hkas 2, 16, 36 and 37
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© 2005-06 Nelson 1
Nelson Lam Nelson Lam CFA FCCA FCPA(Practising)MBA MSc BBA CPA(US) ACA
HKAS 2, 16, 36 and 3729 July 2006
© 2005-06 Nelson 2
Inventories(HKAS 2)
Inventories(HKAS 2)
Property, Plant and Equipment(HKAS 16)
Property, Plant and Equipment(HKAS 16)
Impairment of Assets(HKAS 36)
Impairment of Assets(HKAS 36)
Today’s Agenda
Simple but Comprehensive
Simple but Comprehensive Recap and key
issuesRecap and key
issues Real Life Cases and Examples
Real Life Cases and Examples
Provisions, Contingent Liabilities and Contingent Assets (HKAS 37)
Provisions, Contingent Liabilities and Contingent Assets (HKAS 37)
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Inventories (HKAS 2)
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• The objective of HKAS 2 is to prescribe– the accounting treatment for inventories.
• A primary issue in accounting for inventories is– the amount of cost to be recognised as an
asset and carried forward until the relatedrevenues are recognised.
• HKAS 2 provides guidance on– the determination of cost and its subsequent recognition as an expense,
including any write-down to net realisable value.– the cost formulas that are used to assign costs to inventories.
Objective and Scope of HKAS 2
Inventories are assets:a) held for sale in the ordinary course of business;b) in the process of production for such sale; orc) in the form of materials or supplies to be consumed in the production process
or in the rendering of services.
Inventories are assets:a) held for sale in the ordinary course of business;b) in the process of production for such sale; orc) in the form of materials or supplies to be consumed in the production process
or in the rendering of services.
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• HKAS 2 applies to all inventories, except:a) work in progress arising under construction contracts,
including directly related service contracts (see HKAS 11 Construction Contracts);
b) financial instruments; andc) biological assets related to agricultural activity and
agricultural produce at the point of harvest (see HKAS 41 Agriculture).
Objective and Scope of HKAS 2
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Objective and Scope of HKAS 2
• A jewellery company– is engaged in retailing and wholesale of gold and
diamond and – has a significant level of inventories on golden and
diamond products.• In view of the significant price fluctuation of gold and
diamond in these 2 years– the company considers whether it can carry such kinds
of inventories at market price, instead of cost.• Please advise.
ExampleExample
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Objective and Scope of HKAS 2
• HKAS 2.3(b) states that HKAS 2 does not apply to:– commodity broker-traders who measure their inventories at fair value less
costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change.
• HKAS 2.5 clarifies that:– Broker-traders are those who buy or sell commodities for others or on their
own account.– The inventories referred to in HKAS 2.3(b) are principally acquired with the
purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.
– When these inventories are measured at fair value less costs to sell, they are excluded from only the measurement requirements of HKAS 2.
• The jewellery company can consider accounting for its golden anddiamond products at fair value less costs to sell and recognising such changes in profit or loss.
• HKAS 2.3(b) states that HKAS 2 does not apply to:– commodity broker-traders who measure their inventories at fair value less
costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change.
• HKAS 2.5 clarifies that:– Broker-traders are those who buy or sell commodities for others or on their
own account.– The inventories referred to in HKAS 2.3(b) are principally acquired with the
purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.
– When these inventories are measured at fair value less costs to sell, they are excluded from only the measurement requirements of HKAS 2.
• The jewellery company can consider accounting for its golden anddiamond products at fair value less costs to sell and recognising such changes in profit or loss.
ExampleExample
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• HKAS 2 does not apply to the measurement of inventories held by:a) producers of agricultural and forest products,
agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value in accordance with well-established practices in those industries.When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change.
Objective and Scope of HKAS 2
Producers of agriculture and
minerals
Producers of agriculture and
minerals
Commodity broker-traderCommodity
broker-trader
Using NRV (through P/L)Using NRV
(through P/L)
Using Fair Value (through P/L)
Using Fair Value (through P/L)
b) commodity broker-traders who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change.
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• Inventories shall be measured at– the lower of cost and net realisable value.
Measurement of Inventories
Cost of PurchaseCost of Purchase
• The cost of inventories shall comprise– all costs of purchase,
– costs of conversion and
– other costs incurred in bringing the inventories to their present location and condition.
Cost of ConversionCost of Conversion
Other CostsOther Costs
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Cost Formulas
Measurement of Inventories
Specific IdentificationSpecific Specific IdentificationIdentification
• The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects– shall be assigned by using specific identification of
their individual costs.• Specific identification of cost means that
– specific costs are attributed to identified items of inventory.
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Measurement of Inventories
Entity ST has the following accounting policy in its financial statements of 2006:• Inventories are stated at the lower of cost and net
realisable value. • In respect of unsold machines, cost is determined by
apportionment of the total development costs, including finance costs capitalised, attributable to unsold machines.
• In respect of other inventories, cost, comprising purchase cost from suppliers, is determined:• on first-in-first-out basis and• on the weighted average method.
Please comment.
ExampleExample
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• The cost of inventories, other than those dealt with by using specific identification, shall be assigned by using– the first-in, first-out (FIFO) or – weighted average cost formula.
• For all inventories having a similar nature and use to the entity,– an entity shall use the same cost formula.
• For inventories with a different nature or use,– different cost formulas may be justified.
Measurement of Inventories
Cost Formulas
FIFOFIFOFIFO
Weighted Average Weighted Weighted Average Average
Specific Identification
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Measurement of Inventories
Entity ST has the following accounting policy in its financial statements of 2006:• Inventories are stated at the lower of cost and net
realisable value. • In respect of unsold machines, cost is determined by
apportionment of the total development costs, including finance costs capitalised, attributable to unsold machines.
• In respect of other inventories, cost, comprising purchase cost from suppliers, is determined:• on first-in-first-out basis and• on the weighted average method.
Please comment.
ExampleExample
Are they having a similar nature and use to the entity?
Are they having a similar nature and use to the entity?
• In accordance with HKAS 2.25, an entity shall use the same cost formula for all inventories having a similar nature and use to the entity, • i.e. using either the first-in, first-out (FIFO) or weighted average cost
formula but not both (unless for inventories with a different nature or use, different cost formulas may be justified).
• In accordance with HKAS 2.25, an entity shall use the same cost formula for all inventories having a similar nature and use to the entity, • i.e. using either the first-in, first-out (FIFO) or weighted average cost
formula but not both (unless for inventories with a different nature or use, different cost formulas may be justified).
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Measurement of Inventories
• 2004-05 Annual Report stated its accounting policy on inventories as:– Inventories are stated at the lower of cost or net
realisable value.– Cost is determined on the weighted average basis and,
in the case of work in progress and finished goods, comprises direct materials, direct labour and an appropriate proportion of overheads.
– Net realisable value is based on estimated selling prices less any estimated costs to be incurred to completion and disposal.
CaseCase
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• When inventories are sold, – the carrying amount of those inventories shall be
recognised as an expense in the period in which the related revenue is recognised.
• All write-down and losses of inventories– shall be recognised as an expense in the period
the write-down or loss occurs.• Reversal of any write-down of inventories,
arising from an increase in net realisable value – shall be recognised as a reduction in the amount of
inventories recognised as an expense in the period in which the reversal occurs.
• Some inventories may be allocated to other asset accounts, e.g.– inventory used as a component of self-constructed
property, plant or equipment.
Recognition as an Expense
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• The financial statements shall disclose:a) the accounting policies adopted in measuring inventories, including the
cost formula used;b) the total carrying amount of inventories and the carrying amount in
classifications appropriate to the entity;c) the carrying amount of inventories carried at fair value less costs to sell;d) the amount of inventories recognised as an expense during the period;e) the amount of any write-down of inventories recognised as an expense in
the period in accordance with HKAS 2.34;f) the amount of any reversal of any write-down that is recognised as a
reduction in the amount of inventories recognised as expense in the period in accordance with HKAS 2.34;
g) the circumstances or events that led to the reversal of a write-down of inventories in accordance with HKAS 2.34; and
h) the carrying amount of inventories pledged as security for liabilities.
Disclosure
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Property, Plant and Equipment(HKAS 16)
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From SSAP 17 to HKAS 16 – Summary
• Derecognition rule introduced• No exemption on disclosure of comparative
figures (comparative on reconciliation needed)7. Disclosure
• Sections of transfer, retirements and disposals eliminated
6. Derecognition
• Commencement and cessation of depreciation revised
• Annual review of residual value needed
5. Measurement after recognition
• Element of cost extended• Measurement of assets from exchange of
assets revised
4. Measurement at recognition
• Same recognition principle applied to all costs3. Recognition• Cost and residual value revised2. Definitions
• Exempted entities deleted, some properties excluded
1. Scope
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Scope – Changes & Implication
Exemption for not-for-profit entities eliminated
• The exemption in SSAP 17 for charitable, government subvented and not-for-profit organisations was eliminated in HKAS 16
Implies that all such entities are required to depreciate its PPE from the financial period beginning from 1 Jan. 2005
• Specific transitional provisionsfor this elimination additionally introduced in Nov. 2005
Those entities that have previously taken advantage of the exemption under SSAP 17 are permitted
to deem the carrying amount of an item of PPE immediately before applying HKAS 16 on its effective date (or earlier) as the cost of that item
Charities, not-for-profit entities must follow
More to be discussed later ….
