Accounting & Transaction Series: Selected Accounting Issues (IFRS)
December 2015
www.pwc.com/jp/e/tax
Paul Walters Asia-Pacific Real Estate Assurance Leader, PwC Hong Kong
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IFRS covered today – Hurray!!!!!!!!
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IAS 2 “Inventories”, IAS 16 “Property, plant and equipment and IAS 40 “Investment property” (all effective)
IFRS 15 “Revenue from contracts with customers” (effective for annual periods beginning on or after 1 January 2017)
IFRS 10 “Consolidated Financial Statements” (effective for annual periods beginning on or after 1 January 2013)
IAS 23 “Borrowing Costs”
Amendments to IFRS 10, IFRS 12 and IAS 27 “Investment Entities” - Exception to consolidation (effective for annual periods beginning on or after 1 January 2014)
IFRS 13 “Fair Value Measurement” (effective for annual periods beginning on or after 1 January 2013)
IFRS 7 “Financial Instruments: Disclosures”
New leases accounting standard
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Agenda
Overview of key RE concepts Section I. Accounting for real estate assets under IFRS Section II. Borrowing Costs
Updates on recent developments and key disclosures Section III. “Investment Entities” - Exception to consolidation Section IV. Disclosure of Interests in Other Entities Section V. Fair Value Measurement Section VI. Financial Risk Reporting Disclosure New IFRS relevant for RE Section VII. New leases standard Section VIII. Revenue from contracts with customers
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Section I
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Accounting for real estate assets under IFRS and firstly a quick overview for “non-IFRS users”
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Accounting for real estate assets
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What is investment property? IAS 40 definition has two key Components:
Property Held or PUD for Rental income
Investment Property Capital appreciation
Property
Owner Occupied (IAS 16 - PPE)
Investment Property Trading
(IAS 2 - Inventory)
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Accounting for real estate assets IAS 40 – Investment properties – policy choice
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Accounting (IAS 40 para 30 to 56)
Investment Property
Carry at FV or Cost?
Depreciation Fair Value model – no depreciation requirement. Cost model – depreciate in accordance with IAS 16. Disclose the depreciation methods used; useful lives or depreciation rate used; gross carrying amount and accumulated depreciation.
Subsequent valuation
Fair value as the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date. A gain or loss arising from a change in the fair value of investment property shall be recognised in profit or loss for the period in which it arises.
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Accounting for real estate assets IAS 40 – Investment properties – policy choice
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Disclosure (IAS 40 para 74 to 78)
Should disclose • FV model or Cost model • Reconciliation between the carrying amounts at the beginning and ending (FV model) • Fair value disclosure (Will be explained in Section IV for the details) • Reconciliation between the valuation obtained and the adjusted valuation (where
there are significant adjustment) • Amounts recognised in profit or loss • Amounts of restrictions on the realisability of investment property or the remittance
of income and proceeds of disposal • Contractual obligations to purchase, construct or develop investment property or for
repairs, maintenance or enhancements • Amounts and details of investment property not carried at fair value (Cost model) • Fair value of investment property
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Accounting for real estate assets
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Condition Measurement basis (IFRS)
Measurement basis (JGAAP)
Property under development (“PUD”)
Cost or Valuation choice
Acquisition costs of land and costs incurred in bringing property to present location and condition.
Cost less accumulated depreciation
Trading Property Lower of cost and NRV
Not depreciated
Lower of cost and NRV
Not depreciated
Owner Occupied Property
Cost or Revaluation choice Cost less Accumulated depreciation
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Section II
Borrowing Costs
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What are Borrowing Costs and Qualifying Assets?
- Borrowing costs are defined as “interest and other costs that an entity incurs in connection with the borrowing of funds”
- Qualifying assets are defined as “an asset that necessarily takes a substantial period of time to get ready for its intended use or sale”.
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An entity must capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. All other borrowing costs should be expensed in the period incurred.
