Key Highlights for with first adoption of IFRS/HKFRS 16 · 2 ©2020.For...

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Key Highlights for Preparation of Financial Statements with first adoption of IFRS/HKFRS 16Chew Ping Teo / Lillian ChanJanuary 2020

© 2020. For information, contact Deloitte China. 22

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All materials or explanations (not restricted to the following presentation slides) (collectively “Material”) have been and are prepared in general terms only. The Material is intended as a general guide and shall not be construed as any advice, opinion or recommendation given by Deloitte Touche Tohmatsu and/or its personnel (collectively “DTT”).

In addition, the Material is limited by the time available and by the information made available to us. You should not consider the Material as being comprehensive as we may not become aware of all facts or information. Accordingly, DTT is not in a position to and will not make any representation as to the accuracy, completeness or sufficiency of the Material for your purposes.

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Agenda

Part A – New and amendments to IFRSs effective for annual period beginning on or after 1 January 2019

• Application of IFRS 16 Leases

• IFRIC 23 Uncertainty over Income Tax Treatments

• Amendments to IAS 23 Borrowing Costs

Part B – New and amendments to IFRSs that have been issued but not yet effective

• Amendments to IFRS 3 Definition of a Business

• Amendments to IFRS 9, IAS 39 and IFRS 7 Interest Rate Benchmark Reform

4© 2020. For information, contact Deloitte China.

New and amendments to IFRSs effective for annual period beginning on or after 1 January 2019

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Standard / Interpretation

IFRS 16 LeasesIFRIC 23 Uncertainty over Income Tax TreatmentsAmendments to IFRS 9 Prepayment Features with Negative Compensation

Amendments to IAS 19 Plan Amendment, Curtailment or Settlement

Amendments to IAS 28 Long-term Interests in Associates and Joint Ventures

Amendments to IFRSs Annual Improvements to IFRS Standards 2015-2017 Cycle

Standard Subject of amendment

IFRS 3 Business Combinations Previously held interest in a jointoperationIFRS 11 Joint Arrangements

IAS 12 Income Taxes Income tax consequences of payments on financial instruments classified as equity

IAS 23 Borrowing Costs Borrowing costs eligible for capitalisation

New and amendments to IFRSs effective for annual periods beginning on or after 1 January 2019


IFRS 16 Leases

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Overview


IFRS 16 – In a Nutshell

Judgement / focus areas Some key considerations

Identify a lease (a contract, or part of contract that conveys the right to use an asset for a period of time in exchange for consideration)

• Lease vs service• Contracts with multiple lease/

non-lease components

5


IFRS 16 – In a Nutshell – continued


Lease term • Enforceability of renewal/ termination options?

• Assessment of “reasonable certainty” on enforceable options

• Short term leases?• Revision of lease term through “lease

modification”?• Reassessment and remeasurement of

lease liabilities

Lease payments (payments made by a lessee to a lessor relating to the right to use an underlying asset during the lease term)

• Lease, non-lease and “other” components

• Collection on behalf by lessor vs lessor’s obligation?

• Variable lease payments− depend on an index or a rate?− in substance fixed payments

• Remeasurement of lease liabilities




Lessee’s incremental borrowing rate • Terms and conditions to consider to determine a rate that reflects the rate that lessee would have to borrow:− credit rating / credit worthiness

of the lessee− lease term− security in the lease− amount needed to obtain an

asset of a similar value to the right-of-use assets arising from the lease

− economic environment• Sources and basis

Measurement of right-of-use asset • Own-use/ for rentals/ for sale in ordinary course of business?

• Depreciation period, including the related leasehold improvement

• Restoration/reinstatement obligations

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Lease modification (a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease) and effective date of modification

• When to account for a modification?

Note: Certain leases accounted for as new leases under IAS 17 Leases are considered as lease modifications under IFRS 16

Subleases (transaction for which an underlying asset is re-leased by a lessee (‘intermediate lessor’)

• Operating vs finance lease?• Properties vs non-properties?• “Unit of account” of underlying asset?• Potential upfront recognition of

gain/loss for sub-leasing arrangements

Sale and leaseback transactions • Applies IFRS 15 Revenue from Contracts with Customers to determine whether the transfer is accounted for as a sale

• “Component” accounting for transferthat is accounted for as a sale


Definition of lease /sales and leaseback transaction – transition (lessor & lessee)

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IFRS 16 transition – definition of a lease / sales and leaseback transactions

• Lessee/lessor

• Definition of leaseIFRS 16.C3 choice to apply practical expedient – not to reassess contracts before date of initial application

• Sales and leaseback transactionsIFRS 16.C16 should not reassess transactions entered into before the date of initial application


Lessee - transition

8


IFRS 16 transition - lessee


Lease liabilities at initial application

Note: Examples illustrated are for IFRS 16.C8(b)(ii) transition

IFRS 16

1

2

3

9


“Components” of operating lease commitments at 31 December 2018

• Total minimum lease payment under non-cancellable operating leasesü excluded new leases not yet commenced as at 31 December 2018

− relating to similar underlying assets under lease as at 31 December 2018

− new assets to be leased after 31 December 2018 ü excluded payments in which lessees have the options to renew or

early terminateü included future lease payments for short-term/ low value leasesü based on outstanding lease payments (excluding non-lease

components), as stipulated in lease contracts as at 31 December 2018

Note: Basis of operating lease commitments at 31 December 2018 will affect the reconciling items. Reconciling items illustrated are not exhaustive.


