Investment Property - Nelson CPA

1 Investment Property (HKAS 40). 19 March 2007. Nelson Lam . MBA MSc BBA ACA CFA CPA(Aust). CPA(US) FCCA FCPA(Practising). 2005-07 Nelson 1. Before HKAS 40 . Case Case Accounting policy (2004/05) on buildings: The cost of construction of the Duke of Windsor Social Service Building the Building has been written down to a nominal value of HK$1. The Council hires out meeting rooms and auditorium in the Building to third parties and lease out some portion of usable floor area to certain bodies approved by the Government. Income derived from hiring meeting rooms and auditorium and leasing out usable floor area have been accounted for in the statement of operations as hiring fees, rental and management fee income. Is it Investment Property ? 2005-07 Nelson 2. 1. Before HKAS 40 . Case Case MTR Corporation Ltd. stated: The adoption of HKAS 40 would require all revaluation gains or losses of Investment properties to be taken directly to the profit and loss account .. The volatility of Property prices therefore could have significant impact on the level and consistency of the Company's future operating profits.

2 (2004 Annual Report). 2005-07 Nelson 3. Cases First . Case Case For year ended 31 Dec. 2004 2005 2006. HK$'M HK$'M HK$'M. Turnover 1,154 1,250 1,268. Profit before tax 783 5,176 3,798. 27%. 27%. 561%. 561%. After crediting: Fair value changes on Investment properties - 4,226 2,576. Profit is constantly higher than the revenue! 2005-07 Nelson 4. 2. Cases First . Case Case What if 2006 . For year ended 30 Dec. 2004 2005 2006. HK$'M HK$'M HK$'M. Turnover 5,257 2,275 4,764. Gross profit 959 785 924. Profit before tax 1,705 7,384 9,063. After crediting: Fair value changes on Investment properties - 4,977 6,921. Profit is also constantly higher than the revenue! 2005-07 Nelson 5. Today's Agenda HKAS. HKAS40. 40. HK(SIC). HK(SIC)Interpretation Interpretation21. 21. Application Applicationof ofHKAS. HKAS40. 40in inHK. HK. Simple Simple but but Comprehensive Comprehensive Recap Recap and and key key issues issues Real Real Life Life Cases Cases and Examples and Examples 2005-07 Nelson 6.

3 3. From SSAP 13 to HKAS 40 - Summary 1. Scope Exemption to certain companies removed 2. Definitions Redefine Investment Property Introduce owner-occupied Property 3. Recognition and Same recognition principle applied to all Measurement at costs (aligned with HKAS 16). Recognition Measurement of assets from exchange of assets introduced (aligned with HKAS 16). 4. Measurement Introduce cost model, chosen between fair after recognition value model Fair value model refined 5. Transfers Transfer requirements are similar to those in SSAP 17 PPE before 6. Disposals Introduce new requirements 7. Disclosure Detailed disclosure required, including fair value of Investment Property 2005-07 Nelson 7. 1. Scope Exemption Removed Exemption for some entities eliminated The exemption in SSAP 13 for Implies that all these entities are certain insurance companies required to apply HKAS 40 from and charitable, government the financial period beginning subvented and not-for-profit from 1 Jan.

4 2005. organisations was eliminated in Specific transitional provisions HKAS 40. for this elimination additionally introduced in Nov. 2005. Insurance co., not-for- More profit entities More to to be be must follow discussed discussed later later .. 2005-07 Nelson 8. 4. 2. Definitions Revised Amended and clearer definition on an Investment Property SSAP 13. An Investment Property is an interest in land and/or buildings: a) in respect of which construction work and development have been completed; and b) which is held for its Investment potential, any rental income being negotiated at arm's length HKAS 40. Investment Property is Property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: a) use in the production or supply of goods or services or for administrative purposes; or b) sale in the ordinary course of business 2005-07 Nelson 9. 2.

5 Definitions Revised Amended and clearer definition on an Investment Property Examples SSAP 13 of Investment Property under HKAS 40 include: An Investment Property leasedproperty out underis an interest leases operating in land and/or buildings: a) in respect of which construction work Property held for long-term capital appreciation and development have been completed; and Property held for a currently undetermined future use b) which is held for its Investment potential, any rental income Vacant Property being to be leased negotiated at arm'sout under operating leases length HKAS 40. Investment Property is Property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: a) use in the production or supply of goods or services or for administrative purposes; or b) sale in the ordinary course of business How's about Property held by the lessee under an operating lease?