More to be discussed later ….
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• Copier acquired under an operating lease
• Motor vehicle acquired under finance leases
Objective and Scope
Are the following assets PPE?
HKAS 17
• Owned property used for rental purpose
• Investment property underre-development
• Property held for a currently undetermined future use
• Leasehold land separatedfrom the leasehold building
×
√
×
×
×
×
HKAS 40
HKAS 40
HKAS 40
HKAS 17
ExampleExample
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Definition – Revised
Cost • is the amount of cash or cash equivalents paid or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction, or
• where applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other HKFRSse.g. HKFRS 2 Share-based Payment
Residual value
• Revised but …… discussed later
Cost
extendedResidual
value
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Recognition – Principle Change
Recognition criteria (capitalisation) for Initial CostInitial Cost Subsequent
ExpenditureSubsequent Expenditure
In SSAP 17 Criteria not the same
In HKAS 16 Same criteria
• Probable that future economic benefit of the asset will flow to the enterprise
• Cost measured reliably
• Probable that future economic benefit of the asset will flow to the enterprise
• Cost measured reliably
• Probable that future economic benefits in excess of the originally assessed standard of performance of the existing asset will flow to the entity
• Probable that future economic benefits in excess of the originally assessed standard of performance of the existing asset will flow to the entity
• Probable that future economic benefit of the asset will flow to the entity
• Cost measured reliablySame criteria applied to both costs
• Probable that future economic benefit of the asset will flow to the entity
• Cost measured reliablySame criteria applied to both costs
Clearer approach on so-calledComponent Accounting
Clearer approach on so-calledComponent Accounting
Expenditure not fulfilling the recognition criteria will be charged to income statement
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Recognition – Principle Change
CapitaliseCapitalise
Hong Kong Aircraft Engineering Company Limited Annual Report 2005 states:– Property, plant and equipment are carried at cost less
accumulated depreciation and accumulated impairment losses.
– Cost includes expenditure that is directly attributable to the acquisition of the items.
– Subsequent costs are included in the asset’s carrying amount or recognised as a separate asset, as appropriate, only when • it is probable that future economic benefits
associated with the item will flow to the Group and• the cost of the item can be measured reliably.
– All other repairs and maintenance are expensed in the profit and loss account during the financial period in which they are incurred.
ExpenseExpense
CaseCase
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Recognition – Principle Change
• 2005 Annual Report stated its accounting policy on cost of restoring and improving PPE as follows:– The plant components are depreciated over the period
to overhaul. – Major costs incurred in restoring the plant components
to their normal working condition to allow continued use of the overall asset are• capitalised and • depreciated over the period to the next overhaul.
– Improvements are capitalised and depreciated over their expected useful lives to the Group.
CaseCase
CapitaliseCapitalise
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© 2005-06 Nelson 25New element of PPE costNew element of PPE cost
Measurement at Recognition
• In HKAS 16, the costcost of an item of PPE comprises:a) its purchase price, including import duties and non-
refundable purchase taxes, after deducting trade discounts and rebates;
b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.
c) the initial estimate of the costs of dismantlingand removing the item and restoring the siteon which it is located, the obligation for whichan entity incurs either– when the item is acquired or– as a consequence of having used the item during
a particular period for purposes other than to produce inventories during that period.
Purchase PricePurchase Price
Directly Attributable Cost
Directly Attributable Cost
Dismantling CostDismantling Cost
Element of cost extended
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Measurement at Recognition
• Several same air-condition plants have been installed by GV in several leasehold properties. When the properties are returned to the landlord in 4 years, the plants should be removed.
• The properties include factory (3 plants installed), show room (1 plant installed) and head office (2 plants installed).
• The purchase cost of each plant is $1,000. The installation cost is $1,000 for each plant. Present value of removal costs of the plant include $400 resulted from installation only and $400 from the usage during the 4 years.
• What is the cost of each plant to be recognised?
In accordance with HKAS 16• the cost of each plant installed in the factory should be $2,400 (the purchase
cost, installation cost and present value of removal cost from installation).• the cost of each plant installed in the show room and head office should be
$2,800 (including the present value of all removal costs)• Since the removal costs of such plants are incurred as a consequence of
having used the machine during a particular period for purposes, other than to produce inventories during that period
In accordance with HKAS 16• the cost of each plant installed in the factory should be $2,400 (the purchase
cost, installation cost and present value of removal cost from installation).• the cost of each plant installed in the show room and head office should be
$2,800 (including the present value of all removal costs)• Since the removal costs of such plants are incurred as a consequence of
having used the machine during a particular period for purposes, other than to produce inventories during that period
ExampleExample
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Measurement at Recognition
If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up.
Commercial Substance
Commercial Substance
Fair Value of Exchanged Asset
Fair Value of Exchanged Asset
Rule on Exchange of Assets Revised
Same amendment in HKAS 38 and
HKAS 40
Same amendment in HKAS 38 and
HKAS 40
Element of cost extended
Cost of PPE acquired in exchange is measured at fair value
But not required if:
In HKAS 16 – the exchange transaction lack of
Commercial Substance, or
In SSAP 17– it is an exchange for similar assets
– the Fair Value is not reliably measurable(both asset received and given up)
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Measurement after Recognition
Depreciation
Requirements revised in HKAS 16• Each part of an item of PPE with a
cost that is significant in relation to the total cost of the item shall be depreciated separately
• Begins when PPE is available for use
• Ceases at the earlier of the date that PPE is • classified as held for sale (under
HKFRS 5), and• derecognised
Each significant component shall be depreciated separately (not clearly required in the past)
Implied that depreciation still required even PPE– becomes idle or– is retired from active use
Clearer approach on so-calledComponent Accounting
Clearer approach on so-calledComponent Accounting
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Depreciation
Measurement after Recognition
→ Residual Value
• As stated before, definition of Residual Value is revised as
the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset– were already of the age and– in the condition expected at the end of its useful life
Inflation may be incorporated in residual value
shall be reviewed at least at each financial year endif expectations differ from previous estimates, the change shall be accounted for as a change in an accounting estimate in accordance with HKAS 8No such requirement in SSAP 17
• New requirements (on both residual value and useful life)
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Depreciation
Measurement after Recognition
• PPE’s residual value may increase toan amount equal to or greater than the asset’s carrying amount– If it does, the depreciation charge is zero – unless and until its residual value
subsequently decreases to an amount below the asset’s carrying amount
Be carefulBe careful• By referring to the definition of residual
value• It is still limited to the estimates that it
would receive currently for the asset if– the asset were already of the age and– in the condition expected at the end of
its useful life
Implication:• If
estimated residualvalue > carrying amount⇒ no depreciation is
required• But feasible only if
– the management clearly intends to dispose of the PPE before the end of its physical usage life
– otherwise, the estimated residual value is• minimal or even zero
Implication:• If
estimated residualvalue > carrying amount⇒ no depreciation is
required• But feasible only if
– the management clearly intends to dispose of the PPE before the end of its physical usage life
– otherwise, the estimated residual value is• minimal or even zero
→ Residual Value
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Measurement after Recognition
• At 1 Jan. 1985, Entity A bought a flat in Tai Koo Shing at HK$ 0.5 million• Entity A aimed to use it for 50 years until the end of its estimated useful life• The original estimated residual value is zero• Depreciation is calculated on a straight-line basis• At 31 Dec. 2004, the depreciated historical cost (and carrying amount) of the
property was HK$0.3 million
• Now, the price of a similar flat in Tai Koo Shing is about HK$ 3M
• Shall A revise the residual value?
• If A changes its intention and aims to dispose of the flat in 10 years (i.e. 2015)
• Shall A revise the residual value?
ExampleExample
No!A has not changed its usage plan and the residual value after the estimated useful live would still be around zero
No!A has not changed its usage plan and the residual value after the estimated useful live would still be around zero
Yes!If A can demonstrate that it has an intention to dispose of it before the end of its economic life
Yes!If A can demonstrate that it has an intention to dispose of it before the end of its economic life
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Derecognition
Sections of Transfer, Retirements and Disposals in SSAP 17 were deleted in HKAS 16 (new transfer section added in HKAS 40, to discuss later)
In HKAS 16• The carrying amount of an item of PPE shall be
derecognised:a) on disposal; orb) when no future economic benefits are expected
from its use or disposal.• The gain or loss arising from the derecognition of an
item of PPE shall be included in profit or loss when the item is derecognised (unless HKAS 17 requires otherwise on a sale and leaseback)
• Gains shall NOT be classified as revenue.