IFRS 16 transition - lease modification – Example 1(Lease modification before 1 January 2019)

Background

• Entity A (Lessor, Dec year end entity) entered into a lease agreement with Entity B (Lessee) for a period from 1 April 2016 to 31 March 2019 (Original Agreement)

• Entity A and B entered into a new lease agreement on 30 September 2018 to extend the lease term to 30 September 2022

1 Due at beginning of each month

• Incremental borrowing rate at 1 January 2019 is 5.5%

• No rent-free period

Original AgreementLease term Monthly rental1

1 April 2016 to 31 March 2019 HK$1M

“New” Agreement accounted for as lease modification on application of IFRS 16

Lease term Monthly rental1

1 April 2019 to 30 September 2022 HK$1.2M

1

10


IFRS 16 transition - lease modification – Example 1 – continued (Lease modification before 1 January 2019)

Effective date of lease modification

under IFRS 16

1 Apr 2016 30 Sep 2018 1 Jan 2019 30 Sept 20221 Apr 2019

Original lease

($1M per month)

“New” lease($1.2M per month)

Date of initial application

(DIA)

Operating lease commitment @31 Dec 2018

Lease modification of existing lease

3 months 42 months

Question: What are the adjusting entries at 1 January 2019?


IFRS 16 transition - lease modification – Example 1 – continued

As a lessee

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IFRS 16 transition - lease modification – Example 1 – continued

As a lessor


IFRS 16 transition - lease modification – Example 1 – continued (Lease modification before 1 January 2019)

Lessee Lessor

§ Lease liability = present value of remaining lease payment (3 months + 42 months) @ 5.5%

§ Right-of-use assets to be amortised over 45 months

§ Monthly rental income from 1 Jan 2019 to 30 Sep 2022 is HK$1.19M ((HK$1M × 3 months + HK$1.2M × 42 months) ÷45 months)

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Lease / non-lease components and other payments

“Components” of payments

to lessor

Lease component

Non-lease component

(service component)

Other payments that lessor has

primary responsibility to

pay

Taxes/rates collected by

lessor on behalf of the

government

Reallocate

Lease liabilities on commencement date as required

under IFRS 16.26

Exclude from lease liabilities unless

opt to apply IFRS 16.15

practical expedient

See Example 2A(Slide 24)

See Example 2B(Slide 25)

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Example 2A Direct tax on a lessor recovered through additional payments from lessee

Background

Lessee A enters into a contract with Lessor B to lease an asset for a three-year term with rentals payable each month of CU1,000 PLUS the amount of a tax which Lessor B incurs as a result of its ownership of the leased asset (e.g. property tax payable by the owner).

The tax in question is levied directly on Lessor B as the asset owner (who has the primary responsibility for payment of the tax).

Accounting response

The amounts in respect of this tax should be considered as payments by Lessee A.

If the contract includes lease and non-lease components, total payments to Lessor B (illustrated in Example 2C) will be allocated between the lease and non-lease components of the contract.

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Example 2B Sales tax added to lease payments for collection on behalf of a tax authority

Background

Lessee A enters into a contract with Lessor B to lease an asset for a three-year term with rentals of CU1,000 payable each month.

Local law requires that a sales tax of 20 per cent be added to invoices within the scope of relevant legislation, which includes those for rentals on assets of the type leased by Lessee A. Lessor B does not incur the cost of the sales tax, but rather collects it on behalf of (i.e. as agent of) the tax authority.

Accounting response

As an amount collected by Lessor B on behalf of the tax authority (rather than a reimbursement of a cost incurred by Lessor B), the sales tax does not 'relate to the right to use the underlying asset'.

The sales tax collected by Lessor B on behalf of the tax authority should not be considered as lease payments for calculation of Lessee A’s lease liability.


Example 2C – Lease / non-lease components and other payments

In a contract that contains a lease with lease term of 5 years, the lessee is required to make payments for components besides the lease as below:

Question

What should be included in the initial measurement of lease liability?

Per month (HK$)

Lease term (HK$)

Lease component 1M 60MNon-lease component (property management fee)

200K 12M

Taxes/insurance of lessor to be recharged to lessee

100K 6M

Taxes/ rates to be collected by lessor on behalf of the government

240K 14.4M

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Example 2C – Lease / non-lease components and other payments – continued

IFRS 16


Accounting response

Scenario 1: Lessee opts to account for lease and non-lease components separately

Assume the stand-alone prices for lease and non-lease components are HK$1M and HK$200,000 per month respectively.

Allocate lease and non-lease components based on relative stand-alone price


Per month (HK$)

Lease term (HK$)

Lease component 1M 60MNon-lease component (property management fee)

200K 12M

Taxes/insurance of lessor to be recharged to lessee

100K 6M

Taxes/ rates to be collected by lessor on behalf of the government

240K 14.4M

Lease component HK$60M + 60M72M × 6M = HK$65M

Non-lease component HK$12M + 12M72M × 6M = HK$13M

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Scenario 2: Lessee opts to apply practical expedient not to separate non-lease component

Total lease / non-lease components = HK$78M


Recognition exemptions

IFRS 16.C10(c) exemption

IFRS 16.5 exemptions

Short term lease (leases with lease term of 12 months

or less at commencement

date)

Low value leasesLeases with lease term of <12

months at date of initial application)

ONE-OFF on transition Ongoing accounting policy

By class of underlying assets

Lease by leaseLease by lease

3

16


Right-of-use (ROU) assets at initial application

IFRS 16

as at 31 December 2018

4

5

6

7

Note: Examples illustrated are for IFRS 16.C8(b)(ii) transition

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Lessee’s transition: ROU assets recognised on initial application

ROU asset -own use

ROU asset (included in

property, plant and equipment

or separate line)

ROU asset – under

subleases

Finance lease

Operating lease

Derecognise

For properties

IFRS 16(recognised

on initial application)

ROU asset Investment properties

For non-properties

4

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Lessee’s transition: leasehold lands with ownership interest

IAS 17

IFRS 16

Property, plant and equipment

Prepaid lease

payments

Investment properties (FV model)

Leasehold land

(finance leases)

Land and building (cannot allocate reliably)

Leasehold land

(operating leases)

Any greenboxes

under FV model

Properties held for/under

development/properties held for

sale

Properties held for/under

development/properties held for

sale

üReclassified to ROU assetsüSubject to IFRS 16

measurement and disclosures

ü Not reclassified to ROU assets

ü Subject to IFRS 16 disclosures

ü Not reclassified to ROU assets

ü Subject to IFRS 16 measurement and disclosures

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Lessee’s transition - Assets “acquired” through finance leases (other than properties)

Other PPE “acquired” through finance leases (e.g. plant and machinery, office

equipment)

under lease as at date of initial

application with outstanding lease

liabilities

No longer under lease. Lease

liabilities fully settled as at date of

initial application

Carrying amounts of PPE are

reclassified to ROU assets

Remain in PPE

IAS 17

IFRS 16

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IFRS 16 transition – refundable rental deposits

Are refundable deposits rights and obligations

under leases?

