Module 11
Financial Reporting
Answers
The suggested answers are longer than what candidates are expected to give in the examination.
The purpose of the suggested answers is meant to help candidates in their revision and learning.
The suggested answers may not contain all the correct points and candidates should note that
credit will be awarded for valid answers which may not fully covered in the suggested answers.
SECTION A – CASE QUESTIONS (Total: 50 marks)
Answer 1(a)(i)
HKFRS 3 Business Combinations states that the identifiable assets acquired and the liabilities
assumed as part of a business combination are recognised separately from goodwill at the date of
acquisition, if they:
meet the definition of assets and liabilities in the Conceptual Framework, and
are exchanged as part of the business combination, instead of as a separate transaction.
These items, in general, are measured at the date of acquisition at their fair values.
As the fair value of the recorded net identifiable assets of Peony was close to its book value
(Q$20,000,000 + Q$28,000,000 = Q$48,000,000) as at the acquisition date, the critical question is
whether the ongoing research project, Project IV, should be recognised in the business
combination.
In a business combination, an acquirer recognises an acquiree's intangible assets at the acquisition
date if they are identifiable. An asset is identifiable if it is either separable or arises from
contractual or other legal rights.
In a business combination, the cost of an intangible asset is its fair value at the acquisition date.
The fair value of an intangible asset reflects market participants’ expectations at the acquisition
date about the probability that the expected future economic benefits embodied in the asset will
flow to the entity. In other words, the entity expects there to be an inflow of economic benefits
even if there is uncertainty about the timing or the amount of the inflow. Therefore, the probability
recognition criterion is always considered to be satisfied for intangible assets acquired in business
combination.
If an intangible asset acquired in a business combination is separable or arises from contractual or
other legal rights, there is a presumption that sufficient information exists to measure reliably the
fair value of the asset.
In Peony's case, Project IV was expensed as incurred in Peony's financial statements as it could
not demonstrate that an intangible asset existed which would generate probable future economic
benefits. However, in the business combination, such probability assessment has been neglected
in recognising Project IV. While the ongoing research project did not arise from a contractual or
legal right, Project IV could be transferred independently of the rest of the business. As the
separability criterion was met, Project IV was identifiable, and it should be recognised as an
intangible asset in this business combination at its fair value (i.e., Q$3,000,000).
The fair value of net identifiable assets of Peony in this business combination as at 1 October 2022
was Q$51,000,000 (Q$48,000,000 + Q$3,000,000 Project IV).
Module 11 (December 2023 Session) Page 1 of 20
Answer 1(a)(ii)
The consideration transferred should be measured at fair value. The key issue here is to
determine whether the reimbursement of the acquisition-related costs is part of the business
combination transaction.
HKFRS 3 states that a transaction entered into by or on behalf of the acquirer, or primarily for the
benefit of the acquirer (or combined entity), rather than primarily for the benefit of the acquiree
before the combination, is likely to be a separate transaction. An acquirer is specifically required
to determine whether any portion of the amounts transferred by the acquirer relate to transactions
other than the acquisition of a business that should be accounted for separately from the
consideration exchanged for the acquiree and the assets acquired and liabilities assumed in the
business combination.
In this case, Peony paid the financial and legal due diligence costs, which are considered as
acquisition-related costs in the Acquisition, on behalf of Orchid. As it should have been the
responsibility of Orchid, in economic substance, to pay for such acquisition-related costs, the
reimbursement of such costs should be considered as a separate transaction.
In accordance with HKFRS 3, acquisition-related costs incurred by an acquirer to effect a business
combination are not part of the consideration transferred. HKFRS 3 requires such costs to be
accounted for as an expense in the period incurred, unless such costs are incurred to issue debt
or equity securities. Orchid could not avoid expensing Q$200,000, translated into HK$ using the
spot exchange rate as at the date of transaction, in its separate financial statements:
HK$'000 HK$'000
Dr. Acquisition-related expense (P/L)
(Q$200,000 x 4.5) 900
Cr. Cash 900
It should be noted that the debt issue costs of the Convertible Bonds
(if any) should also be regarded as acquisition-related costs. Such debt issue costs, again, should
not be part of the consideration transferred. Instead, these costs should be recognised in the
statement of financial position as a reduction from the initial carrying amount of the debt and
amortised as interest expense over the three years, if the liability is measured at amortised cost.
