HKAS 17 & 40 and Interpretations - Nelson CPAFixed assets (170,100) Lease premium for land 95,218 Deferred tax liabilities (19,139) Revaluation reserves (73,815) Retained earnings

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Nelson Lam Nelson Lam CFA FCCA FCPA(Practising)MBA MSc BBA CPA(US) ACA

HKAS 17 & 40 and Interpretations10 August 2006

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Leases(HKAS 17)Leases

(HKAS 17)

Investment Property(HKAS 40)

Investment Property(HKAS 40)

Tonight’s AgendaSimple but

ComprehensiveSimple but

Comprehensive

Contentious and key issuesContentious

and key issues

Real Life Cases and Examples

Real Life Cases and Examples

HK-Int 2HKHK--IntInt 22 HK-Int 4HKHK--IntInt 44 HK(IFRIC)-Int 4HK(IFRIC)HK(IFRIC)--IntInt 44

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After crediting:Fair value changes on

investment properties - 4,226

For year ended 31 Dec. 2004HK$’M

Turnover 1,154Profit before tax 783

2005HK$’M1,2505,176

561%561%

Profit is even higher than the revenue

Cases First ……CaseCase

How is this one?How is this one?

540% of 04 profit82% of 05 profit540% of 04 profit82% of 05 profit

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investment properties 2,799 1,130

For 6-month ended 30 Jun. 2005HK$’M

Turnover 613Profit before tax 3,233

2006HK$’M

6201,849

Profit is still higher than the revenue


What if the latest …….What if the latest …….

43%43%

60%60%

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investment properties 1,611 5,080

For 6-month ended 30 Jun. 2005HK$’M

Turnover 429Gross profit 344Profit before tax 2,321

2006HK$’M2,226

4305,948


What if the latest …….What if the latest …….

156%156%

215%215%

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Leases (HKAS 17)

For Rent

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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

Leases – Changes?

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 4Determining Whether an Arrangement Contains a Lease

1. Deleting one sentence, and

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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

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Building only

Building only

Leases – Introducing New Paragraphs

New requirements with significant impact, mainly ……

Separate measurement

(of the land and buildings elements)

Separate measurement

(of the land and buildings elements)

Land onlyLand only

Land and Building

Land and Building

2. Introducing several new paragraphs1. Deleting one sentence

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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 leasesin the same way as leases of other assets

Building only

Building only

Land onlyLand only

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Operating Lease

Operating LeaseLand onlyLand only


Lease of landLease 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 providedLeasehold landwithout title pass

Examples:• Land purchased

in HK• Land use right

acquired in PRC

Examples:• Land purchased

in HK• Land use right

acquired in PRC

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FinanceLease

FinanceLease

Title passed tothe lessee?

Yes

LandLand

No

BuildingBuilding

Operating Lease

Operating Lease

Lease of land and buildingsLease of land and buildings

If a lease contains land and buildingselements

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

Lease of landLease of land

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 leaseThe building element is considered separately

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• 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

• 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

Building only

Building only

Land onlyLand only

Relative Fair ValueRelative Fair ValueRelative Fair Value

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“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.”

CaseCase

2004 Annual Report, HKEX

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Effect of adopting HKAS 17 Leases Increase/(Decrease)Balance sheet as at 31 December 2004 HK$’000Fixed assets (170,100)Lease premium for land 95,218Deferred tax liabilities (19,139)Revaluation reserves (73,815)Retained earnings 18,072

Income statement for the year 2004Increase in premises expenses 548Decrease in depreciation (1,749)Increase in taxation 128

Effect of adopting HKAS 17 Leases Increase/(Decrease)Balance sheet as at 31 December 2004 HK$’000Fixed assets (170,100)Lease premium for land 95,218Deferred tax liabilities (19,139)Revaluation reserves (73,815)Retained earnings 18,072

Income statement for the year 2004Increase in premises expenses 548Decrease in depreciation (1,749)Increase in taxation 128


From valuation to cost (for land)• Non-current assets reduced by

HK$ 75 million

From valuation to cost (for land)• Non-current assets reduced by

HK$ 75 million

CaseCase

2004 Annual Report, HKEX

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• 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

Building only

Building only

Land onlyLand only

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Leases – Separate MeasurementCaseCase

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.

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Leases – Separate MeasurementCaseCase

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.

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FinanceLease

FinanceLease


Yes

LandLand

No

BuildingBuilding

Operating Lease

Operating Lease


Can land and building be reliably separated?

No

No

Yes

Minimum lease payment allocated in proportion to the relative fair values of land and building elements

Minimum lease payment allocated in proportion to the relative fair values of land and building elements

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Entity A

ExampleExample

• 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


FinanceLease

FinanceLease

Operating Lease

Operating Lease

Can land and building be reliably separated?