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Derecognition
Derecognition on replacement• If, under the initial recognition principle, an entity
recognises in the carrying amount of an item of PPEthe cost of a replacement for part of the item– then it derecognises the carrying amount of
the replaced part• regardless of whether
the replaced part had been depreciated separately
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Disclosure
• Detailed information and reconciliation of the carrying amount of PPE are required
• The reconciliation of the carrying amount of PPE for prior period, i.e. comparative reconciliation is now required
The carrying amount of the PPE net book value of PPE• In HK SSAP 17, the requirement is
“a reconciliation of the gross carrying amount andthe accumulated depreciation at the beginning and end of the period ……”
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© 2005-06 Nelson 35
Disclosure
Leasehold buildings
Computertrading and
clearing systems
Other computer hardware
and software
Leaseholdimprovements,
furniture, equipment and motor vehicles Total
$’000 $’000 $’000 $’000 $’000 Net book value at 1 Jan 2003 – as previously reported (note ii) 117,000 444,232 105,304 71,572 738,108 – effect of adopting HKAS 17 (98,500) – – – (98,500) – as restated (note i) 18,500 444,232 105,304 71,572 639,608 Additions – 13,431 16,775 6,041 36,247 Disposals – (3,474) (6,659) (1,604) (11,737) Depreciation (748) (109,510) (39,703) (31,778) (181,739) Revaluation (note 34) 548 – – – 548 Net book value at 31 Dec 2003 18,300 344,679 75,717 44,231 482,927 At 31 Dec 2003 At cost – 1,345,403 347,385 231,519 1,924,307 At valuation 18,300 – – – 18,300 Accumulated depreciation – (1,000,724) (271,668) (187,288) (1,459,680) Net book value 18,300 344,679 75,717 44,231 482,927
CaseCase
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DisclosureHowever, in SME FRS, the requirement is the same (except no comparative requirement), but it gives the following illustrative notes: However, in SME FRS, the requirement is the same (except no However, in SME FRS, the requirement is the same (except no comparative requirement), but it gives the following illustrativcomparative requirement), but it gives the following illustrative notes: e notes:
Property, plant and equipment
4,104,0101,224,0102,880,000At 31 December 20x4
Net carrying amount:5,270,3002,470,3002,800,000At 31 December 20X5
3,051,940811,9402,240,000At 31 December 20x5
2,381,5302,381,530-Additions(1,527,470)(1,527,470)-Disposals
8,322,2403,282,2405,040,000At 31 December 20X5 Accumulated depreciation and impairment losses:
3,364,1701,204,1702,160,000At 1 January 20X5565,770485,77080,000Depreciation for the year
(878,000)(878,000)-Written back on disposal
At 1 January 20X5Cost:
7,468,1802,428,1805,040,000HK$HK$HK$
TotalFurniture, fixtures and equipment
Leasehold land and buildings
ExampleExample
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Transitional Provisions
For exchange of assets• The requirements regarding the initial measurement of an
item of PPE acquired in an exchange of assets transaction– shall be applied prospectively to future transactions.
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Transitional Provisions
• For those entities (charities and not-for-profit entities) that have previously taken advantage of the exemption under SSAP 17– They are permitted to deem the carrying amount
of an item of PPE immediately before applying HKAS 16 on its effective date (or earlier) as the cost of that item.
– Depreciation on the deemed cost of an item of property, plant and equipment commences from the time at which HKAS 17 is first applied.
– In the case where a carrying amount is used as a deemed cost for subsequent accounting, this factand the aggregate of the carrying amounts for each class of property, plant and equipment presented shall be disclosed.
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Transitional Provisions
• All the costs of PPE of an not-for-profit entity had been written off to income and expenditure statement before 2005.
The entity is permittednot to restate the costs of PPEto carry zero beginning balance on PPE in 2005to follow HKAS 16 from 2005
The entity is permittednot to restate the costs of PPEto carry zero beginning balance on PPE in 2005to follow HKAS 16 from 2005
• All the costs of PPE of an not-for-profit entity had not been depreciated before 2005.
The entity is permittedto begin depreciation from 2005to follow HKAS 16 from 2005
The entity is permittedto begin depreciation from 2005to follow HKAS 16 from 2005
ExampleExample
What is the implication on the following cases when HKAS 16 is adopted? What is the implication on the following cases What is the implication on the following cases when HKAS 16 is adopted? when HKAS 16 is adopted?
For both cases, the fact and the aggregate of the carrying amounts for each class of PPE presented shall be disclosed.
For both cases, the fact and the aggregate of the carrying amounts for each class of PPE presented shall be disclosed.
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• Amendment as a result of the introduction of HKFRS 3
Revise the impairment requirements on cash-generating unit and goodwill
Impairment of Assets (HKAS 36)
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Impairment of Assets - Summary
It is the higher of an asset’s
Triggering events
Recoverable Amount
Impairment Loss
At each reporting date, an entity shall assess whether there is any indication that an asset may be impaired.If any such indication exists, the entity shall estimate the recoverable amount of the asset.
If, and only if, the recoverable amount of an asset is less than its carrying amount• The carrying amount of the asset shall be
reduced to its recoverable amount.• That reduction is an impairment loss.
andNet Selling Price Value in UseFair value less costs to sell
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Impairment of Assets – Scope
HKAS 36 applies to financial assets classified as:a) subsidiaries, as defined in HKAS 27 Consolidated and Separate Financial
Statements;b) associates, as defined in HKAS 28 Investments in Associates; andc) joint ventures, as defined in HKAS 31 Interests in Joint Ventures.
For impairment of other financial assets, refer to HKAS 39.
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Identify An Asset That May Be Impaired
Triggering events
At each reporting date, an entity shall assess whether there is any indication that an asset may be impaired.If any such indication exists, the entity shall estimate the recoverable amount of the asset.
Except for• Intangible assets, and• Goodwill ……
Intangible AssetsIntangible AssetsIntangible Assets
GoodwillGoodwillGoodwill
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Identify An Asset That May Be Impaired
Triggering events
• Irrespective of whether there is any indication of impairment, an entity shall also:a) test
• an intangible asset with an indefinite useful life, or
• an intangible asset not yet available for use
for impairment annually by comparing its carrying amount with its recoverable amount.
b) test• goodwill acquired in a business
combinationfor impairment annually
Intangible AssetsIntangible AssetsIntangible Assets
GoodwillGoodwillGoodwill
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Identify An Asset That May Be Impaired
Intangible AssetsIntangible AssetsIntangible Assets
2006 Annual Report states:• Assets that have an indefinite useful life
– are not subject to amortisation,– but are tested at least annually for impairment
and also reviewed for impairment whenever events or changes in circumstances indicatethat the carrying amount may not be recoverable.
• Goodwill – is tested annually for impairment and carried
at cost less accumulated impairment losses.
CaseCase
GoodwillGoodwillGoodwill
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Timing of impairment test on intangible assets• This impairment test may be performed at any time
during an annual period– provided it is performed at the same time every
year.• Different intangible assets may be tested for
impairment at different times.• However, if such an intangible asset was initially
recognised during the current annual period– that intangible asset shall be tested for
impairment before the end of the current annual period.
Identify An Asset That May Be Impaired
Intangible AssetsIntangible AssetsIntangible Assets
GoodwillGoodwillGoodwill Timing of impairment test on goodwill• To be discussed later ……
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Identify An Asset That May Be Impaired
Intangible AssetsIntangible AssetsIntangible Assets
• Intangible assets that have an indefinite useful life, or are not yet ready for use– are tested for impairment annually.
• This impairment test– may be performed at any time during an
annual period,– provided it is performed at the same time
every year.• An intangible asset recognised during the
current period– is tested before the end of the current
annual period.
CaseCase
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Cash-Generating Unit and Goodwill
• If it is not possible to estimate the recoverable amount of the individual asset– an entity shall determine the recoverable
amount of the cash-generating unit to which the asset belongs (the asset’s cash-generating unit).
• Intangible assets may be such individual asset.
• Goodwill is definitely such individual asset.
Intangible AssetsIntangible AssetsIntangible Assets
GoodwillGoodwillGoodwillAmendments of HKAS 36 are mainly for the requirements on cash-generating unit and goodwill
Amendments of HKAS 36 are mainly for the requirements on cash-generating unit and goodwill
25
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Cash-Generating Unit and Goodwill
• A cash-generating unit (CGU)– is the smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets.
• Discussion points on CGU and goodwill include:
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU
Testing CGU with Goodwill for ImpairmentTesting CGU with Goodwill for ImpairmentTesting CGU with Goodwill for Impairment
Minority InterestMinority InterestMinority Interest
Timing of Impairment TestsTiming of Impairment TestsTiming of Impairment Tests
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Cash-Generating Unit and Goodwill
• For the purpose of impairment testing, goodwill acquired in a business combination shall– from the acquisition date, be allocated to each of the acquirer’s CGUs (or
groups of CGUs) that are expected to benefit from the synergies of the combination
– irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units.
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU
CGU 1 CGU 2 CGU 3
Goodwill
Initial allocationInitial allocation
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Cash-Generating Unit and Goodwill
• Each unit or group of units to which the goodwill is so allocated shall:a) represent the lowest level within the entity at which the goodwill is
monitored for internal management purposes; andb) not be larger than a segment
• based on either the entity’s primary or the entity’s secondary reporting format determined in accordance with HKAS 14 Segment Reporting.
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU
CGU 1 CGU 2 CGU 3
Goodwill
Initial allocationInitial allocation
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Cash-Generating Unit and Goodwill
• If the initial allocation of goodwill cannot be completed as required– that initial allocation shall be completed before the end of the first annual
period beginning after the acquisition date (i.e. within 12 months).
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU
CGU 1 CGU 2 CGU 3
Goodwill
• In accordance with HKFRS 3– if the initial accounting for a business
combination can be determined only provisionally, the acquirer:a) accounts for the combination using those
provisional values; andb) recognises any adjustments to those
provisional values as a result of completing the initial accounting within 12 months of the acquisition date.
Initial allocationInitial allocation
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Cash-Generating Unit and Goodwill
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU
Hong Kong Aircraft Engineering Company Limited Annual Report 2005 states:– Goodwill is tested annually for impairment and
carried at costs less accumulated impairment losses. Any impairment arising on goodwill is recognised in the profit and loss account immediately ……
– Goodwill is allocated to cash-generating units for the purpose of impairment testing …….