The consideration transferred for the Acquisition should then exclude the reimbursement of
acquisition-related costs and should be Q$41,460,000 (Q$41,660,000 – Q$200,000).
Module 11 (December 2023 Session) Page 2 of 20
Answer 1(b)
Goodwill as at 31 March 2023 = HK$2,772,000 (W4)
Foreign currency translation reserve as at 31 March 2023
= (HK$15,740,000) (W3) – HK$900,000 (CJ2) – HK$198,000 (CJ3) + HK$3,148,000 (CJ5) +
HK$180,000 (CJ5)
= (HK$13,510,000)
Non-controlling interest as at 31 March 2023
= HK$45,900,000 (W1) + HK$5,896,000 (CJ4) – HK$3,148,000 (CJ5) – HK$180,000 (CJ5)
= HK$48,468,000
Orchid calculated the goodwill in the Acquisition, on 1 October 2022, as follows:
Q$'000 Rate HK$'000
Consideration 41,460 4.5 186,570
Add: Non-controlling interest 10,200 4.5 45,900
Total 232,470
Less: Fair value of net identifiable assets
Book value of recorded net identifiable asset 48,000 4.5 216,000
Intangible asset – Project IV 3,000 4.5 13,500
51,000 4.5 229,500
Goodwill as at 1 October 2022 2,970
Module 11 (December 2023 Session) Page 3 of 20
Alternatively, candidates may present their answers in the form of consolidation adjustment journal entries:
CJ1: Pre-acquisition elimination entries HK$'000 HK$'000
Dr. Share capital (Q$20,000K x 4.5) 90,000
Dr. Retained earnings
(Q$28,000K x 4.5) 126,000
Dr. Intangible assets – Project IV
(Q$3,000K x 4.5) 13,500
Dr. Goodwill (W2) 2,970
Cr. Investment
[(Q$41,660K – Q$200K) x 4.5] 186,570
Cr. Non-controlling interest (B/S) (W1) 45,900
(W1): Non-controlling interest as at the acquisition date
HK$'000
Share capital 90,000
Retained earnings 126,000
Fair value adjustments – Project IV 13,500
Fair value of net identifiable assets 229,500
Proportionate share to non-controlling interest 20%
45,900
(W2): Goodwill HK$'000
Consideration [(Q$41,660K – Q$200K) x 4.5] 186,570
Non-controlling interest (W1) 45,900
232,470
Less: Fair value of net identifiable assets (W1) (229,500)
Goodwill 2,970
(W3): Translation of financial statements of the foreign subsidiary
Statement of financial position as at 31 March 2023
Peony Peony
Q$'000 Rate HK$'000
ASSETS
Total assets 68,300 4.2 286,860
EQUITY AND LIABILITIES
Share capital 20,000 4.5 90,000
Retained earnings, 1 October 2022 28,000 4.5 126,000
Add: Profit for the period 6,700 4.4 29,480
Retained earnings, 31 March 2023 34,700 155,480
Foreign currency translation reserve - Balancing figure (15,740)
Total liabilities 13,600 4.2 57,120
Total equity and liabilities 68,300 286,860
Module 11 (December 2023 Session) Page 4 of 20
HK$'000 HK$'000
CJ2: Update the fair value difference
using closing rate
Dr. Foreign currency translation 900
reserve
[Q$3,000K x (4.5 – 4.2)]
Cr. Intangible assets – Project IV 900
HK$'000 HK$'000
CJ3: Retranslation of goodwill
Dr. Foreign currency translation reserve 198
Cr. Goodwill (W4) 198
(W4): Translation loss
Q$'000 Rate HK$'000
Goodwill, 1 October 2022 660 4.5 2,970
Goodwill, 31 March 2023 660 4.2 2,772
(198)
HK$'000 HK$'000
CJ4: Share of profits to
non-controlling interest
Dr. Non-controlling interest (P/L) 5,896
Cr. Non-controlling interest (B/S) 5,896
(Q$6,700K x 20% x 4.4)
HK$'000 HK$'000
CJ5: Share of translation reserve to
non-controlling interest
Dr. Non-controlling interest (B/S) 3,148
(HK$15,740K (W3) x 20%)
Cr. Foreign currency translation 3,148
reserve (HK$15,740K (W3) x 20%)
Dr. Non-controlling interest (B/S) 180
(HK$900K (CJ2) x 20%)
Cr. Foreign currency translation 180
reserve (HK$900K (CJ2) x 20%)
Module 11 (December 2023 Session) Page 5 of 20
Answer 2(a)
In accordance with HKFRS 15 Revenue from Contracts with Customers, a contract is an
agreement between two or more parties that creates enforceable rights and obligations.