LandLand

No

BuildingBuilding

No

Yes


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FinanceLease

FinanceLease

Operating Lease

Operating Lease


Entity A

ExampleExample





Land premium• assumed to be the fair value of the land

and accounted for as an operating lease under HKAS 17

• amortised over 50 years• disclosed separately from the building cost

as a non-current asset

Land premium• assumed to be the fair value of the land

and accounted for as an operating lease under HKAS 17

• amortised over 50 years• disclosed separately from the building cost

as a non-current asset

Building cost• accounted for as property, plant and

equipment under HKAS 16• carried in accordance with the accounting

policies adopted for that class of assets (either cost model or revaluation model)

Building cost• accounted for as property, plant and

equipment under HKAS 16• carried in accordance with the accounting

policies adopted for that class of assets (either cost model or revaluation model)

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Entity A

ExampleExample





10 years later, Entity B “acquired” the interest of the land and building for own use

At the inception of the lease (of Entity B)• allocated between the land and the buildings

elements in proportion to the relative fair valuesof the leasehold interests in the land element and buildings element of the lease

At the inception of the lease (of Entity B)• allocated between the land and the buildings

elements in proportion to the relative fair valuesof the leasehold interests in the land element and buildings element of the lease

If NO recent transaction for a similar land• It may be impossible to reliably identify the

relative fair value of the land• Whole lease as a finance lease

If NO recent transaction for a similar land• It may be impossible to reliably identify the

relative fair value of the land• Whole lease as a finance lease

If there is recent transaction for a similar land• The relative fair value of the land and building

may be reliably identified• Land as operating lease under HKAS 17• Building as PPE under HKAS 16

If there is recent transaction for a similar land• The relative fair value of the land and building

may be reliably identified• Land as operating lease under HKAS 17• Building as PPE under HKAS 16

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Entity A

ExampleExample






Assuming Entity B “acquired” the property at HK$20 million and

A similar land has a fair value of $12MConstruction cost of a similar building is $4M

• HK$ 20M to be separated in proportion to the relative fair values of the land and building element at the inception of the lease, i.e. by HK$ 12M to HK$ 4M

• Then, the separate measurement will result in:Land = HK$15M ($20M ×$12M / $16M)Building = HK$ 5M ($20M × $ 4M / $16M)

• HK$ 20M to be separated in proportion to the relative fair values of the land and building element at the inception of the lease, i.e. by HK$ 12M to HK$ 4M

• Then, the separate measurement will result in:Land = HK$15M ($20M ×$12M / $16M)Building = HK$ 5M ($20M × $ 4M / $16M)

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Leases – Separate MeasurementExampleExample


Assuming Entity B “acquired” the property at HK$20 millionAn 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.

Entity A





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Leases – Implementation Issues

Can the lease of land and building be reliably separated?

Cannot be reliably separated

Reliably separated

say, “buy” a flat on 2nd hand market in HK

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?

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Reliably separated

Land and Building

Land and Building

FinanceLease

FinanceLease

Revaluation Model

Revaluation Revaluation ModelModel

CostModelCostCost

ModelModel

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 Model• Revaluation Model

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 Model• Revaluation Model

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Reliably separated

LandLandBuildingBuilding

FinanceLease

FinanceLease

Revaluation Model


CostModelCostCost

ModelModel

Operating Lease

Operating Lease

At CostAt CostAt Cost

Land (no choice as under an operating lease)• Prepaid lease payments (i.e.

cost) amortised over lease term

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 withHKAS 16)• Cost Model or• Revaluation Model

Building: management can choose between (in accordance withHKAS 16)• Cost Model or• Revaluation Model

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FinanceLease

FinanceLease


Operating Lease

Operating Lease



Reliably separated

Land and Building

Land and Building

FinanceLease

FinanceLease

Revaluation Model


CostModelCostCost

ModelModelRevaluation

ModelRevaluation Revaluation

ModelModelCost

ModelCostCost

ModelModel At CostAt CostAt Cost

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FinanceLease

FinanceLease

BuildingBuilding


Reliably separated

Revaluation Model


How can we revalue a building alone without considering the land?

How can we revalue a building alone without considering the land?

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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)

FinanceLease

FinanceLease

Revaluation Model


CaseCase

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FinanceLease

FinanceLease

Revaluation Model


HKAS 16 (para. 33) states: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, except as part of a continuing business,an entity may need to estimate fair value using

• an income or• a depreciated replacement cost approach.

HKAS 16 (para. 33) states: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, except as part of a continuing business,an entity may need to estimate fair value using

• an income or• a depreciated replacement cost approach.


“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

CaseCase

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• 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.2005 Annual Report, Jardines Group


What is depreciated replacement cost?

FinanceLease

FinanceLease

Revaluation Model


CaseCase

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Leases – Depreciated Replacement Cost

International Valuation Guidance Note No. 8 definesDepreciated replacement cost• The current cost of reproduction or replacement of

an assetLess: 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.

Replacement CostReplacement Cost

Less: DepreciationLess: Depreciation

What is depreciated replacement cost?

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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

Retrospective Retrospective ApplicationApplication

⇒ as if that policy had always been applied⇒ restate opening balance of retained earnings⇒ restate comparative figures

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Leases – TransitionCaseCase

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.

Retrospective Application

Retrospective Retrospective ApplicationApplication

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Leases – Separation ExemptionExemption 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 owner-

occupied 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.

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Leases – HK Interpretation 4

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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)


Clarifiedhow the length of the lease term of aHK land lease should be determined• for the purpose of applying

the amortisation requirementsunder HKAS 16 and 17

Have a review on such requirement on HKAS 16 and 17 first ……

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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 leaseholdproperty 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


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In HKAS 17• Lease payments under an operating lease shall be

recognised as an expense on a straight-line basis overthe 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

– for which the lessee has the option to continue tolease the asset, with or without further payment,

– when at the inception of the lease it is reasonablycertain that the lessee will exercise the option.