– For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows (cash-generating units).
CaseCase
Initial allocationInitial allocation
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Cash-Generating Unit and Goodwill
• If goodwill has been allocated to a CGU and the entity disposes of an operation within that CGU– the goodwill associated with the operation disposed of shall be:
a) included in the carrying amount of the operation• when determining the gain or loss on disposal; and
b) measured on the basis of the relative values of• the operation disposed of, and• the portion of the CGU retained,
unless the entity can demonstrate that some other method better reflects the goodwill associated with the operation disposed of.
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU DisposalDisposal
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Cash-Generating Unit and Goodwill
• An entity sells for $100 an operation that was part of a CGU to which goodwill has been allocated.
• The goodwill allocated to the unit cannot be identified or associated with an asset group at a level lower than that unit, except arbitrarily.
• The recoverable amount of the portion of the CGU retained is $300.
ExampleExample
• Because the goodwill allocated to the CGU cannot be non-arbitrarily identified or associated with an asset group at a level lower than that unit, the goodwill associated with the operation disposed of is measured on the basis of the relative values of• the operation disposed of, and• the portion of the unit retained.
• Therefore, 25% of the goodwill ($100 / $400) allocated to the CGU is included in the carrying amount of the operation that is sold.
• Because the goodwill allocated to the CGU cannot be non-arbitrarily identified or associated with an asset group at a level lower than that unit, the goodwill associated with the operation disposed of is measured on the basis of the relative values of• the operation disposed of, and• the portion of the unit retained.
• Therefore, 25% of the goodwill ($100 / $400) allocated to the CGU is included in the carrying amount of the operation that is sold.
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU DisposalDisposal
$100$100
$300$300
© 2005-06 Nelson 56
Any improvement?Any improvement?
Cash-Generating Unit and Goodwill
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU
• At the date of disposal of a business– attributable goodwill is included in the
Group’s share of net assets in the calculation of the gain or loss on disposal.
DisposalDisposal
CaseCase
• In its 2005 Interim Report, full setof HKFRS was adopted:– Goodwill is tested annually for impairment and carried at
cost less accumulated impairment losses.– Gains and losses on the disposal of an entity include the
carrying amount of goodwill relating to the entity sold.– Goodwill is allocated to cash-generating units for the
purpose of impairment testing.
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Any improvement?Any improvement?
Cash-Generating Unit and GoodwillCaseCase
Business, instead of EntityBusiness, instead of Entity
• In its 2005 Interim Report, full setof HKFRS was adopted:– Goodwill is tested annually for impairment and carried at
cost less accumulated impairment losses.– Gains and losses on the disposal of an entity include the
carrying amount of goodwill relating to the entity sold.– Goodwill is allocated to cash-generating units for the
purpose of impairment testing.
© 2005-06 Nelson 58
On 1.1.2005• Parent P acquired 20% interest in
Subsidiary S at $3,500 by cash.• Fair value of the property of S was
$8,000.During 2005• Parent P reported nil profit and profit
of S was HK$6,000 (became cash).• Fair value of S is HK$30,000 at
year-end.• P accounted for S as held for
trading.On 1.1.2006• P acquired additional 60% interest in
S at $22,000 by cash.• Fair value of the property of S was
$11,000.
Cash-Generating Unit and Goodwill
On 1.1.2005 Parent P Sub S
Property $ 0 $ 6,000Investment 0 0Cash at bank 30,000 2,000
30,000 8,000
Issued equity $ (30,000) $ (5,000)Retained earnings 0 (3,000)
(30,000) (8,000)
ExampleExample
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Cash-Generating Unit and Goodwill
On 1.1.2006 Parent P Sub SProperty $ 0 $ 6,000Goodwill 0 0Investment 28,000 0Cash at bank 4,500 8,000
32,500 14,000
Issued equity $ (30,000) $ (5,000)Retained earnings (2,500) (9,000)Revaluation reserves 0 0Minority interest 0 0
(32,500) (14,000)
ExampleExample
J#1 J#2 Consolidated5,000 $ 11,000
12,100 12,100(2,500) (25,500) 0
12,50035,600
5,000 $ (30,000)2,500 7,800 (1,200)
(600) (600)(3,800) (3,800)
(35,600)
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Cash-Generating Unit and GoodwillExampleExample
• Assume S mainly involved in holding investment property to derive rental and had 2 properties managed independently.
• On 2.1.2006, S disposed of one property at $8,000 (cost $3,000) and the remaining property’s recoverable amount was $14,000 (cost $3,000).
On company level of S:Sales proceed of property $ 8,000Cost of property (3,000)Gain on disposal $ 5,000On consolidated level:Sales proceed of property $ 8,000Cost of property to the group ($11,000 ÷ 22,000 x 8,000) 4,000Gain on disposal at group level $ 4,000
On company level of S:Sales proceed of property $ 8,000Cost of property (3,000)Gain on disposal $ 5,000On consolidated level:Sales proceed of property $ 8,000Cost of property to the group ($11,000 ÷ 22,000 x 8,000) 4,000Gain on disposal at group level $ 4,000
That’s all?That’s all?Goodwill written off in accordance with HKAS 36($12,100 ÷ 22,000 x 8,000) $ 4,400
Goodwill written off in accordance with HKAS 36($12,100 ÷ 22,000 x 8,000) $ 4,400
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Cash-Generating Unit and Goodwill
Dr($) Cr($)Dr Retained earnings 2,500Cr Investment 2,500To restate the initial 20% investment in Subsidiary S to cost
Original consolidation journals:ExampleExample
Dr Property – fair value adjustment ($11,000 - $6,000) 5,000Issued equity – subsidiary (given) 5,000Retained earnings – subsidiary (given) 9,000Goodwill (as calculated in last slide) 12,100
Cr Investment – cost of combinations (twice) 25,500Minority interest (19,000 x 20%) 3,800Retaining earnings recognised (to the extent thatthey relate to the previously held ownership interests) 1,200Revaluation reserves 600
To recognise the goodwill and eliminate the investments with the equity shares
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Cash-Generating Unit and Goodwill
Dr($) Cr($)Dr Income statement (Retained earnings) 1,000Cr Property 1,000To adjust the gain recognised in S as fair value had been taken up atgroup level before
Additional consolidation journals:ExampleExample
Dr Retained earnings 800Cr Minority interest (4,000 x 20%) 800To allocate the gain on disposal of property to minority interest
Dr Income statement (Retained earnings) 4,400Cr Goodwill 4,400To write off the goodwill allocated to the “business” in accordance withHKAS 36
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Cash-Generating Unit and Goodwill
On 1.1.2006 Parent P Sub S
Property $ 0 $ 3,000Goodwill 0 0Investment 28,000 0Cash at bank 4,500 16,000
32,500 19,000
Issued equity $ (30,000) $ (5,000)Retained earnings (2,500) (14,000)Revaluation reserves 0 0Minority interest 0 0
(32,500) (19,000)
ExampleExample
J#1 J#2 J#3 Consolidated
5,000 (1,000) $ 7,00012,100 (4,400) 7,700
(2,500) (25,500) 020,50035,200
5,000 $ (30,000)2,500 7,800 6,200 0
(600) (600)(3,800) (800) (4,600)
(35,200)
A portion of the fair value changes from 1st to 2nd acquisition relating to the 2 properties should also be realised when one of them was disposed of,$600 ÷ 22,000 x 8,000 = $218. Please suggest journal!
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Cash-Generating Unit and Goodwill
• If an entity reorganises its reporting structure in a way that changes the composition of one or more CGUs to which goodwill has been allocated– the goodwill shall be reallocated to the
CGUs affected.
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU ReorganiseReorganise
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Cash-Generating Unit and Goodwill
• Goodwill had previously been allocated to CGU A.
• The goodwill allocated to CGU A cannot be identified or associated with an asset group at a level lower than CGU A, except arbitrarily.
• A is to be divided and integrated into 3 other CGUs, namely B, C and D.
ExampleExample
• Because the goodwill allocated to CGU A cannot be non-arbitrarily identified or associated with an asset group at a level lower than CGU A.
• Goodwill is reallocated to CGU B, C and D on the basis of the relative values of the 3 portions of CGU A before those portions are integrated with CGU B, C and D.
• Because the goodwill allocated to CGU A cannot be non-arbitrarily identified or associated with an asset group at a level lower than CGU A.
• Goodwill is reallocated to CGU B, C and D on the basis of the relative values of the 3 portions of CGU A before those portions are integrated with CGU B, C and D.
Allocating Goodwill to CGUAllocating Goodwill to CGUAllocating Goodwill to CGU ReorganiseReorganise
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Cash-Generating Unit and Goodwill
• When goodwill relates to a CGU but has not been allocated to that unit– the unit shall be tested for impairment, whenever
there is an indication that the CGU may be impaired– any impairment loss shall be recognised
Testing CGU with Goodwill for ImpairmentTesting CGU with Goodwill for ImpairmentTesting CGU with Goodwill for Impairment
Goodwill Unallocated
Goodwill Allocated
• A CGU to which goodwill has been allocated– shall be tested for impairment
• annually, and• whenever there is an indication that the unit may
be impaired– If the carrying amount of the CGU exceeds its
recoverable amount, the entity shall recognise any impairment loss
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Cash-Generating Unit and Goodwill
• In accordance with HKFRS 3– goodwill recognised in a business combination represents
• the goodwill acquired by a parent based on the parent’s ownership interest,
• rather than the amount of goodwill controlled by the parent as a result of the business combination.