A contract exists when all of the following conditions are met:
The parties to the contract have approved the contract and are committed to performing their
respective obligations;
The entity can identify each party's rights regarding the goods or services to be transferred;
The entity can identify the payment terms for the goods or services to be transferred;
The contract has commercial substance; and
It is probable that the entity will collect the consideration to which it will be entitled in
exchange for the goods or services that will be transferred to the customer.
Rudbeckia is a customer of Peony with reference to the definition of customer in HKFRS 15.
Generally, for a contract to exist with a customer, the terms and conditions in the agreement should
have identified specific (or minimum) quantities to be purchased and/or guarantee minimum
contractual consideration. The Agreement only set the general terms and conditions and did not
establish minimum quantities of the Parts Auto to be purchased. Separate purchase orders would
be raised subsequently, and the Parts Auto would be priced accordingly. No enforceable rights
and obligations arose in relation to the Parts Auto on 1 November 2022, and therefore no contract
existed for the specialised parts upon signing the Agreement.
Regarding the E&D activities, the Agreement was approved on 1 November 2022 by both Peony
and Rudbeckia. Peony could identify each party’s rights as Peony has to conduct the E&D
activities and Rudbeckia has to compensate for such services. Further, the termination clause in
the Agreement guaranteed compensation for such services even if Rudbeckia terminates the
contract. The Agreement has commercial substance, as it will alter the entity's timing and amount
of future cash flows. As Rudbeckia has been a financially-sound car manufacturer, coupled with
the past collection history of Rudbeckia, it is probable that Peony would collect the consideration.
A contract therefore existed for the E&D services upon signing the Agreement.
Module 11 (December 2023 Session) Page 6 of 20
Answer 2(b)
HKFRS 15 requires an entity to assess the goods or services promised in a contract with a
customer and to identify as a performance obligation each promise to transfer to the customer a
good or service that is distinct. A good or service that is promised to a customer is distinct if both
of the following criteria are met:
The customer can benefit from the good or service either on its own (or together with other
resources that are readily available to the customer). In other words, the good or service is
capable of being distinct; and
The entity's promise to transfer the good or service to the customer is separately identifiable
from other promises in the contract. In other words, the promise to transfer the good or
service is distinct within the context of the contract.
The two promises (i.e., the E&D services and the supply of the customised prototype) are capable
of being distinct. Rudbeckia could benefit from the intellectual property generated by the E&D
activities using readily available production services offered by other suppliers. Further, Peony
can produce the prototype using the intellectual property it has already transferred to Rudbeckia.
Peony has been providing a significant service of integrating the E&D activities and the prototype,
specifically, it uses the E&D services as inputs to produce the customised prototype of the Parts
Auto specified by Rudbeckia. Further, the outcome of the E&D processes determines to a great
extent the structure of the prototype. The E&D activities and the prototype are highly
interdependent. The two promises are not distinct within the context of the contract.
The pre-production E&D activities and the supply of the customised prototype is therefore likely to
be a single performance obligation.
Module 11 (December 2023 Session) Page 7 of 20
Answer 3
Integrated reporting promotes a different way of thinking from the traditional reliance on financial
capital. An expenditure for research and development needs to fulfil a list of requirements in
HKAS 38 Intangible Assets for capitalisation. Therefore, under traditional financial reporting, such
expenditures may have limitations to be reflected on the statement of financial position.
Integrated reporting believes that what makes an organisation successful should rely on a much
broader set of capitals, including other than financial capitals, manufactured, human, social and
relationship, natural, and intellectual capitals.
