as its office. What is the accounting implication on the decision? Property A would no no longer be be investment property and and would be be reclassified as as owner-occupied property. Even property A is is held held under operating lease, such operating lease interest would still still be be accounted for for as as a finance lease continuously in in accordance with with HKAS 17 17 and and classified and and measured as as property, plant and and equipment in in accordance with with HKAS 16. 16. The The fair fair value at at the the date date of of change in in use, use, i.e. i.e. 10 10 Feb. Feb. 2005 will will be be regarded as as the the deemed cost cost in in property, plant and and equipment. 2005-06 Nelson 106 53
5. Transfer For a transfer to investment property (i.e. the following cases) and that investment property will be carried at fair value Fair Value Change in use a) End of owner-occupation b) Commencement of an operating lease to another party c) End of construction or development Transfer to investment property Owner-Occupied Property Inventories End of construction Investment Property Measurement at at transfer? 2005-06 Nelson 107 5. Transfer For a transfer to investment property (i.e. the following cases) and that investment property will be carried at fair value Owner-Occupied Property Investment Property Fair Value apply HKAS 16 up to the date of change in use. Revaluation reserve is treat any difference at that date between its frozen and carrying amount under HKAS 16, and accounted for in its fair value accordance with in the same way as a revaluation under HKAS 16 HKAS 16 subsequently Inventories End of construction Measurement at at transfer? Investment Property any difference between the fair value of the property at that date and its previous carrying amount shall be recognised in profit/loss 2005-06 Nelson 108 54
5. Transfer Example GV has adopted HKAS 40 and stated its investment properties at fair value even the properties are held under operating leases. On 1 Mar. 2005, freehold property B stated at revalued amount of $1,000 (originally used as its own office) has been leased out to derive rental income. Revaluation surplus recognised for B was $300 while B s fair value at that date should be $1,200. What is the accounting implication on the decision? Property B would be be reclassified as as investment property. In In accordance with with HKAS 40, 40, GV GV should apply HKAS 16 16 on on B up up to to the the date date of of change in in use use and and treat treat any any difference at at that that date date between its its carrying amount under HKAS 16, 16, and and its its fair fair value in in the the same way way as as a revaluation under HKAS 16. 16. Thus, Thus, a revaluation surplus surplus of of $200 $200 would would be be further further recognised. Total Total revaluation reserves would would become $500 $500 ($200 ($200 + $300) $300) The The revaluation reserves of of $500 would be be frozen and and accounted for for in in accordance with with HKAS 16 16 subsequently. 2005-06 Nelson 109 6. Derecognition (or Disposals) An investment property shall be derecognised (eliminated from the balance sheet): 1. on disposal or 2. when the investment property is permanently withdrawn from use and no future economic benefits are expected from its disposal Gains or losses arising from the retirement or disposal of investment property shall be determined as the difference between 1. the net disposal proceeds and 2. the carrying amount of the asset, and shall be recognised in profit or loss (unless HKAS 17 requires otherwise on a sale and leaseback) in the period of the retirement or disposal 2005-06 Nelson 110 55
7. Disclosure a) Disclosure for both Fair Value and Cost whether the fair value model or the cost model is adopted if fair value model is applied, whether property interests held under operating leases are accounted for as investment property if classification is difficult, the criteria to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business the methods and significant assumptions applied in determining the fair value of investment property whether (and the extent to which) the fair value of investment property is based on a valuation by a qualified independent valuer the amounts recognised in profit or loss, say for rental income from investment property, and direct operating expenses (including repairs and maintenance) arising from investment property the existence and amount of restrictions on the realisability of investment property or the remittance of income and proceeds of disposal contractual obligations to purchase, construct, or develop investment property or for repairs, maintenance or enhancements 2005-06 Nelson 111 7. Disclosure b) Additional Disclosure for Fair Value A reconciliation between the carrying amounts of investment property at the beginning and end of the period similar to that of property, plant and equipment When a valuation obtained for investment property is adjusted significantly for the purpose of the financial statements, the entity shall disclose a reconciliation between the valuation obtained and the adjusted valuation included in the financial statements In the exceptional cases when there is inability to determine fair value reliably and cost model is applied to a particular investment property, additional disclosures are required 2005-06 Nelson 112 56
7. Disclosure c) Additional Disclosure for Cost the depreciation methods used; the useful lives or the depreciation rates used; the gross carrying amount and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period; a reconciliation of the carrying amount of investment property at the beginning and end of the period, similar to that of property, plant and equipment the fair value of investment property In the exceptional cases when there is inability to determine fair value reliably, additional disclosures are required 2005-06 Nelson 113 8. Transitional Arrangements Adopted Fair Value Opening balance of retained earnings shall be adjusted Comparative information Example: listed co. Entities previously disclosed the property s fair value encourage (but not require) to restate comparative information Entities NOT previously disclosed the property s fair value shall NOT restate comparative information Example: unlisted shall disclose this fact co., charities Included the charities taken Adopted Cost exemption of SSAP 13 before Deem the carrying amount of an investment property immediately before the applying HKAS 40 on its effective date (or earlier) as its cost Any adjustments shall be made to the opening balance of retained earnings for the period in which HKAS 40 is first applied Depreciation on deemed cost commences from the time at which HKAS 40 is first applied 2005-06 Nelson 114 57
8. Transitional Arrangements Case Hang Lung Properties adopted a different transitional treatment from Hang Seng Bank As a result of the adoption of HKAS 40, the Group s net profit attributable to ordinary shareholders has increased by $5,136.1 million (2004: $3,035.0 million) and the net assets as at the year has increased by $128.9 million (2004: $130.0 million). These changes in accounting policies have been adopted retrospectively, with the opening balances of retained profits and reserves and the comparative information adjusted for the amounts relating to prior periods as disclosed in the consolidated statement of changes in equity and note 23 of the accounts. 2005-06 Nelson 115 8. Transitional Arrangements Case Hang Seng Bank (2004 Annual Report) Hang Seng Bank has NOT early adopted HKAS 40 but stated that: By adoption of HKAS 40, investment properties are carried at fair value with the changes in fair value reported directly in the profit and loss account. The Group will continue to adopt the fair value model for investment properties. The change in fair value of investment properties will cause volatility in the profit and loss account. On transition, the investment revaluation reserve will be transferred to retained profits. The Group will not restate its 2004 accounts, as permitted under paragraph 80 of HKAS 40. 2005-06 Nelson 116 58