Scope within IAS 17Scope within IFRS 9 – subject to initial

measurement requirement

Yes No

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transition adjustment

Are refundable deposits rights and obligations

under leases?

Scope within IAS 17Scope within IFRS 9 – subject to initial

measurement requirement

IFRS 16 transition – refundable rental deposits – continued

Yes No

(Note: same principle applies for lessor)

IFRS 16 provides clearer guidance of lease

payments, refundable rental deposits are not payments relating to

right to use the underlying assets

Before the application of IFRS 16, the Group considered refundable rental deposits paid as rights and obligations under leases to which IAS 17 applied under other receivables. Based on the definition of lease payments under IFRS 16, such deposits are not payments relating to the right to use of the underlying assets and were adjusted to reflect the discounting effect at transition. Accordingly, HK$[X] was adjusted to refundable rental deposits paid and right-of-use assets.

Transition disclosure

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Background

On or before the date of commencement of a lease, a lessee may be required to pay to the lessor a rental deposit as security:

• that is held as a collateral by the lessor throughout the term of the lease;

• that is refundable in full to the lessee at the end of the lease term except when there is a breach of any provisions in the lease contract; and

• The deposit usually bears no interest throughout the term of the lease.

Question

At transition date, how should the refundable rental deposit be accounted for?

Example 7A – IFRS 16 transition – refundable rental deposits (operating leases)


Accounting response

• Not a payment relating to the right to use the underlying assetsà not meeting a definition of a lease payment

• Should be accounted for as a financial instrument under IFRS 9

• Transition adjustments:

à discount using the lessor’s borrowing rate at transition date

à include the difference in the right-of-use asset (lessee)

Example 7A – IFRS 16 transition – refundable rental deposits(operating leases) – continued

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Background

• On 1 January 2017, entity P (lessee) entered into a 5-year lease with Entity Q (lessor) and P has the option to renew for further 5 years at the same payment terms

• Annual rental: RMB1.5M payable at beginning of each year

• Lessor’s borrowing rate at transition date: 7%

• Entity P is required to pay a non-interest bearing deposit of RMB750K to Entity Q at the commencement of lease, and will be reimbursed at the end of lease term.

• Adjustment on discounting effect of rental deposits at transition date

Ø 3 years lease term = RMB138K

Ø 3 years + 5 years lease term = RMB313K

What are the adjusting journal entries?

Discounted based on remaining lease term

as at transition

Example 7B – IFRS 16 transition – refundable rental deposits(operating leases)


Accounting response

Lessee (3 years lease term, excluding renewal option)

• At transition

Dr Right of use assets 138K

Cr Rental deposit (asset) 138K

• Subsequent measurement

Financial assets à amortised cost

ROU assets and lease liability à IFRS 16 requirement

Example 7B – IFRS 16 transition – refundable rental deposits(operating leases) – continued

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Lessee (Reasonably certain that the lease term will extend for further 5 years)

• At transition

Dr Right of use assets 313K

Cr Rental deposit (asset) 313K

• Subsequent measurement

Financial assets à amortised cost

ROU assets and lease liability à IFRS 16 requirement

Example 7B – IFRS 16 transition – refundable rental deposits(operating leases) – continued


Lessor - transition

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Transition - lessor

1/1/2018 1/1/2019Date of initial application

31/12/2019

Comparatives

IAS 17 IFRS 16

to disclose impacts of application

under IAS 8.28(f)


Disclosure of IAS 8.28(f) – lessor only

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Disclosure of IAS 8.28(f) – lessor only – continued


Disclosure of IAS 8.28(f) – lessor only – continued

(m) Under IFRS 16, the Group accounts for several new lease contracts with existing tenants for the same underlying assetsas lease modification. The Group has recognised rental income for the year ended 31 December 2019 on straight-linebasis after taking into account the modified lease term and rental amount. The adjustments relate to reduction in rentalincome of HK$[X] and income tax expense of HK$[X] and the corresponding lease receivables if IAS 17 wereapplied.

(n) The adjustments relate to reduction in rental income, finance costs and income tax expense of HK$[X], HK$[X] andHK$[X] respectively and the corresponding trade and other payables if the discounting effects for refundable rentaldeposits were not adjusted.

(o) The adjustments relate to sales and leaseback transactions which did not satisfy the requirements of IFRS 15 as a sale.If IAS 17 were applied, there will be reclassification of [receivables arising from financing arrangements] to leasereceivables of HK$[X], as well as the reclassification of interest revenue from [receivables arising from financingarrangements] to interest revenue from finance lease receivables of HK$[X].

(m) Under IFRS 16, the Group accounts for several new lease contracts with existing tenants for the same underlying assetsas lease modification. The Group has recognised rental income for the year ended 31 December 2019 on straight-linebasis after taking into account the modified lease term and rental amount. The adjustments relate to reduction in rentalincome of HK$[X] and income tax expense of HK$[X] and the corresponding lease receivables if IAS 17 wereapplied.

(n) The adjustments relate to reduction in rental income, finance costs and income tax expense of HK$[X], HK$[X] andHK$[X] respectively and the corresponding trade and other payables if the discounting effects for refundable rentaldeposits were not adjusted.