Among the six capitals, the disclosure of intellectual capitals as non-financial information can
supplement the financial reporting of research and development activities. Intellectual capitals
represent the intangibles associated with brand and reputation as well as patents, copyrights,
organisational systems and related procedures.
(Acceptable answer: Human capital – skills and know-how of an organisation's personnel, and their
commitment and motivation that affect their ability to fulfil their roles.)
Integrated reporting provides insights into the company's strategy, and how it relates to the creation
of value in the short, medium and long term, and its use of, and effects on, the capitals.
Specifically, in this case, integrated reporting can describe the Orchid Group's business model in
its devotion to research activities, demonstrating how it draws on intellectual capital inputs and how
its business activities within its business model transform such intellectual capital inputs into
outputs over the short, medium and long term.
Module 11 (December 2023 Session) Page 8 of 20
Answer 4
HKAS 32 Financial Instruments: Presentation states that a financial liability includes a liability that
is a contractual obligation to deliver cash to another entity. It also includes a liability that is a
contract that will (or may) be settled in the entity's own equity instruments and is:
a non-derivative for which the entity is (or may be) obliged to deliver a variable number of
the entity’s own equity instruments; or
a derivative that will (or may be) settled other than by the exchange of a fixed amount of
cash for a fixed number of the entity’s own equity instruments.
On the other hand, an equity instrument, with reference to HKAS 32, should fulfil the following two
conditions:
the instrument includes no contractual obligation to deliver cash to another entity; and
if the instrument will (or may) be settled in the issuer's own equity instruments, it is (i) a non-
derivative that includes no contractual obligation for the issuer to deliver a variable number
of its own equity instruments; or (ii) a derivative that will be settled only by the issuer
exchanging a fixed amount of cash for a fixed number of its own equity instruments.
Orchid has an unavoidable contractual obligation to pay cash as it is required to pay an annual
cash coupon of 3% p.a. and could be required to repay the principal amount at the end of three
years if the holder chooses not to exercise the conversion option. The Convertible Bonds in
question therefore include a financial liability.
Yet, the holders of the Convertible Bonds have the ability to convert into Orchid’s ordinary shares.
The key issue is then whether the conversion option meets the "fixed-for-fixed" requirement in
HKAS 32. It is therefore important for Orchid to evaluate the terms of the Convertible Bonds, in
particular the conversion terms, to determine whether the Convertible Bonds contain both a liability
and an equity component based on the definitions of liability and equity above.
"Fixed-for-fixed" requirement met
The "fixed-for-fixed" requirement is met if, for example, the Convertible Bonds are denominated in
the same functional currency of the issuer (i.e., in HK$) and grant the holders the right to convert it
into a fixed number of ordinary shares of Orchid.
The Convertible Bonds should then be regarded as a compound instrument. HKAS 32 states that
a compound instrument comprises two components: a financial liability and an equity instrument.
On initial recognition of the Convertible Bonds, the liability component is measured first, and the
difference between the proceeds of the bond issue and the fair value of the liability is assigned to
the equity component as the residual. The fair value of the liability component is the present value
of the contractually determined stream of future cash flows discounted at the rate of interest applied
at that time by the market for similar bonds but without the conversion option. Orchid would then
present the liability and equity components separately in its statement of financial position.
Module 11 (December 2023 Session) Page 9 of 20
"Fixed-for-fixed" requirement is not met
The "fixed-for-fixed" requirement is not met if, for example, the Convertible Bonds are converted
into a variable number of ordinary shares of Orchid (say, the number of shares to be issued on
conversion is calculated using the share price at maturity). Another common example where the
conversion feature fails the equity classification is that the Convertible Bonds are denominated in
a foreign currency (say in Q$). Even though the issue and repayment amount in foreign currency
may be fixed, when converted back to the entity's functional currency it results in a variable amount
of cash arising from changes in exchange rates.
The Convertible Bonds should then be regarded as a hybrid contract. A hybrid contract is one
that includes a non-derivative host and an embedded portion.
The conversion feature, failing the "fixed-for-fixed" requirement, is classified as a financial liability
which meets the definition of a derivative. In other words, the Convertible Bonds include a host
debt contract and an embedded derivative liability.