– Thus, goodwill attributable to a minority interest is not recognised in the parent’s consolidated financial statements.
Minority InterestMinority InterestMinority Interest
New requirement ……
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Cash-Generating Unit and Goodwill
• For the purpose of impairment testing a non-wholly-owned CGU with goodwill– the carrying amount of that CGU is notionally adjusted, before being
compared with its recoverable amount• Notional adjustment
– accomplished by grossing up the carrying amount of goodwill allocated to the CGU to include the goodwill attributable to the minority interest.
– this notionally adjusted carrying amount is then compared with the recoverable amount of the unit to determine whether the CGU is impaired.
– If it is impaired, the entity allocates the impairment loss first to reduce the carrying amount of goodwill allocated to the CGU.
Minority InterestMinority InterestMinority Interest
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Cash-Generating Unit and Goodwill
• Entity A acquires 80% interest in GV at $1,600 on 1 Jan. 2005 • It implies that 100% interest of GV to Entity A would be $2,000.• Subsidiary GV has identifiable net assets at a fair value of $1,500
80% 100%Cost of combination $1,600 $2,000Fair value of GV 1,200 1,500Goodwill 400 500
• Goodwill recognised in the consolidation is $400.• Assume at 30 Jun. 2005, the carrying amount of all the balances are the
same but the recoverable amount of GV (a single CGU) is $1,900.• Compare the calculation with or without notional adjustment on goodwill
attributable to minority interest
Minority InterestMinority InterestMinority Interest
ExampleExample
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Cash-Generating Unit and Goodwill
Minority InterestMinority InterestMinority Interest
ExampleExample
Without Notional AdjustmentCarrying amount of GV in A’s consolidation $ 1,500Goodwill recognised (attributable to A) 400Total carrying amount $ 1,900Recoverable amount of GV $ 1,900
Without Notional AdjustmentCarrying amount of GV in A’s consolidation $ 1,500Goodwill recognised (attributable to A) 400Total carrying amount $ 1,900Recoverable amount of GV $ 1,900
With Notional AdjustmentTotal carrying amount (as above) $ 1,900Notional adjustment• Goodwill attributable to minority interest 100Notionally adjusted carrying amount $ 2,000Recoverable amount of GV $ 1,900
With Notional AdjustmentTotal carrying amount (as above) $ 1,900Notional adjustment• Goodwill attributable to minority interest 100Notionally adjusted carrying amount $ 2,000Recoverable amount of GV $ 1,900
No impairment observed
Impairment loss of $100
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Cash-Generating Unit and Goodwill
• Annual impairment test for a CGU to which goodwill has been allocated– may be performed at any time during an annual period, provided the test is
performed at the same time every year.• Different CGUs may be tested for impairment at different times.• However, if some or all of the goodwill allocated to a CGU was
acquired in a business combination during the current annual period,– that unit shall be tested for impairment before the end of the current annual
period.
Timing of Impairment TestsTiming of Impairment TestsTiming of Impairment Tests
Similar to that for Intangible Assets!
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Cash-Generating Unit and Goodwill
• The most recent detailed calculation made in a preceding period of the recoverable amount of a CGU to which goodwill has been allocated– may be used in the impairment test of that CGU in the current period
provided all of the following criteria are met:a) the assets and liabilities making up the CGU have not changed
significantlyb) the most recent recoverable amount calculation resulted in an
amount that exceeded the carrying amount of the CGU by a substantial margin; and
c) the likelihood that a current recoverable amount determination would be less than the current carrying amount of the CGU is remote.
Timing of Impairment TestsTiming of Impairment TestsTiming of Impairment Tests
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Cash-Generating Unit and Goodwill
Corporate AssetsCorporate Assets are assets other than goodwill that contribute to the future cash flows of both• the CGU under review and• other CGUs.
• In testing a CGU for impairment– an entity shall identify all the corporate
assets that relate to the CGU under review.– The allocation approach of the corporate
assets is also amended ……
Examples include:• Building of a headquarter• EDP Equipment• Research centre
Examples include:• Building of a headquarter• EDP Equipment• Research centre
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Cash-Generating Unit and Goodwill
such portion shall be included as part of the carrying amount of the CGU for impairment test
Corporate AssetsCorporate Assets
Can be allocated on a reasonable and consistent basis
Cannot be allocated on a reasonable and consistent basis
The entity shall:1) compare the carrying amount of the CGU (excluding the
corporate asset) with its recoverable amount• recognise any impairment loss first
Firstly, test smaller CGU
Then, test larger CGU containing the goodwill
2) identify the smallest group of CGUs that includes the CGU under review and to which a portion of the carrying amount of the corporate asset can be allocated on a reasonable and consistent basis; and
3) compare the carrying amount of that group of CGUs, including the portion of the carrying amount of the corporate asset allocated to that group of CGUs, with the recoverable amount of the group of CGUs.
• Any impairment loss shall be recognised.
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Impairment loss for CGU
• An impairment loss– shall be recognised for a CGU
• if, and only if, the recoverable amount of the CGU (group of CGUs) is less than the carrying amount of the CGU (group of CGUs).
– shall be allocated to reduce the carrying amount of the assets of the CGU (group of CGUs) in the following order:a) first, to reduce the carrying amount of any goodwill
allocated to the CGU (group of CGUs); andb) then, to the other assets of the CGU (group of
CGUs) pro rata on the basis of the carrying amount of each asset in the CGU (group of CGUs).
These reductions in carrying amounts shall be treated as impairment losses on individual assets
Goodwill first
Goodwill first
Other on pro rata
Other on pro rata
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Impairment loss for CGU
• In allocating an impairment loss for a CGU, an entity shall not reduce the carrying amount of an asset below the highest of:a) its fair value less costs to sell (if determinable);b) its value in use (if determinable); andc) zero.
• The amount of the impairment loss that would otherwise have beenallocated to the asset shall be allocated pro rata to the other assets of the CGU (group of CGUs).
• A liability shall be recognised for any remaining amount of an impairment loss for a CGU– if, and only if, that is required by another HKAS/HKFRS.
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© 2005-06 Nelson 77
Impairment loss for CGUExampleExample
Entity A performed an impairment review on the CGU X, which has the following assets on hand:
Carrying amountGoodwill $ 1,500Property, plant and equipment
(carried at revalued amounts) 4,000Property, plant and equipment
(carried at cost) 5,700Inventory, at net realisable value 2,400AFS financial assets, at fair value 1,300
Total 14,900
• After an impairment review, Entity A found that the recoverable amount of CGU X is $12,000.
• Calculate the impairment loss and allocate to the individual asset.
© 2005-06 Nelson 78
• Then, the residual loss is allocated to other non-current assets pro rata based on the carrying amounts of those non-current asset.
Impairment loss for CGUExampleExample
Carrying Carrying amount after Allocated amount after
impairment loss impairment loss impairment loss
Goodwill $ 1,500 $ (1,500) $ 0Property, plant and equipment
(carried at revalued amounts) 4,000 (577) 3,423Property, plant and equipment
(carried at cost) 5,700 (823) 4,877Inventory 2,400 - 2,400AFS financial assets 1,300 - 1,300
Total 14,900 (2,900) 12,000
• Firstly, the impairment loss reduces any amount of goodwill
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© 2005-06 Nelson 79
• Largely the same as SSAP 31, except for reversal of impairment loss on goodwill
• An impairment loss recognised for goodwill shall not be reversed in a subsequent period.
• HKAS 38 Intangible Assets prohibits the recognition of internally generated goodwill.
• Any increase in the recoverable amount of goodwill subsequent to the recognition of an impairment loss for that goodwill is
– likely to be an increase in internally generated goodwill,
– rather than a reversal of the impairment loss recognised for the acquired goodwill.
Reversing an Impairment Loss
© 2005-06 Nelson 80
• In respects of assets other than goodwill, an impairment loss is reversedif there has been a change in the estimates used to determine the recoverable amount and the circumstances and events leading to the impairment cease to exist.
• A reversal of impairment loss is limited to the asset’s carrying amount that would have been determined had no impairment loss been recognised in prior years.
• Reversal of impairment losses are credited to the profit and loss accountexcept when the asset is carried at valuation, in which case the reversal of impairment loss is treated as a revaluation movement.
HKEX HKEX (2004 Annual Report)
Accounting Policy on Impairment of Assets
Reversing an Impairment LossCaseCase
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© 2005-06 Nelson 81
Transition and Effective Date• If an entity elects to apply HKFRS 3 from any date
before the effective dates set out in HKFRS 3, it also shall apply HKAS 36 prospectively from that same date.
• Otherwise, an entity shall apply HKAS 36:a) to goodwill and intangible assets acquired in business
combinations for which the agreement date is on or after 1 January 2005; and
b) to all other assets prospectively from the beginning of the first annual period beginning on or after 1 January 2005.
• Entities to which the above paragraph applies are encouraged to apply the requirements of HKAS 36 before the effective dates specified above.
• However, if an entity applies HKAS 36 before those effective dates, it also shall apply HKFRS 3 and HKAS 38 Intangible Assets at the same time.