(o) The adjustments relate to sales and leaseback transactions which did not satisfy the requirements of IFRS 15 as a sale.If IAS 17 were applied, there will be reclassification of [receivables arising from financing arrangements] to leasereceivables of HK$[X], as well as the reclassification of interest revenue from [receivables arising from financingarrangements] to interest revenue from finance lease receivables of HK$[X].

see Example 1 Lessee transition

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Presentation and disclosures

© 2020. For information, contact Deloitte China. 4848© 2008 Deloitte Touche Tohmatsu

Primary statements

25


Statement of profit and loss

IFRS 16.49


Statement of financial position

IFRS 16.47

26


Statement of cash flows

IFRS 16.50


Statement of cash flows – continued

Financing cash flows

•Repayment of lease liabilities (principal portion)• Interest portion of lease liabilities

Investing cash flows

• Payment of lease payments on or before lease commencement (including payment for leasehold lands)• Payment of rental deposits

Operating cash flows

• Payment of short term leases / lease of low value assets•Variable lease payments not depending on index/rate •Changes in properties held for/under development/

properties held for sale• Interest portion of lease liabilities

Consistent with reporting entity’s accounting policies on interest paid for other borrowings, i.e. operating or financing

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Disclosures - Lessee


Summary of disclosures as lessee

General leasing activities (IFRS 16.59(a) & B48)

ROU assets (own use and non-properties

subleases) (IFRS 16.57)

On balance sheet Off balance sheet

Investment properties

(IFRS 16.56)

Properties held for /

under development / properties

for sale

Short term / low-value

leases (IFRS 16.55)

ROU assets(IFRS 16.53)

Variable lease payments (IFRS 16.B49)

On balance sheet

Future cash flows (IFRS 16.59(b))

Extension / termination options

(IFRS 16.B50)

Residual value (IFRS 16.B51)

Leases not yet commenced

Lease payments Lease

liabilities(IFRS 16.58)

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IFRS 16.59


Nature of lessee’s leasing activities

IFRS 16.59(a)• Based on lessee’s specific facts and circumstances• Disclosures should include

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IFRS 16.53

Exempt for ROU classified as asinvestment properties at fair value model (IFRS 16.56)


ROU assets (own use and non-properties subleases) – Presentation choice

IFRS 16.47(a)

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ROU assets (own use and non-properties subleases) (Presentation – Alternative 1) IFRS 16.53

Adjustments upon application of IFRS 16

Note of property, plant and equipment


ROU assets (own use and non-properties subleases) (Presentation – Alternative 1) – continued

IFRS 16.53Note of property, plant and equipment

of IFRS 16

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ROU assets (own use and non-properties subleases) (Presentation – Alternative 2)

Note of right-of-use assets

of IFRS 16

IFRS 16.53


ROU assets – other disclosures

IFRS 16.55

Short-term leases

IFRS 16.59(b)(i)

Variable lease payment

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ROU assets – other disclosures – continuedIFRS 16.59(b)(iii)

IFRS 16.59(c)

To better manage the Group’s capital structure and financing needs, the Group sometimes enters into sale and leaseback arrangements in relation to machinery leases. These legal transfer does not satisfy the requirements of IFRS 15 to be accounted for as a sale of the machinery. During the year ended 31 December 2019, the Group has raised HK$[X] borrowings in respect of such sale and leaseback arrangements.

IFRS 16.59(d)

As at 31 December 2019, the Group entered into new leases for several retail stores that have not yet commenced, with average non-cancellable period ranging from [X] to [X] years, excluding period under extension options, the total future undiscounted cash flows over the non-cancellable period amounted to HK$[X].

IFRS 16.59(b)(iv)


Disclosures – Future cash flows for renewal/ termination options

Lease liability Future cash flows

A1 A2 B

IFRS 16.

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Disclosures – Future cash flows for renewal/ termination options - continued

IFRS 16.59(b)(ii) & B49

A1

A2

+B


ROU assets – additional lease liabilities recognised during the year due to renewal/ termination options

IFRS 16.59(b)(ii) / B50

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Disclosures: Lease liabilities

IFRS 16.58


ROU assets – properties held for/under development/ properties held for sale

Effective from 1 January 2019, the carrying amount of leasehold lands is measured under IFRS 16 at cost less any accumulated depreciation and any impairment losses. The residual values are determined as the estimated disposal value of the leasehold land component.

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Disclosures - Lessor


Summary of disclosures as lessor

Leasing activities and risk management (IFRS 16.92)

Maturity analysis & qualitative / quantitative explanation on significant

changes(IFRS 16.93-94)

Property, plant and equipment under operating leases / maturity analysis

(IFRS 16.95-97)

Operating leases Finance leases

Lease income (IFRS 16.90(b))

Finance income & other related income / gains /

losses(IFRS 16.90(a))

Investment properties –maturity analysis

(IFRS 16.97)

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Leasing activities and risk management

IFRS 16.92


Profit or loss disclosure

IFRS 16.90(b)

IFRS 16.90(a)(ii)&(iii)

IFRS 16.90(a)(i)

Operating lease

Finance lease

Finance lease

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Property, plant and equipment under operating leases

IFRS 16.95


Property, plant and equipment under operating lease – continuedIFRS 16.95

Operating lease

38


Operating leases: Maturity analysis

IFRS 16.97

Operating lease


Finance leases: Maturity analysis – continued

IFRS 16.93

IFRS 16.94

Finance lease

39


Some practical issues


Presentation - Obtaining ownership of a leased asset

40


Presentation - Obtaining ownership of a leased asset

For entities presenting right-of-use assets as a separate line item


Net basis

Property, plant and equipment

Right-of-useassets

580

…

690

120 (200)

…

1,220

220

…

290

- (80)

…

680

Gross basis

(in CU’000) Property, plant and equipment

Right-of-useassets

Cost

At 1 Jan 2018 580

… …

At 31 Dec 2018 690

Transfer from ROU assets to PPE upon exercise of purchase option

200 (200)

…. …

At 31 Dec 2019 1,300

Accumulated depreciation

At 1 Jan 2018 220

… …

At 31 Dec 2018 290

Transfer from ROU assets to PPE upon exercise of purchase option

80 (80)

…. …

At 31 Dec 2019 760

Presentation - Obtaining ownership of a leased asset – continued

Accounting policy choice

Include exercise price if not includedat initial recognition

Deemed cost for subsequent

measurement

41


Enforceability of renewal/termination options


Renewal options

42


Enforceability of options

IllustrationLessor has no right to terminate / extend in the following scenarios.