On initial recognition of the Convertible Bonds, the embedded option-based financial liability (i.e.
the conversion feature) are typically accounted for separately from the host debt instruments,
because the economic characteristics and risks of the conversion feature (i.e., its fair value being
affected by changes in the fair value of the issuer's shares) are not closely related to the host
contract (i.e., its fair value not being affected by changes in the fair value of the issuer's shares).
In accordance with HKFRS 9 Financial Instruments, the fair value of the embedded derivative is
measured first, and the residual value is assigned to the debt host liability. In this case, there is
no separation of liability and equity components on Orchid’s statement of financial position.
* * * END OF SECTION A * * *
Module 11 (December 2023 Session) Page 10 of 20
SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)
Answer 5(a)
Sid made the following claims regarding the accounting treatment of investment properties:
(i) investment properties at fair value do not need to be depreciated or to go through impairment
tests; and
(ii) valuation surplus on revaluation of investment properties would only be charged to profit or
loss on disposal.
According to HKAS 40 Investment Properties para. 33, after initial recognition, an entity that
chooses the fair value model shall measure all its investment property at fair value, except in the
cases described in para. 53.
A gain or loss arising from a change in the fair value of an investment property shall be recognised
in profit or loss for the period in which it arises.
Based on the above, when investment properties are recorded at fair value, it is true that the
reporting entity does not need to consider depreciation and impairment. The property will be
stated at fair value at the date of reporting with all gains and losses arising from change in the fair
value going to profit or loss in the period in which they arise.
Therefore, I agree with Sid on (i) above, but disagree with him on (ii).
Sid made the following claims in regard to the accounting treatment of PPE:
(iii) PPE at fair value do not need to be depreciated or go through impairment tests; and
(iv) valuation surplus on revaluation of PPE would only go to profit or loss on disposal.
Following HKAS 16 Property, Plant and Equipment para. 31, if an item of PPE is measured using
the revaluation model, then it will be stated at fair value at the date of the revaluation less any
subsequent accumulated depreciation and subsequent accumulated impairment losses.
The revaluation surplus included in equity in respect of an item of PPE may be transferred directly
to retained earnings when the asset is derecognised. This may involve transferring the whole of
the surplus when the asset is retired or disposed of. However, some of the surplus may be
transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred
would be the difference between depreciation based on the revalued carrying amount of the asset
and deprecation based on the asset's original cost. Transfers from revaluation surplus to retain
earnings are not made through profit or loss. [HKAS 16.41]
Accordingly, if the reporting entity is applying the revaluation model to PPE, then the relevant items
are still subject to depreciation and impairment. And on disposal, there will not be transfer of
accumulated revaluation surplus to profit or loss. It will be directly transferred to retained earnings
either as a whole or over the life of the asset.
Module 11 (December 2023 Session) Page 11 of 20
Under HKAS 16 para. 39, if an asset's carrying amount is increased as a result of a revaluation,
the increase shall be recognised in other comprehensive income and accumulated in equity under
the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to
the extent that it reverses a revaluation decrease of the same asset previously recognised in profit
or loss.
As a result, if there had been revaluation decrease of the asset in profit or loss, the increase in
carrying amount resulting from revaluation would also go to profit or loss even when the item is not
yet disposed of.
Therefore, I disagree with Sid on (iii) and (iv).
Answer 5(b)
I disagree with Sid that IP should be grouped under Level 1.
Under HKFRS 13 Fair Value Measurement Appendix A, Level 1 inputs are quoted prices
(unadjusted) in active markets for identical assets or liabilities that the entity can access at the
measurement date.
Level 2 are inputs other than quoted prices included within Level 1 that are observable for the asset
or liability, either directly or indirectly. The inputs are based on market data obtained from sources
independent of the reporting entity. Such inputs must be observable for substantially the full term
of the asset.
Level 3 inputs would be unobservable inputs for the asset or liability for which market data are
not available and which are developed using the best information available about the assumptions
that market participants would use when pricing the asset.
Level 1 is unlikely to be applicable to real estate investments as it is difficult to imagine
circumstances where multiple identical properties could exist. Above all, two properties cannot
share the exact same location. Consequently, estimating the fair value of an investment property
typically requires a range of methodologies, input, and adjustments to reflect the wide range of
factors that contribute towards the value of a property, e.g., state and condition, location, in-place
leases, development potential, and infrastructure.