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Disclosure
• More extensive disclosure required now• Main additional disclosure requirements include:
– Extensive information for each CGU (or group of CGUs) for which the carrying amount of goodwill or intangible assets with indefinite useful lives allocated, including• Key assumptions used and the management approach to
measure the recoverable amounts (aligned with revised HKAS 1)• Period for cash flow projection, growth rate, discount rate ……• Certain other information when a reasonably possible change in
a key assumption would cause the carrying amount of CGUs to exceed its recoverable amount
– any portion of the goodwill acquired in a business combination during the period has not been allocated to a CGU (group of CGUs) at the reporting date• the amount of the unallocated goodwill shall be disclosed
together with the reasons why that amount remains unallocated.
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Disclosure
Esprit Holdings LimitedEsprit Holdings Limited• In accordance with IAS 36, the Group completed its annual
impairment test for Esprit trademarks by comparing their recoverable amount to their carrying amount as at June 30, 2004.
• The Group appointed independent professional valuers to conduct a valuation of the Esprit trademarks as one corporate asset based on value-in-use calculation.
• The resulting value of the Esprit trademarks as at June 30, 2004was significantly higher than their carrying amount.
Only these ……
CaseCase
© 2005-06 Nelson 84
Disclosure
• This valuation uses cash flow projections based on financial estimates covering a three-year period, expected royalty ratesderiving from the Esprit trademarks in the range of 3% to 8% and a discount rate of 14%.
• The cash flows beyond the three-year period are extrapolated using a steady 3% growth rate.
• This growth rate does not exceed the long-term average growth rate for apparel markets in which the Group operates.
• Management has considered the above assumptions and valuation and also taken into account the business expansion plan going forward, the current wholesale order books and the strategic retail expansion worldwide and believes that there is no impairment in the Esprit trademarks.
• Management believes that any reasonably foreseeable change in any of the above key assumptions would not cause the aggregate carrying amount of trademarks to exceed the aggregate recoverable amount.
Esprit Holdings LimitedEsprit Holdings LimitedCaseCase
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Provisions, Contingent Liabilities andContingent Assets (HKAS 37)
© 2005-06 Nelson 86
Objective of HKAS 37
• To ensure appropriate recognition criteriaand measurement bases are applied to
ProvisionProvision
Contingent liabilitiesContingent liabilities
Contingent assetsContingent assets
– that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount
44
© 2005-06 Nelson 87
Provisions
• A provision is– a liability of uncertain timing or amount
Definition →
• A liability is– a present obligation of the entity arising from past events,– the settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits• Not include those adjustments to the carrying amount of assets, say
provision for depreciation, provision for doubtful debt• Distinguished from other liabilities such as trade payables and
accruals because there is– Uncertainty about the timing or– Uncertainty about the amount of the future expenditure required in
settlement
ProvisionProvision
© 2005-06 Nelson 88
Provisions
• A provision shall be recognised when:a) an entity has a present obligation (legal or
constructive) as a result of a past event;b) it is probable that an outflow of resources
embodying economic benefits will be required to settle the obligation; and
c) a reliable estimate can be made of the amount of the obligation.
• If these conditions are not met, no provision shall be recognised.
Present Present obligationobligation
Past eventPast event
Probable Probable outflowoutflow
Reliable Reliable estimateestimate
⇓⇓
⇓⇓
⇓⇓
Definition → Recognition
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Provisions
• Entity A– gives warranties at the time of sale to buyers of its product– commits to make good (by repair or replacement)
manufacturing defects that become apparent within 3 years from the date of sale
• On past experience, it is probable (i.e. more likely than not) that there will be some claims under the warranties.
• Is there present obligation as a result of a past obligating event?
Present Present obligationobligation
ExampleExample
Yes• The obligating event is the sale of the product with a warranty,
which gives rise to a legal obligation.• As it is also probable to have an outflow of resources
embodying economic benefits in settlement, a provision is recognised for the best estimate of the costs of making good under the warranty products sold before the balance sheet date.
Yes• The obligating event is the sale of the product with a warranty,
which gives rise to a legal obligation.• As it is also probable to have an outflow of resources
embodying economic benefits in settlement, a provision is recognised for the best estimate of the costs of making good under the warranty products sold before the balance sheet date.
© 2005-06 Nelson 90
Provisions
• A past event that leads to a present obligation is called an Present obligation
Definition → Recognition
Past eventPast event⇓⇓
An obligating event is an event that creates
– a legal obligation or constructive obligation
– that results in an entity having no realistic alternative to settling that obligation
Obligating eventObligating event
Legal ObligationLegal Obligation
Constructive Obligation
Constructive Obligation
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Provisions
Legal obligation is an obligation that derives from:a) a contract (through its explicit or implicit terms);b) legislation; orc) other operation of law.
Present obligation
Definition → Recognition
Past eventPast event⇓⇓
Legal ObligationLegal Obligation
Constructive Obligation
Constructive Obligation
Constructive obligation is an obligation that derives from an entity’s actions where:a) by an established pattern of past practice, published
policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and
b) as a result, the entity has created a valid expectationon the part of those other parties that it will discharge those responsibilities
© 2005-06 Nelson 92
Provisions
• The only liabilities recognised in an entity’s balance sheet are those that exist at the balance sheet date.– Independent of future actions (i.e. the future
conduct of business)– Examples of such obligations are
• Penalties or clean-up costs for unlawful environmental damage
• Provision for the decommissioning costs of an oil installation (to the extent that the entity is obliged to rectify damage already caused)
Present obligation
Definition → Recognition
Past eventPast event⇓⇓
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© 2005-06 Nelson 93
Provisions
Present obligation
Past eventPast event⇓⇓
ExampleExample
• Entity A in the nuclear power industry causes contamination but cleans up only when required by the law.
• Country X in which Entity A operates has had no legislation requiring cleaning up, and Entity A has been contaminating land there for many years.
• At 31 Dec. 2000, it is virtually certain that a draft law requiring a clean-up of land already contaminated will be enacted shortly after the year end.
• Is there present obligation as a result of a past obligating event?
Yes• The obligating event is the contamination of the land because
of the virtual certainty of legislation requiring cleaning up.• As it is also probable to have an outflow of resources
embodying economic benefits in settlement, a provision is recognised for the best estimate of the costs of the clean-up
Yes• The obligating event is the contamination of the land because
of the virtual certainty of legislation requiring cleaning up.• As it is also probable to have an outflow of resources
embodying economic benefits in settlement, a provision is recognised for the best estimate of the costs of the clean-up
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Present obligation
Past eventPast event⇓⇓
ExampleExample
• Entity C operating power station– causes contamination and in Country Z where there is no
environmental legislation.– has a widely published environmental policy in which it
undertakes to clean up all contamination that it causes.– has a record of honouring this published policy.
• Is there present obligation as a result of a past obligating event?
Yes• The obligating event is the contamination of the land, which
gives rise to a constructive obligation because the conduct of the entity has created a valid expectation on the part of those affected by it that the entity will clean up contamination.
• As it is also probable to have an outflow of resources embodying economic benefits in settlement, a provision is recognised for the best estimate of the costs of the clean-up
Yes• The obligating event is the contamination of the land, which
gives rise to a constructive obligation because the conduct of the entity has created a valid expectation on the part of those affected by it that the entity will clean up contamination.
• As it is also probable to have an outflow of resources embodying economic benefits in settlement, a provision is recognised for the best estimate of the costs of the clean-up
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• Nette has recently constructed a natural gas extraction facility and commenced production one year ago (1 June 2003). There is an operating licence given to the company by the government which requires the removal of the facility at the end of its life which is estimated at 20 years. Depreciation is charged on the straight-line basis.
• The cost of the construction of the facility was $200 million and the net present value at 1 June 2003 of the future costs to be incurred in order to return the extraction site to its original condition are estimated at $50 million (using a discount rate of 5% per annum). 80% of these costs relate to the removal of the facility and 20% relate to the rectification of the damage caused through the extraction of the natural gas. The auditors have told the company that a provision for decommissioning has to be set up.
• Explain with reasons and suitable extracts/computations the accounting situations in the financial statements for the year ended 31 May 2004; and
• Discuss whether the treatment of the items appears consistent with the ‘Framework’.
ExampleExample
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a) Under HKAS 37, a provision should be made at the balance sheet date for the discounted cost of the removal of the extraction facility because of the following reasons:i) The installation of the facility creates an obligating eventii) The operating licence creates a legal obligation which is likely to occuriii) The costs of removal will have to be incurred irrespective of the future
operations of the company and cannot be avoidediv) A transfer of economic benefits (i.e. the costs of removal) will be required
to settle the obligationv) A reasonable estimate of the obligation can be made although it is difficult
to estimate a cost which will be incurred in twenty years time (HKAS 37 says that only in exceptional circumstances will it not be possible to make some estimate of the obligation).
a) Under HKAS 37, a provision should be made at the balance sheet date for the discounted cost of the removal of the extraction facility because of the following reasons:i) The installation of the facility creates an obligating eventii) The operating licence creates a legal obligation which is likely to occuriii) The costs of removal will have to be incurred irrespective of the future
operations of the company and cannot be avoidediv) A transfer of economic benefits (i.e. the costs of removal) will be required
to settle the obligationv) A reasonable estimate of the obligation can be made although it is difficult
to estimate a cost which will be incurred in twenty years time (HKAS 37 says that only in exceptional circumstances will it not be possible to make some estimate of the obligation).