Lease term includesNon-cancellable

periodPeriod in which lessee has option to extend

Lessee has no right to terminate/extend √ X

Lessee has the option to extend √ Assessment of

“reasonably certain” *Lessee has the option to terminate √ Assessment of

“reasonably certain” *

* Assessment of reasonably certain (i) to exercise the extension option or (ii) not to exercise the termination option


Assessment of “reasonable certain” for termination options

Termination option at end of Year 3

Year 5Commencement date

Assessment : “reasonably certain” NOT to exercise the termination option

Reasonably certain

Probability

Highly probable

Probable

NOT to exercise the termination option

Lease liabilities = Year 1 to 3 Lease liabilities = Year 1 to 5

Reasonably certain

Probability

Highly probable

Probable

To exercise the termination option

Lease liabilities = Year 1 to 5 Lease liabilities = Year 1 to 3

43


IFRS 16.B37 Factors to consider on renewal/ termination option – assessment of “reasonably certain”

How favourablethe renewal

terms compared with the market?

Any significant leasehold

improvement undertaken?

Will the lessee be heavily

penalised if the termination option is

exercised?

Is the underlying asset an

important asset of the lessee?

How likely do the conditions

associated with exercise of

options exist?

Disclosure of significant judgement (IAS 1.122)

Determine at lease commencement date

Reassess upon occurrence of significant event / significant

change in circumstances

Factors to consider on renewal/

termination option – assessment of “reasonably certain”

AND


Background

1st – 3rd year = HK$1M per annum, if renew for further 3 years:

Scenario 1: HK$1.3M per annum

Scenario 2: revise rental to market rent but cap at HK$1.5M per annum

Scenario 3: revise rental at market rent

Scenario 4: Greater of 95% of market rent or 110% of base rent (i.e. HK$1M × 110% = HK$1.1M)

If the renewal option is enforceable and it is reasonably certain lessee will exercise the option (i.e. lease term = 6 years), what should be included in the initial measurement of lease liabilities?

Lessee’s renewal option at market rate

44


Lessee’s renewal option at market rate – continued

IFRS 16


Accounting responseScenario 1: HK$1M for 3 years & HK$1.3M for 3 years

Scenario 2: HK$1M for 6 years

Scenario 3: HK$1M for 6 years

Scenario 4: HK$1M for 3 years & HK$1.1M for 3 years

For Scenario 2 & 3- Market rent review is a type of variable lease payment based on

index/rate (IFRS 16.27 & 28) and future changes in market rent are not forecast included in initial measurement

For Scenario 4- The minimum amount of HK$1.1M represents in-substance fixed

payments and therefore be included in lease payments at the commencement date


45



IFRS 16


Lessor’s termination option

3 years 3 years

Lessee - Non-cancellable period

Only the lessor has the right to terminate

46


Lessor and lessee have the right to terminate


IFRIC Discussion (June 2019 & November 2019)

§ No specific contractual term§ Continues indefinitely until either party gives 12 months

notice to terminate§ No penalty on termination

Example 1 – Cancellable lease

1 year 1 year 1 year

§ Specific initial term§ Renew indefinitely unless terminated by either lessor/lessee

Example 2 – Renewable lease

1 year

Termination option with 12 month notice any time

Non-cancellable initial term

Both parties can terminate any time

47


What is “penalty”? (IFRS 16.B34)

Contractual penalty VS

1 year

Non-cancellable period

Both lessee and lessor can terminate

Enforceable?

View 1

if more than insignificantè Lessee to assess “reasonably certain”

Contractual + other economic penalties

View 2Accounting response:

If nil/insignificantè Not enforceable


Accounting for “rebate” or “compensation” from lessors

48


Lease modification - definitions


“Rebate” / “Compensation” / Rental reduction from lessors

“Rebate” / “Compensation” / “Rental reduction”?

Lump sum compensation

Wavier of 50% of rental for past 3 months

Waiver of 50% rental for the future 3 months

Compensation for closure of business (proportion to the closure days)

Stipulated in original lease agreement?If yes, recognise in P/L in the current If yes, recognise in P/L in the current year

Lease modificationLessee Lessor• Adjust right-of-use

asset• Remeasurement

lease liabilities at incremental borrowing rate at the date of modification

• Determine the lease term of the modified lease

• “Lease incentive” recognised as a separate asset

• Impact on fair value of investment properties (IAS 40.50)

49


Business combinations –accounting for leases


28A The acquirer shall recognise right-of-use assets and lease liabilities for leasesidentified in accordance with IFRS 16 in which the acquiree is the lessee. Theacquirer is not required to recognise right-of-use assets and lease liabilities for:

• leases for which the lease term (as defined in IFRS 16) ends within 12 monthsof the acquisition date; or

• leases for which the underlying asset is of low value (as described inparagraphs B3–B8 of IFRS 16).

IFRS 3.28A & 28B

28B The acquirer shall measure the lease liability at the present value of theremaining lease payments (as defined in IFRS 16) as if the acquired lease werea new lease at the acquisition date. The acquirer shall measure the right-of-useasset at the same amount as the lease liability, adjusted to reflect favourable orunfavourable terms of the lease when compared with market terms.