It is likely that the valuation will fall within the Level 3 category, unless there are frequent sale
transactions of properties of a similar nature, location, and characteristics such that significant
adjustments are not required.
To achieve a Level 2 classification, management and valuation experts will have to provide
objective evidence that all significant assumptions are based on recent and relevant market
transactions.
Module 11 (December 2023 Session) Page 12 of 20
Answer 5(c)
According to HKAS 33 Earnings per share para. 64, if the number of ordinary shares outstanding
increases as a result of a share split, the calculation of basic and diluted earnings per share for all
periods presented shall be adjusted retrospectively. If these changes occur after the reporting
period but before the financial statements are authorised for issue, the per share calculations for
those and any prior period financial statements presented shall be based on the new number of
shares. The fact that per share calculations reflect such changes in the number of shares shall
be disclosed.
Therefore, if RLL's financial statements were authorised for issue on 28 February 2023, (i.e., after
the one-to-four share split on 14 February 2023), even though the share split took place after 31
December 2022 (the end of the financial period), the basic and diluted earnings per share for all
periods presented (i.e., current and all prior periods presented) need to be adjusted retrospectively.
In addition, the fact that per share calculations reflect such changes in the number of shares shall
be disclosed.
Module 11 (December 2023 Session) Page 13 of 20
Answer 6(a)
From: Asuka Chan
To: Elizabeth Lung
Subject: Accounting Treatment of arrangements with LL
Dear Elizabeth,
Thank you for your message. Further to your earlier email I have set out below my comments for
your consideration.
Under HKFRS 16 Leases ("HKFRS 16") Appendix A, a lease is a contract, or part of a contract,
that conveys the right to use an asset (the underlying asset) for a period of time in exchange for
consideration.
According to HKFRS 16 paras. 9 and B9, to assess whether a contract conveys the right to control
the use of an identified asset for a period of time, an entity shall assess whether, throughout the
period of use, the customer has both of the following:
(a) the right to obtain substantially all of the economic benefits from use of the identified asset;
and
(b) the right to direct the use of the identified asset.
If the customer has the right to control the use of an identified asset for only a portion of the term
of the contract, the contract contains a lease for that portion of the term. [HKFRS 16 para. B10]
An asset is typically identified by being explicitly specified in a contract.
However, an asset can also be identified by being implicitly specified at the time that the asset is
made available for use by the customer. [HKFRS 16 para. B13]
Even if an asset is specified, a customer does not have the right to use an identified asset if the
supplier has the substantive right to substitute the asset throughout the period of use. A supplier's
right to substitute an asset is substantive only if both of the following conditions exist:
(a) the supplier has the practical ability to substitute alternative assets throughout the period of
use (for example, the customer cannot prevent the supplier from substituting the asset, and
alternative assets are readily available to the supplier or could be sourced by the supplier
within a reasonable period of time); and
(b) the supplier would benefit economically from the exercise of its right to substitute the asset
(i.e., the economic benefits associated with substituting the asset are expected to exceed
the costs associated with substituting the asset).
[HKFRS 16 para. B14]
Module 11 (December 2023 Session) Page 14 of 20
If the customer cannot readily determine whether the supplier has a substantive substitution right,
the customer shall presume that any substitution right is not substantive. [HKFRS 16 para. B19]
A capacity portion of an asset is an identified asset if it is physically distinct (for example, a floor of
a building). A capacity or other portion of an asset that is not physically distinct (for example, a
capacity portion of a fibre optic cable) is not an identified asset, unless it represents substantially
all of the capacity of the asset and thereby provides the customer with the right to obtain
substantially all of the economic benefits from use of the asset. [HKFRS 16 para. B20]
A customer has the right to direct the use of an identified asset throughout the period of use only if
either:
(a) the customer has the right to direct how and for what purpose the asset is used throughout
the period of use; or
(b) the relevant decisions about how and for what purpose the asset is used are predetermined
and:
(i) the customer has the right to operate the asset (or to direct others to operate the asset
in a manner that it determines) throughout the period of use, without the supplier having
the right to change those operating instructions; or
(ii) the customer designed the asset (or specific aspects of the asset) in a way that
predetermines how and for what purpose the asset will be used throughout the period
of use.