JGAAP has the optionality as to be capitalized or expensed, but it should be capitalized under IFRS !
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Borrowing Costs – Capitalised or Expensed?
To be a Qualifying Asset, is there any bright line for determining the ‘substantial period of time’? 1
Are borrowing costs incurred on inter-company loans capitalised? 2
When does capitalisation cease if the construction is completed in phases and each phase can be operated separately?
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Section III
“Investment Entities” - Exception to consolidation
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Yes
Fair Value “Special Purpose Entities” holding RE operating companies
Power to control SPE’s return
Consolidate SPEs and operating companies
No
Decision Decision……
(Assumed Yes)
Are you an Investment Entity?
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Accounting for investment entities – treatment under IFRS 10
Investment property
Joint Venture 50%
Associate 21%
Investment Entity
Subsidiary 55%
Subsidiary 100% Investment Services to the Investment Entity
Consolidate!
FV model
FVTPL under
IFRS10
FVTPL under scope exclusion
IAS 31
FVTPL under scope exclusion
IAS 28
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MUST manage on a fair value basis, but also : Typical Characteristics of investment entities
Multiple investments and multiple investors
Investors that are not related to the parent entity or investment manager
Ownership interests in the form of equity or partnership interests
NO material business purposes other than investing (e.g. property development or leasing business?)
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Why does it matter?
FV accounting vs consolidation
operational and cost implications
system implications
Commercial implications! ….investor tax implications…..
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Section IV
Disclosure of Interests in Other Entities
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Structured entities (SEs)
• Voting or similar rights are NOT dominant factor in deciding control
• Voting rights may only relate to administrative tasks
• Relevant activities directed by contractual arrangements
• Common types of SE
o Securitisation vehicles
o Asset-backed financings
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IFRS 12 – Disclosure (1)
Disclosure of unconsolidated entities (IFRS 12.26-29) Required?
The nature and purpose of the SE
The size of the SE
The activities and financing of the SE
The policy for determining SEs that are sponsored
A summary of income from the SE
The carrying amount of assets transferred to the SE
The recognised assets and liabilities relating to interests in the SE
√ √ √
√ √ √
√
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IFRS 12 – Disclosure (2)
•Applies to ‘interests’ in:
o Subsidiaries
o Joint arrangements
o Associates
o Structured entities
• Complexities and understanding
of requirements only becoming clear as entities determine their disclosures
TO FOCUS ON PRACTICAL
APPLICATION
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Section V
Fair Value Measurement
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IFRS 13 - Fair value measurement
• Introduction of fair value hierarchy for non-financial assets and liabilities held at fair value (large disclosure impact for investment property and revalued PPE)
• FV of liabilities to be based on assumption that liability would be transferred to another party (as opposed to settled or extinguished)
• Removal of requirement to use bid and ask prices for actively-quoted instruments (e.g. REITS)
• Introduction of additional disclosures related to fair value
Important Notice
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Quick recap on levelling: IFRS 13 establishes a fair value hierarchy that classifies fair value inputs into three levels
IFRS 13 - Fair value hierarchy levelling
Level 1
Level 2
Level 3
Quoted prices (unadjusted) in active markets for identical assets assessable by the reporting entity at the measurement date (e.g. shares in REIT)
Inputs that are observable for the asset, directly or indirectly. The inputs are based on market data obtained from sources independent of the reporting entity (e.g. residential apartment)
Unobservable inputs, for which market data are not available, are developed using the best information available about the assumptions that market participants would use when pricing the asset/liability (e.g. Okura Hotel)
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Examples of possible inputs
Level 2 “Observable”
• Sales price per square feet for similar properties in similar locations (e.g. other floors in strata building, small adjustments)
• Observable market rent per square feet for similar properties in similar locations
• Property yields derived from recent transactions
Level 3 “Unobservable”
• Property yields based on management’s or valuer’s estimations, vacancy rates, new rent levels etc.