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Provisions
The cost to be incurred will be treated as part of the cost of the facility to be depreciated over its production life. However, the costs relating to the damage caused by the extraction should not be included in the provision, until the gas is extracted which in this case would be 20% of the total discounted provision.
The accounting for the provision is as follows: $mPresent value of obligation at 1 June 2003 50Provision for decommissioning (80% x $50m) 40Provision for damage through extraction
(20% x $50m ÷ 20 years x 1·0520) (note) 1.33
Note: A simple straight line basis has been used to calculate the required provision for damage. A more complex method could be used whereby the present value of the expected cost of the provision ($10m) is provided for over 20 years and the discount thereon is unwound over its life. This would give a charge in the year of $0·5m + $10m x 5% i.e. $1m.
The cost to be incurred will be treated as part of the cost of the facility to be depreciated over its production life. However, the costs relating to the damage caused by the extraction should not be included in the provision, until the gas is extracted which in this case would be 20% of the total discounted provision.
The accounting for the provision is as follows: $mPresent value of obligation at 1 June 2003 50Provision for decommissioning (80% x $50m) 40Provision for damage through extraction
(20% x $50m ÷ 20 years x 1·0520) (note) 1.33
Note: A simple straight line basis has been used to calculate the required provision for damage. A more complex method could be used whereby the present value of the expected cost of the provision ($10m) is provided for over 20 years and the discount thereon is unwound over its life. This would give a charge in the year of $0·5m + $10m x 5% i.e. $1m.
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Balance Sheet at 31 May 2004 (extracts)Tangible non current assets: $mCost of extraction facility 200Provision for decommissioning 40
240Less: depreciation (240 ÷ 20 years) (12)Carrying value 228
Other provisions:Provision for decommissioning 40Unwinding of discount ($40m x 5%) 2
42Provision for damage 1.33
43.33
Income statement $mDepreciation 12Provision for damage 1.33Unwinding of discount (finance cost) 2
Balance Sheet at 31 May 2004 (extracts)Tangible non current assets: $mCost of extraction facility 200Provision for decommissioning 40
240Less: depreciation (240 ÷ 20 years) (12)Carrying value 228
Other provisions:Provision for decommissioning 40Unwinding of discount ($40m x 5%) 2
42Provision for damage 1.33
43.33
Income statement $mDepreciation 12Provision for damage 1.33Unwinding of discount (finance cost) 2
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b) The HK ‘Framework’ would require recognition of the full discounted liability for the decommissioning. The problem is that this can only be achieved by creating an asset on the other side of the balance sheet.This asset struggles to meet the Framework’s definition of an asset and is somewhat dubious by nature.An asset is a resource controlled by the company as a result of past events and from which future economic benefits are expected to flow. It is difficult to see how a future cost can meet this definition.The other strange aspect to the treatment of this item is that depreciation (and hence part of the provision) will be treated as an operating cost and the unwinding of the discount could be treated as a finance cost.This latter treatment could fail any qualitative test in terms of the relevance and reliability of the information.A liability is defined in the Framework as a present obligation arising from past events, the settlement of which is expected to result in an outflow of economic benefits.The idea of a ‘constructive obligation’ utilised in HKAS 37 is also included as a requirement in the Framework. Assets and liabilities are essentially a collection of rights and obligations. (ACCA 2004.06)
b) The HK ‘Framework’ would require recognition of the full discounted liability for the decommissioning. The problem is that this can only be achieved by creating an asset on the other side of the balance sheet.This asset struggles to meet the Framework’s definition of an asset and is somewhat dubious by nature.An asset is a resource controlled by the company as a result of past events and from which future economic benefits are expected to flow. It is difficult to see how a future cost can meet this definition.The other strange aspect to the treatment of this item is that depreciation (and hence part of the provision) will be treated as an operating cost and the unwinding of the discount could be treated as a finance cost.This latter treatment could fail any qualitative test in terms of the relevance and reliability of the information.A liability is defined in the Framework as a present obligation arising from past events, the settlement of which is expected to result in an outflow of economic benefits.The idea of a ‘constructive obligation’ utilised in HKAS 37 is also included as a requirement in the Framework. Assets and liabilities are essentially a collection of rights and obligations. (ACCA 2004.06)
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Provisions
• For recognition of provision, an entity also considers– the probability of an outflow of resources embodying
economic benefits to settle that obligation• An outflow of resources (or other event) is regarded as
probable if the event is more likely than not to occur– i.e. the probability that the event will occur is greater
than the probability that it will not• Where it is not probable that a present obligation exists
an entity discloses a contingent liability, unless the possibility is remote
• Where there are a number of similar obligations (e.g. product warranties or similar contracts)
the probability is determined by considering the class of obligations as a whole
Present obligation
Definition → Recognition
Past event⇓
Probable Probable outflowoutflow
⇓⇓
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Hong Kong Aircraft Engineering Company Limited Annual Report 2005 states:– Provisions are recognised when the Group has a
present legal or constructive obligation as a result of past events; it is more likely than not that an outflow
– of resources will be required to settle the obligation; and the amount has been reliably estimated.
– Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole.
– A provision is recognised even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.
CaseCase
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√
Provisions
Definition → Recognition
Past eventPast event
Probable Probable outflowoutflow
Present Present obligationobligation
ProvisionProvision Contingent liabilityContingent liability Do nothingDo nothing
Possible obligation
× ×
Remote
√
×
×
√
⇓⇓
⇓⇓
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• Use of estimates– an essential part of the preparation of financial statements– does not undermine their reliability– especially true in the case of provisions, which by their
nature are more uncertain than most other balance sheet items.
• An entity (except in extremely rare cases)– will be able to determine a range of possible outcomes
and– can therefore make an estimate of the obligation that is
sufficiently reliable to use in recognising a provision.
Present obligation
Definition → Recognition
Past event⇓
Probable outflow
⇓
Reliable Reliable estimateestimate
⇓⇓
ProvisionProvision More on measurement ……
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Provisions
Definition → Recognition
Past eventPast event
Probable Probable outflowoutflow
Present Present obligationobligation
ProvisionProvision Contingent liabilityContingent liability Do nothingDo nothing
Possible obligation
× ×
Remote
√
×
×
√
⇓⇓
⇓⇓
Reliable Reliable estimateestimate
⇓⇓
√
√
√
×
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Contingent Liabilities
Definition• A contingent liability is:
a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or
b) a present obligation that arises from past events but is not recognised because:i) it is not probable that an outflow of resources
embodying economic benefits will be requiredto settle the obligation; or
ii) the amount of the obligation cannot bemeasured with sufficient reliability.
→ No Recognition → Disclosed unless remote
Contingent liabilityContingent liability• An entity shall
not recognise
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Contingent Liabilities
Contingent liabilityContingent liability
Possible obligation
Remote
√
×Reliable Reliable estimateestimate
×
Definition → No Recognition → Disclosed unless remote
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Contingent Assets
• A contingent asset is:– a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future eventsnot wholly within the control of the entity.
• An entity shall not recognise a contingent asset
Definition → No Recognition → Disclosed
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Provisions – Measurement
1. Best estimate– the amount recognised as a provision shall be the best estimate of the
expenditure required to settle the present obligation at the balance sheet date.
– expected value can be used
Definition → Recognition → Measurement
ProvisionProvision
2. Risks and uncertainties– that inevitably surround many events and circumstances shall be taken
into account in reaching the best estimate of a provision
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Provisions – Measurement
Definition → Recognition → Measurement
ProvisionProvision
3. Present Value– where the effect of the time value of money is material
• the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation
– the discount rate shall be a pre-tax rate that reflects• current market assessments of the time value of money and• the risks specific to the liability• not reflect risks for which future cash flow estimates have been
adjusted
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Provisions – Measurement
4. Future events– that may affect the amount required to settle an obligation shall be
reflected in the amount of a provision where there is sufficient objective evidence that they will occur
5. Expected disposal of assets – shall not be taken into account
Definition → Recognition → Measurement
ProvisionProvision
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Provisions – Measurement
• Entity A is involved in a court case about the plagiarism of software.• Legal opinion seems to indicate that Entity A will lose the case.• Entity A estimates that
– the most likely outcome (60% chance) will be a settlement payment of costs and penalties of $1 million in 2 years’ time
– the best case scenario (30% chance) is deemed to be a settlementpayment of $500,000 in one year’s time and
– the worst case scenario (10% chance) will be a settlement payment of $2 million in 3 years’ time (discount rate is 5%)
• Discuss the implication on the financial position.
ExampleExample
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Provisions – Measurement
• As regards the plagiarism case the following table illustrates the potential outcomes (present values at 5%):
$000 Year PV($000) Probability Total ($)Best case 500 1 476 30% 142,857Most likely 1,000 2 907 60% 544,218Worse case 2,000 3 1,728 10% 172,768
859,843
• As compared with the most likely outcome, which indicates a provision of $907,000, the expected value of the provision as above is $859,843.
• The difference, while an accounting estimate has been used, is not material.
• In consequence, a provision of $860,000 can be made as it is estimated by a more scientific approach.
(ACCA 2003.06)
• As regards the plagiarism case the following table illustrates the potential outcomes (present values at 5%):
$000 Year PV($000) Probability Total ($)Best case 500 1 476 30% 142,857Most likely 1,000 2 907 60% 544,218Worse case 2,000 3 1,728 10% 172,768
859,843
• As compared with the most likely outcome, which indicates a provision of $907,000, the expected value of the provision as above is $859,843.