[HKFRS 16 para. B24]
Protective rights typically define the scope of the customer’s right of use but do not, in isolation,
prevent the customer from having the right to direct the use of an asset. [HKFRS 16 para. B30]
Overall
The arrangement involves a contract between SL and LL, be it in the Master Agreement or further
supplementary agreement, over a period of two years in exchange for specified consideration.
The key consideration would be whether each of the arrangements below conveys the right to use
an asset as further discussed below.
The requirements that SL can only use the space during specific hours only set the boundaries of
when the assets can be used, and the need to restore the facilities after use, is protective at most.
They do not have an impact on the consideration in determining whether the arrangements contain
a lease.
Hot desks for individual tuition services
As there are many desks on the premise, when students enter, the desks that they use would not
be implicitly specified.
Module 11 (December 2023 Session) Page 15 of 20
As the asset is not explicitly or implicitly specified and the students can sit anywhere in the premise
any time, the contract does not convey the right to control the use of an identified asset. Therefore,
I agree with you that it does not contain a lease.
Spaces for short-term events
LL has only one meeting room that meets SL's need to run seasonal events and the supplementary
agreement will also specify the room. There is also no substantive substitution right as it is
impossible for replacement.
Therefore, there is an identified asset.
During the 2-month period, the room is exclusively used by SL for its own purposes, so they have
control over the use of the meeting room and direct how they want to use it to obtain substantially
all of the economic benefits.
Therefore, I differ from your view. This arrangement contains a lease.
Even when SL only has control of the use of the identified asset for a portion of the 2-year period,
the arrangement contains a lease for that portion of the term.
Designated rooms for recurring programmes
The contract explicitly specifies a designated room to be used by SL for its own purposes, i.e., the
contract contains an identified asset.
In addition, SL has exclusive use of the rooms to conduct their own courses – meaning they have
control over the use of the area, as they can direct how they want to use it to obtain substantially
all of the economic benefits.
Therefore, I have a different view from yours that this arrangement actually contains a lease.
This is based on the assumption that LL does not have substantive substitution rights of the rooms.
The fact pattern is silent in this regard. By virtue of HKFRS 16 para. B19, it is assumed any
substitution right is not substantive.
Module 11 (December 2023 Session) Page 16 of 20
Answer 6(b)
Treatment of considerations paid for hot desks for individual tuition services
Since there is no lease and there are no other financial reporting standards covering such
transactions, the amount payable for the use of the desks will be expensed as incurred.
I agree that the accounting consequence would be similar to what you described.
Treatment of considerations paid for spaces for short-term events
As short-term lease is a lease that, at the commencement date, has a lease term of 12 months or
less. A lease that contains a purchase option is not a short-term lease. [HKFRS 16 Appendix A]
Under HKFRS 16 para. 5(a), a lessee may elect not to apply the requirements in HKFRS 16 para.
22-49 to short-term leases.
If a lessee elects not to apply the requirements in paragraphs 22 - 49 to short-term leases, the
lessee shall recognise the lease payments associated with those leases as an expense on either
a straight-line basis over the lease term or another systematic basis. The lessee shall apply
another systematic basis if that basis is more representative of the pattern of the lessee's benefit.
[HKFRS 16 para. 6]
In this situation, the arrangement meets the definition of being a short-term lease as the use of the
meeting room is ad hoc, with each contract lasting 2 months and even cumulatively not expected
to exceed 12 months.
SL can elect to apply the practical expedient for short-term leases and recognise the payments as
an expense on either a straight-line basis over the lease term or another systematic basis, the basis
of which is more representative of the pattern of SL's benefit.
On this basis I agree that the accounting consequence could be similar to what you described.
Alternatively, SL can choose not to apply the practical expedient and recognise a lease liability at
the present value of the payments that are not yet paid, discounted at the interest rate implicit in
the lease.
Treatment of considerations paid for designated rooms for recurring programmes
According to HKFRS 16 para. 22, at the commencement date, a lessee shall recognise a right-of-
use asset and a lease liability.