Lessee has the optionLessee has the option

At the inceptionAt the inception

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HK-Int. 4 further interprets that:• For the purpose of applying the amortisation

requirements under HKAS 16 and 17– the lease term of a HK land lease shall be

determined by reference to the legal form and status of the lease

– renewal of a lease is assumed only when• the lessee has a renewal option

and• it is reasonably certain at the inception of the lease

that the lessee will exercise the option.

Options for extending the lease term that are not at the discretion of the lessee shall not be taken into account by the lessee in determining the lease term.


Further ……



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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

extensions in the determination of the lease term for amortisation



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• 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



ExampleExample

HK Interpretation 4 becomes effective on 24 May 2005

© 2005-06 Nelson 44


• 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.

ExampleExample

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HK(IFRIC) Interpretations 4

Determining Whether an Arrangement Contains a LeaseDetermining Whether an Arrangement Contains a Lease

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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.

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Examples of arrangements 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,include:

Examples of arrangements 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,include:

1. Background and ScopeExampleExample

Right to use an asset

Right to use Right to use an assetan asset ServicesServicesServices++

1. outsourcing arrangementse.g. the outsourcing of the data processing functions of an entity (IT system plus support services)

2. arrangements in the telecommunications industryin 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 contractsin which purchasers must make specified payments regardless of whether they take delivery of the contracted products or servicese.g. a take-or-pay contract to acquire substantially all of the output of a supplier’s power generator (power generator plus related services)

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1. Background and Scope

• HK(IFRIC) Interpretation 4– provides guidance for determining

whether such arrangements are, or contain, leases that should be accounted for in accordance with 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.



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1. Background and ScopeCase 7Case 7

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 do we determine whether there is a right to use an asset in a contract?

How do we determine whether there is a How do we determine whether there is a right to use an asset in a contract?right to use an asset in a contract?

Right to use an asset as leases

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2. Issue

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.

How to DetermineHow to DetermineHow to Determine

When to DetermineWhen to DetermineWhen to Determine

How to SeparateHow to SeparateHow to Separate



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3. Conclusions

• Determining whether an arrangement is, or contains, a lease

– shall be based on the substance of the arrangement and

– requires an assessment of whether:

a) Fulfilment of the arrangement is dependent onthe use of a specific asset or assets (the asset); and

b) The arrangement conveys a right to use the asset.

Dependent on specific assetDependent on Dependent on specific assetspecific asset

Convey an asset use right

Convey an Convey an asset use rightasset use right


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3. Conclusions

• 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.



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No• Although a specific asset is explicitly identified in the contract, it is not

the subject of a lease.• Since the fulfilment of the arrangement 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 the contact.

No• Although a specific asset is explicitly identified in the contract, it is not

the subject of a lease.• Since the fulfilment of the arrangement 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 the contact.

3. Conclusions

• 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?


ExampleExample

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3. Conclusions• 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 insignificant amount of the asset output).

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.




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The contract contains a lease within the scope of HKAS 17 Leases

The contract contains a lease within the scope of HKAS 17 Leases

3. Conclusions• 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. The contract terms include:

– The generator is explicitly identified in the arrangement.

– UX has a right to supply the generator’s electricity to other customers but ABC has the ability to control physical access to the generator

– UX is responsible for repairs, maintenance, and capital expenditures and must stand ready to deliver a minimum quantity of electricity each month.


ExampleExample

Asset explicitly identified and fulfillment depend onthe power generator

Asset explicitly identified and fulfillment depend onthe power generator

The purchaser has the ability to controlphysical access to the asset

The purchaser has the ability to controlphysical access to the asset




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3. Conclusions When to DetermineWhen to DetermineWhen to Determine

• 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.




When to assess and reassess

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3. Conclusions

• 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:


d) There is a change in the contractual terms, unless the change only renews or extends the arrangement.

c) There is a change in the determination of whether fulfilment is dependent on a specified asset.

b) There is a substantial change to the asset, for example, a substantial physical change to property, plant or equipment.

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.




When to assess and reassess

Such reassessment shall be based on the facts and circumstances as of the date of reassessment, including the remaining term of the arrangement.

Such reassessment shall be based on the facts and circumstances as of the date of reassessment, including the remaining term of the arrangement.

• Changes in estimate would not trigger a reassessment.e.g. estimated amount of output to be delivered to the purchaser

© 2005-06 Nelson 58

3. ConclusionsIf 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 ……


d) There is a change in the contractual terms, unless the change only renews or extends the arrangement.

c) There is a change in the determination of whether fulfilment is dependent on a specified asset.

b) There is a substantial change to the asset, for example, a substantial physical change to property, plant or equipment.

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.

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

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© 2005-06 Nelson 59

3. Conclusions

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.




Other elements of the arrangement not within the scope of HKAS 17 shall be accounted for in accordance with other standards.

© 2005-06 Nelson 60

3. ConclusionsFor 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.




Fair value of lease

Fair value of others

The minimum lease payments as defined in HKAS 17– include only payments for the lease (i.e. the right to use the asset) and– exclude payments for other elements in the arrangement

(e.g. for services and the cost of inputs).