6 2005-07 Nelson 10. 5. 2. Definitions Extend to Operating Leases A Property interest that is held by a lessee under an operating lease may be classified and accounted for as An entity has a choice Investment Property if, and only if the Property would otherwise meet the definition of an Investment Property and the lessee uses the Fair Value Model This classification alternative is available on a Property -by- Property basis However, once this classification alternative is selected for one such Property interest held under an operating lease, all properties classified as Investment Property shall be accounted for using the Fair Value Model Simple? Simple? Let's Let's How's about term term this classification thisheld Property classification as as by the lessee under Operating Operating an operating lease?Lease Lease IP IP Alternative Alternative . 2005-07 Nelson 11. 2. Definitions Extend to Operating Leases Example Example Entity GV has 3 properties as follows: Leasehold Property A.

7 Leasehold Property B. Freehold Property C. All the properties are held to earn rental. What is the implication of HKAS 40 on its properties? Property PropertyCCisisan aninvestment investmentproperty propertyunder underHKAS. HKAS40 40and andGV GVmust mustuseuse HKAS 40 to account for HKAS 40 to account for itit Property PropertyAAandandBBare arenot notinvestment investmentproperty propertyunder underHKAS. HKAS40. 40. However, However, GV can choose to account for either A or Bor GV can choose to account for either A or B orboth bothasas Investment investmentproperty propertyunder underHKAS. IfIfProperty PropertyAAand andBBare arenot notaccounted accountedforforunder underHKAS. HKAS40,40,they theywill willbe be accounted accountedforforunder underHKAS. HKAS17. 17. Measurement MeasurementunderunderHKAS. HKAS40 40 ..totobe bediscussed discussedlater. later. 2005-07 Nelson 12. 6. 2. Definitions Owner-Occupied Property Introduce a new term, owner-occupied Property Defined as a Property held (by the owner or by the lessee under a finance lease) for use in the production or supply of goods or services or for administrative purposes In substance, a Property under HKAS 16.

8 Being one of the examples that is NOT an Investment Property 2005-07 Nelson 13. 2. Definitions Owner-Occupied Property Example Example Examples that are NOT Investment Property include: Which HKAS? Owner-occupied Property HKAS 16 & 17. Property (completed or under development) intended for sale in the ordinary course of business HKAS 2. Property being constructed or developed for third parties HKAS 11. Property leased out under finance lease HKAS 17. Property that is being constructed or developed for future use as Investment Property HKAS 16 & 17. How's the classification for existing Investment Property being redeveloped for continued future Still Still Investment Investment Property Property use as Investment Property ? 2005-07 Nelson 14. 7. 2. Definitions Owner-Occupied Property Case Case Annual Report 2004 stated that: Investment and hotel properties with an unexpired lease term of more than 20 years are included in the balance sheet at their open market value.

9 It is the group's practice to maintain hotel properties such that the residual values result in depreciation being insignificant. The related maintenance expenditure is dealt with in the income statement in the year in which it is incurred. Hotel furniture and fixtures is included in other fixed assets and is depreciated. 2005-07 Nelson 15. 2. Definitions Owner-Occupied Property Refer back to HKAS 16 for definition of Property , plant and equipment Property , plant and equipment are tangible items that: a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and b) are expected to be used during more than one period. Both for rental, how to distinguish? Investment Investment For example, how to distinguish: Property Property A flat leased out for rental Owner-occupied Owner-occupied A hotel Property Property Extent of Ancillary Cash Flow Services 2005-07 Nelson 16. 8. 2. Definitions Owner-Occupied Property One of the key indicators in determining the Cash Flow classification between Investment Property and owner-occupied Property Investment Investment Owner-occupied Owner-occupied Property Property Property Property held to earn rentals or for the production or supply of capital appreciation or both goods or services (or the use therefore, generates cash of Property for administrative flows largely independently purposes).

10 Of the other assets held by generates cash flows that are an entity. attributable not only to Property , but also to other assets used in the production or supply process 2005-07 Nelson 17. 2. Definitions Owner-Occupied Property Extent of Ancillary provided by an entity to Cash Flow Services the occupants of a Property it holds is also considered Ancillary Investment services Investment Ancillary services Investment Property Significant Owner-occupied Significant ancillary Owner-occupied ancillary not notProperty significant Property significant owner-occupied Property services Property services provided Property provided a owner-managed hotel is not an Investment Property If owner-managed hotel was classified as Investment Property before 2005, it should be reclassified as Property , plant and equipment (HKAS 16) or lease (HKAS 17). Significant Significant impact impact on on hotel hotel group group 2005-07 Nelson 18. 9. 2. Definitions Owner-Occupied Property It may be difficult to determine whether ancillary services are so significant that a Property does not qualify as Investment Property for example, there may be a spectrum from one end to another: Ancillary Ancillary services services How to determine those in Significant Significant ancillary ancillary not not significant significant between these 2 ends?