Business combinations – accounting for leases (lessee)

50


Business combinations – accounting for leases (lessee) – continued

On acquisition date, for acquiree as a lessee:Recognise right-of-use (ROU) assets and lease liabilities for leases identified asif the acquired leases were new leases at the acquisition date (i.e. assessmentperformed based on the remaining lease terms)

Low value lease

- Not required to recognise ROU asset or lease liability

- Not adjusted for off-market terms

Remaining lease term < 12 months

- Not required to recognise ROU asset or lease liability

- Not adjusted for off-market terms

Remaining lease term > 12 months

- Recognise ROU asset and lease liability

- Adjusted for off-market terms

- No initial recognition exception under IAS 12 on acquisition


Business combinations – accounting for leases (lessee) - Example

Item HK$Plant and equipmentRight-of-use assetsAccounts receivablesOther receivablesBank and cashTrade payablesAccrued expensesLease liabilitiesBank loansDeferred tax liability

Acquiree’s books at acquisition date (15 April 2019)

Summary of lease terms existed at date of acquisition

For Lease #4, monthly rent in the lease contract is HK$30,000 per month but market rent of the leased properties amounted to HK$35,000 per month at the date of acquisition.

For Lease #5, the underlying asset is a low-value asset.

Assume there is no extension or termination options for the above leases.

Leasecommencement date

Lease term

1 1 January 2019 2 yrs

2 1 February 2015 5 yrs

3 1 February 2019 1 yr

4 1 May 2018 3 yrs

5 1 July 2017 8 yrs

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Business combinations – accounting for leases (lessee) – Accounting response to Example

Lease commencement date

Lease term (on commencement date)

Remaining lease term from date of acq

Included in lease liabilities

1 1 January 2019 2 yrs 1 yr + 8.5 m Yes

2 1 February 2015 5 yrs 9.5 m Optional

3 1 February 2019 1 yr 9.5 m Optional

4 1 May 2018 3 yrs 2 yrs + 0.5 m Yes

5 1 July 2017 8 yrs 6 yrs + 2.5 m Optional

Step 1: Determine the lease liabilities amount at date of acquisition (based on remaining lease payment and IBR @ date of acq)

Step 2: Determine the ROU amount (Equals to lease liabilities adjusted by the favourable or unfavourable lease terms)

Step 3: Ascertain the deferred tax liabilities and assets (no initial recognition exemption under IAS 12 is allowed)


Business combinations – accounting for leases (lessee) – Adjustment to reflect favourable or unfavourable terms of lease (Example)

For Lease #4, monthly rent in the lease contract is HK$30,000 per month but market rent of the leased properties amounted to HK$35,000 per month at the date of acquisition.

Remaining lease term 2 years + 0.5 m (24.5 months)

Market rent HK$35,000 per month

Contractual rent HK$30,000 per month (è favourable lease)

Difference HK$5,000

Additional ROU asset recognised

HK$5,000 × 24.5 months (discounted using appropriate discount rate at date of acq)

Note: In practice, there could be other methods in determining the favourable or unfavourable terms of the lease.

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Acquired lease contracts in business combination

At date of acquisition, when acquirer measures lease liability assumed, should it use its own discount rate? or the discount rate of the target?


Business combinations – accounting for leases (lessor)

IFRS 3.17 & B42

53


Impairment assessment after application of IFRS 16


• Recognition of right-of-use assets will increase the carrying amount of cash-generating units that include assets subject to leases

• Estimated future cash outflows for lease payments recognised as lease liabilities are excluded from value-in-use measurement

• Present value of future estimated cash flows will increase but likely not at the same amount of the additional right-of-use assets included in cash-generating units

Question: will application of IFRS 16 result in revision in discount rate for IAS 36 impairment assessment?

Impairment assessment under IAS 36 Impairment of Assets after application of IFRS 16

54


IAS 24 Related Party Disclosures – upon application of IFRS 16


BackgroundEntity A entered into several operating lease agreements with its parent and an associate.

As at the date of initial application, Entity A applied IFRS 16.C8(b)(ii) transition and recognised the following ROU assets and lease liabilities:

ROU assets HKD10MLease liabilities HKD10M

(parent HKD6M and associate HKD4M)

QuestionHow should Entity A disclose the transactions under IAS 24 Related Party Disclosures?

Accounting response

Note: In addition, new leases entered into and lease modification effected during the reporting period should also be disclosed.

IAS 24 Related Party Disclosures – upon application of IFRS 16

IAS 17 IFRS 16• operating lease expenses • interest expense

• lease liabilities

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IAS 24 Related Party Disclosures – upon application of IFRS 16– continued


IAS 19 & IAS 24 Staff cost / Directors’ emoluments

56


IAS 19 & IAS 24 Staff cost / Directors’ emoluments

IAS 24 Definition

IAS 19.9


IAS 19 & IAS 24 Staff cost / Directors’ emoluments – illustration

Note on profit for the year

Presented in the line “Depreciation”

Note: there could be other presentation alternatives

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Note on related party transactions

Not included in the above table

IAS 19 & IAS 24 Staff cost / Directors’ emoluments – illustration – continued

Note: there could be other presentation alternatives


Potential tax effects on lessees

58



ROU assets

Lease payments/

lease liabilities

Initial direct costs

Estimated dismantling/ restoration

costs

Adjustment to rental deposits

Questions:1) Are tax deductions attributable to right-of-use assets or the

lease payments/ lease liabilities?2) Are interest expense on lease liabilities deductible?


Potential tax effects on lessees – Hong Kong

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Tax regulation quoted from State Taxation Administrationhttp://www.chinatax.gov.cn/n810341/n810765/n812176/n812748/c1193046/content.html

Potential tax effects on lessees – PRC

Operating lease



IAS 12.8

Scenario 1 Scenario 2Deduction

attributable to ROU assets (i.e. tax

allowance)

Deduction attributable to lease liabilities (i.e. lease

payments)At initial recognitionDr. ROU assets 12,000 Tax base = 12,000 Tax base = nilCr. Lease liability 12,000 No tax consequence

since tax base = 12,000

Tax base = nil

Accounting depreciation vs tax allowance

Accounting policy between gross vs net basis

Temporary difference

http://www.chinatax.gov.cn/n810341/n810765/n812176/n812748/c1193046/content.html

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For Scenario 2, tax deduction attributable to lease payments/ lease liabilities:

ROU assets: taxable temporary difference (12,000 - 0 = 12,000)

Lease liabilities: deductible temporary difference (12,000 – 0 = 12,000)

Question:

Should these temporary differences be assessed on a net or gross basis?