The minimum lease payments as defined in HKAS 17– include only payments for the lease (i.e. the right to use the asset) and– exclude payments for other elements in the arrangement

(e.g. for services and the cost of inputs).

31

© 2005-06 Nelson 61

3. ConclusionsIn 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:




Fair value of lease

Fair value of others

ExampleExample

1. Estimate the lease payments by reference to a lease agreement for a comparable asset that contains no other elements

1. Estimate the lease payments by reference to a lease agreement for a comparable asset that contains no other elements

2. Estimate the payments for the other elements in the arrangement by reference to comparable agreements andThen, deducting these payments from the total payments under the arrangement.

2. Estimate the payments for the other elements in the arrangement by reference to comparable agreements andThen, deducting these payments from the total payments under the arrangement.

© 2005-06 Nelson 62

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).

Service element

Element of the right to use the asset


ExampleExample

Service element

32

© 2005-06 Nelson 63

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 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).

Service element

Element of the right to use the asset


ExampleExample

Service element

• Separate the elements based on their relative fair values and

• Recognise the element of the right to use the asset in accordance with HKAS 17

• Separate the elements based on their relative fair values and

• Recognise the element of the right to use the asset in accordance with HKAS 17

• Alternatively, estimate the lease payments by reference to a lease agreement for a comparable power generator that contains no service elements (and recognise in accordance with HKAS 17, too)

• Alternatively, estimate the lease payments by reference to a lease agreement for a comparable power generator that contains no service elements (and recognise in accordance with HKAS 17, too)

© 2005-06 Nelson 64

3. ConclusionsHow 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 leasethe purchase shall treat all payments under the arrangement as lease payments for the purpose of complying with the disclosure requirements of HKAS 17, buti) 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.


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© 2005-06 Nelson 65

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 66

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 presentedon the basis of facts and circumstances existing at the start of that period.

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© 2005-06 Nelson 67

Investment Property (HKAS 40)

© 2005-06 Nelson 68

From SSAP 13 to HKAS 40 – Summary

• Introduce new requirements6. Disposals

• Exemption to certain companies removed1. Scope

• Detailed disclosure required, including fair value of investment property

7. Disclosure

• Transfer requirements are similar to those in SSAP 17 PPE before

5. Transfers

• Introduce cost model, chosen between fair value model

• Fair value model refined

4. Measurementafter recognition

• Same recognition principle applied to all costs (aligned with HKAS 16)

• Measurement of assets from exchange of assets introduced (aligned with HKAS 16)

3. Recognition and Measurement at Recognition

• Redefine investment property• Introduce owner-occupied property

2. Definitions

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© 2005-06 Nelson 69

1. Scope – Exemption RemovedExemption 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

Implies that all these entities are required to apply HKAS 40 from the financial period beginning from 1 Jan. 2005

Specific transitional provisionsfor this elimination additionally introduced in Nov. 2005

Insurance co., not-for-profit entities must follow

More to be discussed later ….

More to be discussed later ….

© 2005-06 Nelson 70

• Amended and clearer definition on an investment property

SSAP 13An investment property is an interest in land and/or buildings:a) in respect of which construction work and development have

been completed; andb) which is held for its investment potential, any rental income

being negotiated at arm’s lengthHKAS 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 appreciationor both, rather than for:a) use in the production or supply of goods or

services or for administrative purposes; orb) sale in the ordinary course of business

2. Definitions – Revised






36

© 2005-06 Nelson 71

• Amended and clearer definition on an investment property






2. Definitions – Revised






How’s about property held by the lessee under an operating lease?

Examples of investment property under HKAS 40 include:• Property leased out under operating leases• Property held for long-term capital appreciation• Property held for a currently undetermined future use• Vacant property to be leased out under operating leases

ExampleExample

© 2005-06 Nelson 72

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 asinvestment property if, and only if• the property would otherwise meet the definition of an

investment property and• the lessee uses the Fair Value Model

• This classification alternative is available on a property-by-property basis

• However, once this classification alternative is selected forone such property interest held under an operating lease,all properties classified as investment property shall be accounted for using the Fair Value Model

An entity has a choice

How’s about property held by the lessee under an operating lease?

Simple?Simple?Let’s term this classification as

“Operating Lease IP Alternative”Let’s term this classification as

“Operating Lease IP Alternative”

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© 2005-06 Nelson 73

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?

ExampleExample

• Property C is an investment property under HKAS 40 and GV must use HKAS 40 to account for it

• Property A and B are not investment property under HKAS 40. However, GV can choose to account for either A or B or both as investment property under HKAS 40.

• If Property A and B are not accounted for under HKAS 40, they will be accounted for under HKAS 17.

• Measurement under HKAS 40 ……. to be discussed later.

• Property C is an investment property under HKAS 40 and GV must use HKAS 40 to account for it

• Property A and B are not investment property under HKAS 40. However, GV can choose to account for either A or B or both as investment property under HKAS 40.

• If Property A and B are not accounted for under HKAS 40, they will be accounted for under HKAS 17.

• Measurement under HKAS 40 ……. to be discussed later.