• The difference, while an accounting estimate has been used, is not material.
• In consequence, a provision of $860,000 can be made as it is estimated by a more scientific approach.
(ACCA 2003.06)
ExampleExample
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Provisions – Measurement
Annual Report 2004/05:• Provisions are recognised for liabilities of uncertain timing or
amount when the Board has a legal or constructive obligation arising as a result of a past event, it is probable that an outflow of economic benefits will be required to settle the obligation and a reliable estimate can be made.
• Where the time value of money is material,– provisions are stated at the present value of the
expenditure expected to settle the obligation.
CaseCase
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Provisions – Reimbursements
• Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party
– the reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation.
– The reimbursement shall be treated as a separate asset.
– The amount recognised for the reimbursement shall not exceed the amount of the provision.
– In the income statement, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.
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Provisions – Reimbursements
• 2005 Annual Report stated its accounting policy on provisions as follows:– Provisions are recognised when the Group has a present
legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate of the amount can be made.
– Where the Group expects a provision to be reimbursed, • the reimbursement is recognised as a separate asset• but only when the reimbursement is virtually certain.
CaseCase
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Provisions – Changes and Use
• Provisions shall be
– reviewed at each balance sheet date and
– adjusted to reflect the current best estimate.
• If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation
the provision shall be reversed.
• A provision shall be used only for expenditures for which the provision was originally recognised.
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Provisions – Application
• Future operating losses– Provisions shall not be recognised for future operating losses
• Onerous Contracts– Being a contract in which the unavoidable costs of meeting the
obligations under the contract exceed the economic benefitsexpected to be received under it (unavoidable cost > economic benefits expected)
– If an entity has a contract that is onerous, the present obligation under the contract
shall be recognised and measured as a provision
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Provisions – Application
• Entity A operates profitably from a factory that it has leased under an operating lease.
• During the year, Entity A relocates its operations to a new factory.• The lease on the old factory continues for the next 4 years.• Entity A cannot cancel that lease and the factory cannot be re-let to
another user.• Discuss.
• The obligating event is the signing of the lease contract, which gives rise to a legal obligation.
• When the lease becomes onerous (unavoidable costs > economic benefits), an outflow of resources embodying economic benefits is probable.
• Until the lease becomes onerous, it is accounted under HKAS 17 Leases.
• A provision is recognised for the best estimate of the unavoidable lease payments.
• The obligating event is the signing of the lease contract, which gives rise to a legal obligation.
• When the lease becomes onerous (unavoidable costs > economic benefits), an outflow of resources embodying economic benefits is probable.
• Until the lease becomes onerous, it is accounted under HKAS 17 Leases.
• A provision is recognised for the best estimate of the unavoidable lease payments.
ExampleExample
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• A constructive obligation to restructure arises only when an entity:a) has a detailed formal plan for the restructuring identifying at least:
i) the business or part of a business concerned;ii) the principal locations affected;iii) the location, function, and approximate number of employees who will be
compensated for terminating their services;iv) the expenditures that will be undertaken; andv) when the plan will be implemented; and
b) has raised a valid expectation in those affected that it will carry out the restructuring by
i) starting to implement that plan orii) announcing its main features to those affected by it.
Provisions – ApplicationRestructuring
• A restructuring is a programme that is planned and controlled by management, and materially changes either:a) the scope of a business undertaken by an entity; orb) the manner in which that business is conducted
When shall provision be recognised?
When shall provision be recognised?
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Provisions – Application
• No obligation arises for the sale of an operation until the entity is committed to the sale, i.e. there is a binding sale agreement.
• A restructuring provision shall include only the direct expendituresarising from the restructuring, which are those that are both:a) necessarily entailed by the restructuring; and
b) not associated with the ongoing activities of the entity.
• A restructuring provision does not include such costs as:a) retraining or relocating continuing staff;
b) marketing; or
c) investment in new systems and distribution networks.
Restructuring
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Provisions – Application
• The directors of Desolve, planned and approved the closure of its glass making activity, a 100% owned subsidiary company, Glass. This decision was announced on 30 June 2001 and the subsidiary was closed down on 30 November 2001. The year end of the group is 31 July 2001 and the financial statements were approved on 10 December 2001.
• Desolve wished to make a provision of $15 million at 31 July 2001 for the costs of closing the glassmaking business. This amount has taken into account approximately $3 million for the potential profit on the disposal of the land and buildings of the subsidiary. Desolve has included this amount ($15 million) in non-current assets and not the income statement as the costs will berecoverable from the estimated disposal proceeds. The contracts for the sale of the land and buildings were signed on 1 Nov 2001 and were completed on 20 Dec 2001 for a price of $25 million at a profit of $4 million.
• It was anticipated that between 31 July 2001 and 30 Nov 2001 the subsidiary would make operating losses of $20 million before it is closed. Also there would be a cost of $5 million incurred in retraining and relocating the employees who accept employment in the refocused Group.
ExampleExample
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Provisions – Application
• A provision for the closure of the subsidiary is dealt with by HKAS 37, which classifies the sale or termination of a business as a restructuring and then provides specific guidance on how the general recognition criteria for provisions apply to restructuring.
• HKAS 37 describes the characteristics of an obligating event for a restructuring as being a detailed formal plan and a valid expectation on the part of those affected that the plan will be effected. It restricts a restructuring provision to direct expenditure necessarily incurred and not associated with the ongoing activities.
• There is no scope for providing for future operating losses, as there is no present obligation, nor scope, to include expected gains on disposal of assets.
• Thus, a provision should be recognised of $15 million + $3 million (potential profit on the disposal of land and buildings), i.e. $18 million.
• The amount of $15m should not have been included in non-current assets even though the sale proceeds of the land and buildings would cover this amount.
• Additionally the operating losses of $20 million cannot be provided for under HKAS 37 nor can the costs of retraining and relocating the employees ($5 million) who accept employment in the refocused group as these latter costs benefit the ongoing activities of the enterprise.
(ACCA 2001.12)
• A provision for the closure of the subsidiary is dealt with by HKAS 37, which classifies the sale or termination of a business as a restructuring and then provides specific guidance on how the general recognition criteria for provisions apply to restructuring.
• HKAS 37 describes the characteristics of an obligating event for a restructuring as being a detailed formal plan and a valid expectation on the part of those affected that the plan will be effected. It restricts a restructuring provision to direct expenditure necessarily incurred and not associated with the ongoing activities.
• There is no scope for providing for future operating losses, as there is no present obligation, nor scope, to include expected gains on disposal of assets.
• Thus, a provision should be recognised of $15 million + $3 million (potential profit on the disposal of land and buildings), i.e. $18 million.
• The amount of $15m should not have been included in non-current assets even though the sale proceeds of the land and buildings would cover this amount.
• Additionally the operating losses of $20 million cannot be provided for under HKAS 37 nor can the costs of retraining and relocating the employees ($5 million) who accept employment in the refocused group as these latter costs benefit the ongoing activities of the enterprise.
(ACCA 2001.12)
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Disclosure – Provisions• For each class of provision, an entity shall disclose:
a) the carrying amount at the beginning and end of the period;b) additional provisions made in the period, including increases to existing
provisions;c) amounts used (i.e. incurred and charged against the provision) during the
period;d) unused amounts reversed during the period; ande) the increase during the period in the discounted amount arising from the
passage of time and the effect of any change in the discount rate. • Comparative information is not required.• An entity shall disclose the following for each class of provision:
a) a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits;
b) An indication of the uncertainties about the amount or timing of those outflows. Where necessary to provide adequate information, an entity shall disclose the major assumptions made concerning future events; and
c) the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement.
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Disclosure – Contingent Liabilities
• Unless the possibility of any outflow in settlement is remote, an entity shall disclose for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and, where practicable:a) an estimate of its financial effect;b) an indication of the uncertainties relating to the amount or timing of any
outflow; andc) the possibility of any reimbursement.
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Disclosure – Other
• Where an inflow of economic benefits is probable, an entity shall disclose a brief description of the nature of the contingent assets at the balance sheet date, and, where practicable, an estimate of their financial effect, measured using the principles set out for provisions in paragraphs 36-52 of HKAS 37
• Where any of the information required in HKAS 37 is not disclosed because it is not practicable to do so, that fact shall be stated.
• In extremely rare cases, disclosure of some or all of the information can be expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter of the provision, contingent liability or contingent asset.
• In such cases, an entity need not disclose the information, but shall disclose the general nature of the dispute, together with the fact that, and reason why, the information has not been disclosed.
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Other Examples
• The HK Building Management Ordinance S20(2) suggests the (Owners) Corporation to consider establishing a contingency fund to provide for any expenditure of an unexpected or urgent nature.
• In line with the above, a Maintenance and Repair Fund is normally established by a property management company in order to providefunds for the estimated cost of anticipated maintenance, redecoration and repair works which will be undertaken in the foreseeable future on the premises.
• Should the property management company recognise a provision for such repairs and maintenance in the financial statements?
ExampleExample
• There is no present obligation and no provision is recognised.• However, HKAS 37 neither encourages nor prohibits the segregation of
funds to meet future obligations as suggested by the Building Management Ordinance.
• There is no present obligation and no provision is recognised.• However, HKAS 37 neither encourages nor prohibits the segregation of
funds to meet future obligations as suggested by the Building Management Ordinance.
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