Tax deduction attributable to lease payments/ lease liabilities


Accounting policy choice


Note: § This policy should be consistently applied to transactions of similar nature, e.g.

provision for dismantling / restoration costs and the related assets (PPE/ROU)§ No initial recognition exemption under IAS 12 for assets and liabilities arising from

business combinations

Alt 2 Applies IAS 12 Income Taxes requirements to the leasing transaction as a whole

For leasing transactions in which the tax deductions are attributable to the lease liabilities, the Group applies IAS 12 Income Taxes requirements to the leasing transaction as a whole. Temporary differences relating to right-of-use assets and lease liabilities are assessed on a net basis. Excess of depreciation on right-of-use assets over the lease payments for the principal portion of lease liabilities resulting in net deductible temporary differences.

Alt 1 Applies IAS 12 Income Taxes requirements to right-of-use assets and lease liabilities separately

For leasing transactions in which the tax deductions are attributable to the lease liabilities, the Group applies IAS 12 Income Taxes requirements to right-of-use assets and lease liabilities separately. Temporary differences on initial recognition of the relevant right-of-use assets and lease liabilities are not recognised due to application of the initial recognition exemption. Temporary differences arising from subsequent revision to the carrying amounts of right-of-use assets and lease liabilities, resulting from remeasurement of lease liabilities and lease modification, that are not subject to initial recognition exemption are recognised on the date of remeasurement or modification.

61


Example

• Entity A rents a building for 5 years

• Lease payments are $100 per year, payable at the end of each year, and deductible for tax purposes on a cash basis

• Lessee’s incremental borrowing rate is 5%

Potential tax effects on lessees – continued


Example


Right-of-use asset, CU

Lease liability, CU

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Alternative 1 – Gross basis

• On initial recognition, temporary differences arise on initial recognition of the ROU asset and liability à initial recognition exemption applies

• No deferred tax expense or income over the 5-year lease term is recognised



CommencementROU assets – HK$1MLease liability – HK$1M

March 2019Renewed the lease for further 3 years

Initial recognition exemption (“IRE”)

under IAS 12

Alternative 1 – Gross basis

Example – Lease modification (increase in consideration)

Lease modificationAdditional ROU assets & lease liability of HK$1.5M recognised

Subjectto IRE?


63


Alternative 2 – Net basis

• In subsequent years, net temporary difference would be:


Year 1 Year 2 Year 3 Year 4 Year 5ROU assetsOpening carrying amount 435 348 261 174 87Closing carrying amount 348 261 174 87 0Changes in taxable temporary difference (A) 87 87 87 87 87

Lease liabilitiesOpening carrying amount 435 357 274 187 96Closing carrying amount 357 274 187 96 0Changes in deductible temporary difference (B) 78 83 87 91 96

Net (A-B) 9 4 0 -4 -9

Deducible temp diff Reversal of deducible temp diff


Alternative 2 – Net basis

• A simplified calculation:


Year 1 Year 2 Year 3 Year 4 Year 5ROU assetsClosing carrying amount (A) 348 261 174 87 0

Lease liabilitiesClosing carrying amount (B) 357 274 187 96 0

Net (A-B) -9 -13 -13 -9 0

Deferred tax asset Reversal of deferred tax asset

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Future development

• Proposed narrow scope amendment to IAS 12 Income Taxes

Ø Narrow the scope of the initial recognition exemption so that it does not apply to transactions that give rise to both deductible and taxable temporary differences to the extent that an entity recognises a deferred tax asset and liability of the same amount

Ø Double entries at initial recognition of lease / date of initial application:

ROU assets CU435 (taxable temp diff = DTL)

Lease liability CU435 (deductible temp diff = DTA)


Subject to general recognition criteria under

IAS 12


IFRIC 23 Uncertainty over Income Tax Treatments

65


How does an uncertain tax treatment affect the determination of anentity’s accounting tax position?

Is it probable that the tax authority will accept the tax treatment used or planned to be used by an entity in its income tax filings?

Determine taxable profit (tax loss) etc. consistently with the

tax treatment used or planned to be used in the entity’s

income tax filings

Yes No

Reflect the effect of uncertainty in determining taxable profit (tax loss), etc., following the method the entity expects to

better predict the resolution of the uncertainty

The most likely amount

The expected value amount

IFRIC 23 Uncertainty over Income Tax Treatments

Limited retrospective application Adjustments to retained profits (no comparative restated) + Disclosures

Retrospective application ONLY be selected without the use of hindsight

Transition approach


Amendments to IAS 23 Borrowing Costs

66


Amendments to IAS 23 Borrowing Costs

IAS 23 para 14 is amended as follows:

14 To the extent that an entity borrows funds generally and uses them for the purpose ofobtaining a qualifying asset, the entity shall determine the amount of borrowing costseligible for capitalisation by applying a capitalisation rate to the expenditures on thatasset. The capitalisation rate shall be the weighted average of the borrowing costsapplicable to all borrowings of the entity that are outstanding during the period., otherthan borrowings However, an entity shall exclude from this calculation borrowingcosts applicable to borrowings made specifically for the purpose of obtaining aqualifying asset until substantially all the activities necessary to prepare thatasset for its intended use or sale are complete. The amount of borrowing coststhat an entity capitalises during a period shall not exceed the amount of borrowingcosts it incurred during that period.