© 2005-06 Nelson 74

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

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© 2005-06 Nelson 75

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 investmentproperty being redeveloped for continued futureuse as investment property? Still Investment PropertyStill Investment Property

ExampleExample

Which HKAS?Which HKAS?HKAS 16 & 17

HKAS 2HKAS 11HKAS 17

HKAS 16 & 17

© 2005-06 Nelson 76


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.

Investment Property

Investment Property

Owner-occupied Property

Owner-occupied Property

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

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© 2005-06 Nelson 77


• One of the key indicators in determining the classification between investment property and owner-occupied property

Cash Flow

• 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

Investment Property

Investment Property

Owner-occupied property


© 2005-06 Nelson 78

Investment Property

Investment Property



Ancillary services not significant


Significant ancillary services provided



→ investment property

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


Cash Flow Extent of Ancillary Services

• provided by an entity to the occupants of a property it holds is also considered

owner-occupied property e.g. a owner-managed hotel is not an

investment property

40

© 2005-06 Nelson 79


• 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:

• Then, judgement is required to determine• Entities should develop consistent criteria

for use in exercising the judgement





Passive investor⇒ Investment property⇒ Use HKAS 40

Significant exposure to variation in the cash flows ⇒ Owner-occupied⇒ Use HKAS 16

How to determine those in between these 2 ends?



© 2005-06 Nelson 80




• 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 impairment2. The underlying freehold land will be stated at cost less impairment3. The underlying leasehold land will be stated at cost and subject to

annual operating lease rental charge (amortization of land cost)

ShangriShangri--La Asia Ltd.La Asia Ltd.(extracted from 2003 Annual Report and Announcement of 17 Dec. 2004)

• 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)



CaseCase

41

© 2005-06 Nelson 81

• 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 reducedb) 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.”

ShangriShangri--La Asia Ltd.La Asia Ltd.





2. Definitions – Owner-Occupied PropertyCaseCase

© 2005-06 Nelson 82

• Let’s do some comparison for 2004 (in US$’000)

ShangriShangri--La Asia Ltd.La Asia Ltd.

Net assets at 31.12.2004• as reported in 2004 Annual Report 3,109• 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 47,41021%21%

23%23%

CaseCase

42

© 2005-06 Nelson 83

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 be sold separately

Could not be sold separatelyCould not be

sold separately

or leased out separately under a finance lease⇒ an entity accounts for the portions separately

⇒ the property is investment propertyonly if an insignificant portion is NOT held as investment property

© 2005-06 Nelson 84

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.

2. Definitions – Partially Used OnlyCaseCase

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?

43

© 2005-06 Nelson 85


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.

Changed from SSAP 13• 15% benchmark is removed• Property leased to group companies is still

investment property in an entity’s individual financial statements

ConsolidatedConsolidated

IndividualIndividual

© 2005-06 Nelson 86


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

ExampleExample

Individual Consolidation

Yes No

Yes No

Yes No

Yes Yes

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© 2005-06 Nelson 87

3. Recognition and MeasurementRecognition 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 88

4. Measurement after Recognition

Introduce Cost Model and choose either

Cost ModelCost Model

Fair Value ModelFair Value Model

HKAS 40 implicitly implies that the choice can only be elected on the first-time adoption of HKAS 40The model chosen should be applied to all investment properties, except for1. Property held under operating lease

classified as investment properties 2. Investment property backing liabilities

that pay a return linked directly to thefair value of, or returns from specificassets including that investment property

3. Investment property with a fair value thatcannot be reliably determinable on acontinuing basis (i.e. inability to determinefair value reliably)

and

No choice,only fair value model

Choose a model for all such properties

No choice,only cost model

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© 2005-06 Nelson 89


• However, even Cost Model 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?More Flexible?

Introduce Cost Model and choose either

and

© 2005-06 Nelson 90


Fair Value ModelFair Value ModelAfter initial recognition, an entity that chooses →

• shall measure all of its investment property at fair value, except in the cases that

1. the fair value cannot be determined reliably, or2. 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?

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© 2005-06 Nelson 91


• 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?

ExampleExample

• Then, GV has no choice in accounting for the investment property.• It must adopt fair value model in accounting for all investment properties

including property A and C (subject to specific exceptions)• While property A is accounted for at fair value model under HKAS 40,

property B can still be accounted for under HKAS 17.

• Then, GV has no choice in accounting for the investment property.• It must adopt fair value model in accounting for all investment properties

including property A and C (subject to specific exceptions)• While property A is accounted for at fair value model under HKAS 40,

property B can still be accounted for under HKAS 17.

© 2005-06 Nelson 92

HKAS 40• 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 reflectmarket conditions at the balance sheet date

Depreciation?Tax Implication?

No depreciation required in HKAS 40

Not our concern this time!

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© 2005-06 Nelson 93


Interim Report 2005 clearly stated that:Interim Report 2005 clearly stated that:

CaseCase

• 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 94

4. Measurement after RecognitionCaseCase

• 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 short-term 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 year-end, revaluation would still be conducted.At year-end, revaluation would still be conducted.

48

© 2005-06 Nelson 95

4. Measurement after RecognitionCaseCase

• 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 businesssince, 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)


However, 2005 Final Results Announcement disclosed that provision for deferred tax was finally made with regard to revaluation of the HK investment properties (total HK$2.2 billion) at 2005 year-end.