• Significant yield adjustments based on management’s or valuer’s assumptions
• Cash flows forecast using the entity’s own data • Projected value of the property on the date when it is
anticipated to be completed • Period required to reach realistic long-term occupancy • Sums remaining to be paid by the entity under binding
construction contracts • Estimated profit margin from holding and developing
property to completion
IFRS 13 - Fair value hierarchy levelling
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IFRS 13 – Disclosures requirement Level 1 Level 2 Level 3
Reasons for level 1/2/3 transfers
Valuation techniques & Inputs, changes from prior year
• Opening/closing reconciliation;
• Unrealised gains/losses • Quantitative significant
unobservable inputs • Valuation processes • Sensitivity analysis • Interrelationships between
unobservable inputs • Non-financial assets not
HABU (Highest And Best Use); reasons
In addition:
For assets that disclose (but are not measured at) FV:
• FV amount
• FV hierarchy
• Level 2/ 3 valuation techniques/inputs
• Non-financial assets not HABU (Highest And Best Use); reasons
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As at 31 December 2013
Valuation
US$’000 Valuation technique
Term Capitalisation
rate %
Reversion Capitalisation
rate %
Discount rate %
Capitalisation rate for
terminal value %
Monthly Market rent
Office
Australia 113,362 Discounted cash flow Not applicable Not applicable 8.8 7.8 AUD 583 – 759 psm
China 46,428 Direct income capitalisation/ Discounted cash flow
5.0 6.0 10.0 5.0 CNY 109.5 – 155.0 psm
Japan 104,582 Direct income capitalisation
5.1 – 6.7 Not applicable Not applicable Not applicable JPY 10,000 – 20,000 per tsubo
Mixed-use
Japan 217,558 Direct income capitalisation
5.3 – 7.0 Not applicable Not applicable Not applicable JPY 10,297 – 34,733 per tsubo
Singapore 4,358,365 Direct income capitalisation/ Discounted cash flow
3.8 – 4.0 4.0 – 4.5 6 4.3 SGD 12.6 – 15.3 psf
Thailand 22,287 Sales comparison Not applicable Not applicable Not applicable Not applicable Not applicable
IFRS 13 – Quantitative disclosure
Illustrative disclosures on quantitative significant unobservable inputs (Level 3)
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There are inter-relationships between unobservable inputs. Increase in the growth in market rent will result in an increase to the fair value of investment properties. An increase in the capitalisation rate or discount rate will result in a decrease to the fair value of investment properties. All investment properties have been valued internally or externally by independent professionally qualified valuers with recent experience in the location and category of the investment property being valued. Amongst other things, this assumes that the properties had been properly marketed and that exchange of contracts took place on this date. Independent professionally qualified valuers must be appropriately accredited. Valuers were provided with all necessary information including rent rolls, capex and refurbishment plans, quantity surveyor reports, etc. by the Entity. Indicative values of individual assets were also covered allowing for a comparison between the external valuations, the internal valuations, including the respective assumptions and bid price received from potential buyers. At each financial year end, the Entity: verifies all major inputs to the independent valuation report and internal valuation methodologies; assesses property valuation movements when compared to the prior year valuation report; holds discussions with the independent valuer.
Change in Level 3 fair values are analysed at each reporting date during the quarterly valuation discussions by the Entity. At the end of the discussion, the Entity presents a report that explains the valuation amount to be adopted, the process and rationale on how the amounts to be adopted, is concluded, and the reasons for fair value movements.
IFRS 13 – Qualitative disclosure
Illustrative disclosures on valuation process
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In applying the direct income capitalisation method, the market rent of the property is divided by capitalisation rate, the significant unobservable inputs include: Market rent Based on the location, type and quality of the property and supported by the
terms of any existing leases, other contracts or external evidence such as current market rents for similar properties, adjusted for estimated vacancy rates based on current and expected future market conditions after expiry of any current leases; and
Capitalisation rate Based on location, size and quality of the property and taking into account
market data at the valuation date.