Borrowing costs eligible for capitalisation

• if any specific borrowing remains outstanding after the related assetis ready for its intended use or sale, that borrowing becomes part ofthe funds that an entity borrows generally when calculating thecapitalisation rate on general borrowings


Specific borrowings- Have all the activities

necessary to prepare the specific qualifying asset for its intended use or

sale completed?

include in the general borrowing pool

capitalise borrowing costs to the specific qualifying

asset

Amendments to IAS 23 Borrowing Costs – continued

Yes No

67


New and amendments to IFRSs that have been issued but not yet effective


New and amendments to IFRSs that have been issued but not yet effective

New and amendments to IFRSsEffective date (annual period beginning)

IFRS 17 Insurance Contracts 1 January 2021

Amendments to IFRS 3 Definition of a Business 1 January 2020*

Amendments to IFRS 9, IAS 39 and IFRS 7

Interest Rate Benchmark Reform 1 January 2020

Amendments to IFRS 10 and IAS 28

Sale or Contribution of Assets between an Investor and its Associate or Joint Venture

To be determined

Amendments to IAS 1 and IAS 8 Definition of Material 1 January 2020

* Effective for acquisition date is on or after the beginning of that period.

68


Amendments to IFRS 3 Definition of a Business


Amendments to IFRS 3 Definition of a Business

The concentration test (optional)

An optional test that provides a simplified assessment of whether an acquired set of activities and assets is not a business is introduced.

If the concentration test is met, the set of activities and assets is determined not to be a business and no further assessment is needed.

The concentration test is met if substantially all of the fair value of the gross assets (with certain asset items excluded) acquired is concentrated in a single identifiable asset or group of similar identifiable assets.

69


AssetsNOT

considered similar

A tangible and an intangible

asset

Tangible assets in different

classes

Identifiable assets in

different classes

A financial asset and a non-

financial asset

Financial assets in different

classes

Identifiable assets within the same class but

have significantly different risk

characteristics

Amendments to IFRS 3 Definition of a Business – continued

Concentration test – what are “similar assets”?



Optional concentration test

If fail optional test, does it mean the acquiree = business?

No. If fail optional concentration test, still need to do further assessment under IFRS 3. B8 – B12

After assessment, may still conclude as having no business (i.e. asset deal)

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Application of concentration test – Example 1 (family homes)

Acquired assets

• 10 Single family homes each with in-placed lease, including:• Land• Building • Property improvement

• FV of consideration paid = FV of family homes

• Each family home is in similar location and has similar customers (tenants)

• No workforce or other process acquired

AnalysisHow many identifiable assets in this acquisition – unit of account

è Ten, combined assets per IFRS 3:(i) Building and property improvement

cannot be removed without incurringsignificant costs

(ii) Building and in-place lease areconsidered one single identifiableasset in business combination

For each identifiable asset, are they similar?

Yes, each family home similar in natureand risks associated with managing andcreating outputs are not significantlydifferent (rental income)

Any concentration of fair value in in a single identifiable asset or group of similar identifiable assets?

In this case, considered to be “fair value concentrated in a group of similar identifiable assets”

Pass test? Asset deal?

FV of gross assets

acquired $$$

FV of all family home

Concentration test satisfiedà ASSET DEAL

No further assessment

under IFRS 3 required



Application of concentration test – Example 2 (family homes + corporate offices)

AnalysisHow many groups of identifiable assets in this acquisition – unit of account

Are these identifiable assets similar?

è Two, because single-family homes and the office buildings differ significantly in in the risks associated with operating the assets, obtaining tenants and managing tenants

Any concentration of fair value in in a single identifiable asset or group of similar identifiable assets?

In this case, the fair value of the gross assets acquired is not substantially all concentrated in a group of similar identifiable assets.


Business Combination? Asset deal?

Family homes

Corporate office

Consideration paid for family

homes

Consideration paid for corporate

offices

Concentration test NOTsatisfied

To further assess based on

requirements of IFRS 3

Acquired assets

• 10 Single family homes each with in-placed lease, including:• Land• Building • Property improvement

• A 10-storey office buildings that are fully leased

• Each family home is in similar location and has similar customers (tenants)

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INPUT PROCESS OUTPUT

Must be SUBSTANTIVE

More weight on WORKFORCE

An acquired contract is an input & not a substantive

process, but it may give access to workforce

e.g. workforce may be “ACQUIRED” through indirect

acquisition (e.g. hidden contract that

comes along)

Restrict to goods and services to customers

OR

Investment or other income from ordinary activities

Input together with substantive

process is a minimum

requirement for business

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AcquireeHAVE OUTPUTSat date of acquisition

IFRS 3.B12C

AcquireeDOES NOT HAVE

OUTPUTSat date of acquisitionIFRS 3.B12A + B12B

Additional guidance oncontract and workforce

(for all cases with or without output)

IFRS 3.B12D

IFRS 3 detailed assessment - whether an acquired process is substantive (IFRS 3.B12A to B12D)



Amendments to IFRS 9, IAS 39 and IFRS 7 Interest Rate Benchmark Reform

73


Amendments to IFRS 9, IAS 39 and IFRS 7 Interest Rate Benchmark Reform

Background

• Interest rate benchmarks such as interbank offered rates play akey role in global financial markets and index trillions of dollars infinancial products.• Fundamental reviews of benchmark interest rates have been

undertaken by various jurisdictions to seek for alternative risk-freerates to replace the existing interest rate benchmarks.

Issue

• The interest rate benchmark reforms led to uncertainty of existinginterest rate benchmarks. In particular, the uncertainty potentiallyimpacts hedge accounting as the interest rate benchmark onwhich both the hedged item and hedging instrument are basedmay be altered as well as the existing hedge relationships.

The amendments

• Modifies specific hedge accounting requirements to that entitieswould apply those hedge accounting requirements assuming that theinterest rate benchmark on which the hedged cash flows and cashflows from the hedging instrument are based will not be altered as aresult of interest rate reform.• Requires specific disclosures about the extent to which the entities’

hedging relationships are affected by the amendments• Provides additional amendments regarding the uncertainty arising

from the interest rate benchmark reform.

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