However, However, 2005 Final Results 2005 Final Results AnnouncementAnnouncement disclosed that disclosed that provision for deferred tax was finally provision for deferred tax was finally made with regard to revaluation of made with regard to revaluation of the HK investment properties (total the HK investment properties (total HK$2.2 billion) at 2005 yearHK$2.2 billion) at 2005 year--end.end.

© 2005-06 Nelson 96

Under HKAS 40Fair 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 the differences between fair value and value in use?

What are the differences between What are the differences between fair value and value in use?fair value and value in use?

49

© 2005-06 Nelson 97

• Value in use consists of the following attributes which are not found in fair value:a) additional value derived from creation of a portfolio of properties;b) synergies between investment property and other assets;c) legal rights or restrictions that are specific only to the current owner;

andd) tax benefits or tax burdens that are specific to the current owner.

• Value in use consists of the following attributes which are not found in fair value:a) additional value derived from creation of a portfolio of properties;b) synergies between investment property and other assets;c) legal rights or restrictions that are specific only to the current owner;

andd) tax benefits or tax burdens that are specific to the current owner.



What are the differences between fair value and value in use?

What are the differences between What are the differences between fair value and value in use?fair value and value in use?

© 2005-06 Nelson 98



• The best evidence of fair value is given by current prices inan 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

50

© 2005-06 Nelson 99



• If NO current prices in an active market, an entity considers the information from a variety of sources, includinga) 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 100


Fair Value ModelFair Value Model• There is a rebuttable presumption that an entity can reliably determine the fair value of an investment property on a continuing basis.

• 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

51

© 2005-06 Nelson 101



• 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 chose Fair Value Model, you cannot fall back to Cost Model


© 2005-06 Nelson 102


After initial recognition, an entity that chooses →• 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





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© 2005-06 Nelson 103

• 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:

Measurement at transfer?Measurement at transfer?

a) Commencement of owner-occupation

b) Commencement of development with a view to sale

Change in use Transfer from investment property

a) End of owner-occupation

b) Commencement of an operating lease to another party

c) End of construction or development

Change in use Transfer to investment property

Depend on the model the entity is using ……

Owner-Occupied Property


InventoriesInventoriesInvestment

PropertyInvestment

Property

Investment Property

Investment Property



InventoriesInventories

End of construction

End of construction

5. Transfer

© 2005-06 Nelson 104

• When an entity uses →– 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.



5. Transfer

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• For a transfer from investment property (i.e. the following cases) carriedat fair value


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.

a) Commencement of owner-occupation

b) Commencement of development with a view to sale

Change in use Transfer from investment property




PropertyInvestment

Property

5. Transfer

© 2005-06 Nelson 106

5. Transfer

• 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?

ExampleExample

• Property A would no longer be investment property and would be reclassified as owner-occupied property.

• Even property A is held under operating lease, such operating lease interest would still be accounted for as a finance lease continuously in accordance with HKAS 17 and classified and measured as property,plant and equipment in accordance with HKAS 16.

• The fair value at the date of change in use, i.e. 10 Feb. 2005 will be regarded as the deemed cost in property, plant and equipment.

• Property A would no longer be investment property and would be reclassified as owner-occupied property.

• Even property A is held under operating lease, such operating lease interest would still be accounted for as a finance lease continuously in accordance with HKAS 17 and classified and measured as property,plant and equipment in accordance with HKAS 16.

• The fair value at the date of change in use, i.e. 10 Feb. 2005 will be regarded as the deemed cost in property, plant and equipment.

54

© 2005-06 Nelson 107


• For a transfer to investment property (i.e. the following cases) and that investment property will be carried at fair value


a) End of owner-occupation

b) Commencement of an operating lease to another party

c) End of construction or development

Change in use Transfer to investment property

Investment Property

Investment Property



InventoriesInventories

End of construction

End of construction

5. Transfer

© 2005-06 Nelson 108

⇒ Revaluation reserve is • frozen and• accounted for in

accordance withHKAS 16 subsequently

Investment Property

Investment Property




5. Transfer


apply HKAS 16 up to the date of change in use.treat any difference at that date between its • carrying amount under HKAS 16, and• its fair value

in the same way as a revaluation under HKAS 16

• For a transfer to investment property (i.e. the following cases) and that investment property will be carried at fair value

any difference between• the fair value of the property

at that date and• its previous carrying amount

shall be recognised in profit/loss


PropertyInvestment

PropertyEnd of construction

End of construction

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5. Transfer• 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?

ExampleExample

• Property B would be reclassified as investment property.• In accordance with HKAS 40, GV should apply HKAS 16 on B up to the

date of change in use and treat any difference at that date between its carrying amount under HKAS 16, and its fair value in the same way as a revaluation under HKAS 16.• Thus, a revaluation surplus of $200 would be further recognised.• Total revaluation reserves would become $500 ($200 + $300)

• The revaluation reserves of $500 would be frozen and accounted for in accordance with HKAS 16 subsequently.

• Property B would be reclassified as investment property.• In accordance with HKAS 40, GV should apply HKAS 16 on B up to the

date of change in use and treat any difference at that date between its carrying amount under HKAS 16, and its fair value in the same way as a revaluation under HKAS 16.• Thus, a revaluation surplus of $200 would be further recognised.• Total revaluation reserves would become $500 ($200 + $300)

• The revaluation reserves of $500 would be frozen and accounted for in accordance with HKAS 16 subsequently.