At the commencement date, a lessee shall measure the lease liability at the present value of the
lease payments that are not paid at that date. The lease payments shall be discounted using the
interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be
readily determined, the lessee shall use the lessee's incremental borrowing rate. [HKFRS 16
para. 26]
Module 11 (December 2023 Session) Page 17 of 20
Under HKFRS 16 para. 36, after the commencement date, a lessee shall measure the lease liability
by:
(a) increasing the carrying amount to reflect interest on the lease liability;
(b) reducing the carrying amount to reflect the lease payments made; and
(c) remeasuring the carrying amount to reflect any reassessment.
SL should recognise a lease liability at the present value of the payments that are not yet paid,
discounted at the interest rate implicit in the lease. Therefore, I disagree that the payment would
be expensed as incurred.
I hope the above is clear. If you need any further clarifications, please do not hesitate to contact
me.
Regards,
Asuka
Module 11 (December 2023 Session) Page 18 of 20
Answer 7(a)
Both Ari and Jin have to comply with the fundamental principles of integrity, objectivity, professional
competence and due care, confidentiality, and professional behaviour as set out in 110.1 A1 of the
Code of Ethics for Professional Accountants (the Code).
Ari’s objectivity could be compromised if he allowed Jin's threats to influence his decision to go
back to review the presentation of the disclosures.
With Ari holding share-based payments over the company, there could be a conflict of interest that
could potentially impact his judgement.
If Ari eventually identifies something wrong with the disclosures and subsequently decides to let it
be, then his integrity would also be called into question.
If Ari decides to follow Jin's instructions, then he does not perform his duties with due care, as he
is supposed to provide professional service in preparing and examining the financials.
Threats that Ari needs to face when he complies with the Code include the following:
- A self-interest threat may be created, as Ari participates in the share-based payment scheme
offered by the Company.
- There could also be a self-review threat when there is an inclination to rely on and follow
previous years' approaches in preparing the financial statement without diligently reviewing
whether the disclosures remain relevant and the details remain complete, accurate, and in
compliance with relevant financial reporting standards.
- Ari could also be facing an intimidation threat if Jin is aggressive and exercises dominance
for the purpose of influencing Ari's judgement and decisions.
Ari may disclose the matter in line with the Company's policies, including ethics and whistleblowing
policies, using any established mechanism. If the Company has not taken appropriate action, Ari
may consult with another appropriate professional accountant, relevant professional body, or legal
counsel. (270.3 A4 of the Code).
In extreme situations where all available safeguards have been exhausted and it is not possible to
reduce the threat to an acceptable level, Ari shall refuse to be or remain associated with information
he determines is misleading and may conclude that it is appropriate to resign from the company
(200.8.A2 of the Code).
Module 11 (December 2023 Session) Page 19 of 20
Answer 7(b)
I agree with Ari that the draft operating segment disclosures would need to be modified for the
reasons further set out below.
According to HKFRS 8 Operating Segments para. 5, an operating segment is a component of an
entity:
(a) that engages in business activities from which it may earn revenues and incur expenses
(including revenues and expenses relating to transactions with other components of the same
entity);
(b) whose operating results are regularly reviewed by the entity's chief operating decision maker
to make decisions about resources to be allocated to the segment and assess its
performance; and
(c) for which discrete financial information is available.
The term "chief operating decision maker" identifies a function, not necessarily a manager with a
specific title. That function is to allocate resources to and assess the performance of the operating
segments of an entity. Often the chief operating decision maker of an entity is its chief executive
officer or chief operating officer, but, for example, it may be a group of executive directors or others.
[HKFRS 8 para. 7]
Based on the fact pattern provided, it appears that Jin, rather than the Executive Committee, is the
person that is responsible for allocating resources to and assessing the performances of the
operating segments of the Group. In other words, Jin is the chief operating decision maker.
By virtue of HKFRS 8 para. 5(b), the identification of operating segments of the Group should make
reference to what Jin reviews, as opposed to what the Executive Committee obtains.
Accordingly, for the purposes of year end reporting, GF would need to disaggregate the operating
segment information by geographical areas.
* * * END OF EXAMINATION PAPER * * *
Module 11 (December 2023 Session) Page 20 of 20