© 2005-06 Nelson 110

6. Derecognition (or Disposals)• An investment property shall be derecognised (eliminated from the

balance sheet):1. on disposal or2. 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 between1. the net disposal proceeds and2. 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

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7. Disclosurea) Disclosure for both Fair Value Model and Cost Model

• 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 112

7. Disclosureb) Additional Disclosure for Fair Value Model

• 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

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© 2005-06 Nelson 113

7. Disclosurec) Additional Disclosure for Cost Model

• 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 114

Adopted →• 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

Adopted →• Opening balance of retained earnings shall be adjusted• Comparative information

– 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⇒ shall disclose this fact

8. Transitional Arrangements



Example: listed co.

Example: unlisted co., charities

Included the charities taken exemption of SSAP 13 before

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© 2005-06 Nelson 115

• 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.

8. Transitional ArrangementsCaseCase

• Hang Lung Properties adopted a different transitional treatment from Hang Seng Bank

© 2005-06 Nelson 116

Hang Hang SengSeng BankBank (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.”

8. Transitional ArrangementsCaseCase

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© 2005-06 Nelson 117

Application of HKAS 40 in HK



When HKAS 40 Meets HKAS 16 and HKAS 17

in Hong Kong ……

When HKAS 40 Meets HKAS 16 and HKAS 17

in Hong Kong ……

© 2005-06 Nelson 118


Complicated by HKAS 17 since land in HK can only be held under operating lease



Reliably separated

Property held to earn rentals and/or for

capital appreciation

Property held to earn rentals and/or for

capital appreciation

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© 2005-06 Nelson 119


The entire lease is accounted for as a finance lease (under HKAS 17)If the definition of investment property under HKAS 40 is fulfilled, HKAS 40 must be followed and either one of the following models can be chosen• Cost Model • Fair Value Model

The entire lease is accounted for as a finance lease (under HKAS 17)If the definition of investment property under HKAS 40 is fulfilled, HKAS 40 must be followed and either one of the following models can be chosen• Cost Model • Fair Value Model



Land and Building

Land and Building

FinanceLease

FinanceLease

Fair Value Model

Fair Value Fair Value ModelModel

CostModelCostCost

ModelModel

Simple!Simple!

© 2005-06 Nelson 120


Land (and building) under operating leaseChoose to either• HKAS 17• HKAS 40

(using Operating Lease IP Alternative)

Land (and building) under operating leaseChoose to either• HKAS 17• HKAS 40

(using Operating Lease IP Alternative)


Reliably separated

LandLand

Operating Lease

Operating Lease

At CostAt CostAt Cost Fair Value Model


CostModelCostCost

ModelModel

FinanceLease

FinanceLease

BuildingBuilding

Fair Value Model


Building under finance leaseHKAS 40 must be followed and either one of the following models can be chosen• Cost Model • Fair Value Model

Building under finance leaseHKAS 40 must be followed and either one of the following models can be chosen• Cost Model • Fair Value Model Be careful ……

Under HKAS 17

Under HKAS 40

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© 2005-06 Nelson 121


If land is accounted for under HKAS 40 by using Operating Lease IP Alternative• all the investment properties

must be accounted for by using Fair Value Model

• no choice for all investment properties then!

If land is accounted for under HKAS 40 by using Operating Lease IP Alternative• all the investment properties

must be accounted for by using Fair Value Model

• no choice for all investment properties then!


Reliably separated

LandLand

Operating Lease

Operating Lease

Fair Value Model


FinanceLease

FinanceLease

BuildingBuilding

Fair Value Model


Under HKAS 40

© 2005-06 Nelson 122

CostModelCostCost

ModelModel


FinanceLease

FinanceLease


Operating Lease

Operating Lease


Reliably separated

Fair Value Model

Fair Value Fair Value ModelModel At CostAt CostAt Cost

Under HKAS 17

Under HKAS 40

Choice under HKAS 40 exists only if land is not accounted for as investment property.

Choice under HKAS 40 exists only if land is not accounted for as investment property.

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© 2005-06 Nelson 123

CostModelCostCost

ModelModel


FinanceLease

FinanceLease


Operating Lease

Operating Lease



Reliably separated

Land and Building

Land and Building

FinanceLease

FinanceLease

Fair Value Model


CostModelCostCost

ModelModelFair Value

ModelFair Value Fair Value

ModelModel At CostAt CostAt Cost Fair Value Model


Under HKAS 17

Under HKAS 40

Under HKAS 40

Any element held under lease?

Whether the element can be reliably separated?

Choose the available options

© 2005-06 Nelson 124

“Investment properties are properties held for long-term rental yields.”

“Investment properties are carried at fair value, representing open market value determined annually by independent qualified valuers.”

“Changes in fair values are recorded in the consolidated profit and loss account.”

“In accordance with IAS 40 (revised), leasehold properties held for long-term rental yields are classified as investment properties and carried at fair value.”

“Investment properties are properties held for long-term rental yields.”⇒ definition (and/or for capital appreciation)

“Investment properties are carried at fair value, representing open market value determined annually by independent qualified valuers.”

⇒ adopt Fair Value Model (Recognised) with independent revaluation

“Changes in fair values are recorded in the consolidated profit and loss account.” ⇒ changes in fair value recognised in P/L

“In accordance with IAS 40 (revised), leasehold properties held for long-term rental yields are classified as investment properties and carried at fair value.” ⇒ same as the requirement in HKAS 40.75(b)

JardinesJardines Group Group (2005 Annual Report)

Application of HKAS 40 in HKCaseCase

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© 2005-06 Nelson 125


• Can PPE or Investment Property in HK or PRC be carried at cost model after the adoption of HKAS 17 and HKAS 40?


ExampleExample

© 2005-06 Nelson 126

Summary

Property for own use


FinanceLease

FinanceLease

Revaluation Model


CostModelCostCost

ModelModel

Investment property

Investment property

FinanceLease

FinanceLease

Fair Value ModelFair Value ModelFair Value Model

CostModelCostCost

ModelModel

Under HKAS 16

Under HKAS 40

Land and building cannot be reliably separated

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© 2005-06 Nelson 127

Summary Land and buildingcan be reliably separated



Investment property

Investment property


Finance LeaseFinance Lease Operating LeaseOperating Lease

CostModelCostCost

ModelModel

Revaluation Model


CostModelCostCost

ModelModel

CostModelCostCost

ModelModel

CostModelCostCost

ModelModelCost

ModelCostCost

ModelModel

Fair Value Model


CostModelCostCost

ModelModel

Fair Value Model


Fair ValueModel

Fair ValueFair ValueModelModel

1st Choice

2nd Choice

1st Choice

2nd Choice

3rd Choice

Under HKAS 16

Under HKAS 40 Under HKAS 17

Under HKAS 40

More companies have argued ……More companies More companies have argued ……have argued ……

© 2005-06 Nelson 128

Summary

Annual Report 2005• In the opinion of the directors, the lease payments

of the Group cannot be allocated reliably between the land and building elements, therefore, the entire lease payments are included in the cost of land and building and are amortised over the shorter of the lease terms and useful lives.

CaseCase

Annual Report 2005• As the Group’s lease payments cannot be

allocated reliably between the land and buildings elements, the entire lease payments are included in the cost of the land and buildings as a finance lease in property, plant and equipment.

• The adoption of HKAS 17 has not resulted in any change in the measurement of the Group’s land and buildings.

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SummaryCaseCase

Accounting policy on land use right (annual report 2005):• Land use rights are recognised initially at ‘cost’,

– being the consideration paid for the rights to use and occupy the land.• Land use rights are amortised

– using the straight-line method to write off the cost over their estimated useful lives of 30 to 70 years.

• Land use rights are not separately presented from building, when– they are acquired together with the building at inception and– the costs attributable to the land use rights cannot be reasonably

measured and separated from that of the building.

© 2005-06 Nelson 130

SummaryExampleExample

• PPE can be carried at cost model if either:– The lease of land and building cannot be reliably allocated between

land and building element• The whole lease will be

– classified as finance lease (other than exception case) and– then accounted for at cost model under HKAS 16; or

– The lease of land and building can be reliably allocated between land and building• The land is carried at amortised cost under HKAS 17• The building is carried at cost model under HKAS 16



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Summary



FinanceLease

FinanceLease

CostModelCostCost

ModelModelUnder

HKAS 16



Property for own use LandLandBuildingBuilding


CostModelCostCost

ModelModelCost

ModelCostCost

ModelModel


Land and buildingcan be reliably separated

© 2005-06 Nelson 132

Annual Report 2005• In the current year, the Group has applied HKAS 17 “Leases”. • Under HKAS 17, the land and buildings elements of a lease of land and

buildings are considered separately for the purposes of lease classification,

– unless the lease payments cannot be allocated reliably between the land and buildings elements,

– in which case, the entire lease is generally treated as a finance lease …….– where the allocation between the land and buildings elements cannot be

made reliably, the leasehold interests in land continue to be accounted for as property, plant and equipment.

SummaryCaseCase

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© 2005-06 Nelson 133

SummaryExampleExample

• Investment Property can be carried at cost model if either:– The lease of land and building cannot be reliably allocated between

land and building element• The whole lease will be

– classified as finance lease (other than exception case) and– then accounted for at cost model under HKAS 40; or

– The lease of land and building can be reliably allocated between land and building• The land is carried at amortised cost under HKAS 17• The building is carried at cost model under HKAS 40



© 2005-06 Nelson 134

Summary

FinanceLease

FinanceLease

CostModelCostCost

ModelModelUnder

HKAS 16


Investment property

Investment property



CostModelCostCost

ModelModelCost

ModelCostCost

ModelModel


Land and buildingcan be reliably separated

Investment property

Investment property

Disclose fair value on which

element?

Disclose fair Disclose fair value on which value on which

element?element?

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HKAS 17 & 40 and Interpretations10 August 2006

Nelson Lam Nelson Lam [email protected]

Full version of the slides can be found in www.NelsonCPA.com.hk

HKAS 17 & 40 and Interpretations - Nelson CPAFixed assets (170,100) Lease premium for land 95,218 Deferred tax liabilities (19,139) Revaluation reserves (73,815) Retained earnings

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