IFRS 13 – Qualitative disclosure
Illustrative disclosures on valuation techniques and inputs (1)
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In applying the discounted cash flow (“DCF”) method, DCF projections are based on significant unobservable inputs. These inputs include: Future rental cash inflow Based on the actual location, type and quality of the property and supported
by the terms of any existing leases, other contracts or external evidence such as current market rents for similar properties;
Discount rate Reflecting current market assessments of the uncertainty in the amount and
timing of cash flows; Estimated vacancy rate Based on current and expected future market conditions after expiry of any
current leases; Maintenance costs Including necessary investments to maintain functionality of the property for
its expected useful life; Capitalisation rate for terminal value Based on forecast market trends, the perceived marketability of the property at
the terminal date and assumptions regarding income and capital expenditure of the property through the cash flow horizon; and
Terminal value Taking into account assumptions regarding maintenance costs, vacancy rates
and market rents.
IFRS 13 – Qualitative disclosure
Illustrative disclosures on valuation techniques and inputs (2)
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Section VI
Financial Risk Reporting Disclosure
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Financial Risk Reporting Disclosure under IFRS 7 – key principles
Disclosure requirements on each type of financial risk
Qualitative and quantitative disclosures
Credit risk Liquidity risk Market risk
Through the eyes of management
Minimum disclosure requirements
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Minimum disclosures – Credit risk
Neither past due nor impaired
Past due Impaired
Carrying amount – maximum exposure*
Credit quality Aging analysis Analysis of individually
impaired assets
Reconciliation of allowance account
Description of collateral held and financial effect
Possessed collateral
*Disclose required for financial instruments whose carrying amount does not best represent the maximum exposure to credit risk
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Minimum disclosures – Liquidity risk
Liquidity analysis for financial liabilities
Non-derivative • Contractual maturity • Undiscounted cash flows • Principal and interest
payments • And on expected basis if
managed on this basis
Derivative • based on how risk is
managed (for example, expected and discounted)
Financial guarantees • Disclose in the earliest
time band a cash payment under the guarantee could be called upon
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Minimum disclosures – Liquidity risk
Liquidity analysis also required for
Financial Assets • If held for managing liquidity risk and • if that information is necessary to enable users of its
financial statements to evaluate the nature and extent of liquidity risk.
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Minimum disclosures – Market risk
Interest rate risk Currency risk
Commodity price risk
Other price risk
Equity price risk
Market risk
Other risk
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Either disclose a sensitivity analysis with effect on PL and equity or value at risk
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Section VII
New leases standard
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Leasing Project - Timeline
The expected timing of publication of the final standard is 2015….
Exposure Draft issued
Effective date?
Re-deliberations begin
Aug 2010
Jan 2011
Jan 2014
2019?
May 2013
2015?
Re- Exposure
Re-deliberations begin
Final Standard?
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All leases on
balance sheet!
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Redeliberations — Lessee accounting (Tentative)
Front — loaded expenses pattern:
Amortisation expense (ROU asset)
+ Interest expense (Lease liability)
2010 ED IAS 17
Finance Lease
Operating
Lease
2013 Re-ED
Type A
Type B
Tentative IASB Decision
All leases on B/S (except short-term and small-ticket leases ) ….BUT what about the income statement?
Consume insignificant portion of the underlying assets?
Front — loaded expenses pattern:
Amortisation expense (ROU
asset) +
Interest expense (Lease liability)
FASB: tentatively decided for a dual
approach based on the current dividing line (similar with IAS17 )
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Redeliberations — A Single Lessee Model (Tentative)
• The chart above depicts the impact on earnings for a basic 10-year lease with an initial annual rent of C2,000, a 2% annual escalation rate and an assumed incremental borrowing rate of 7%.
1500
1600
1700
1800
1900
2000
2100
2200
2300
2400
2500
2600
2700
1 2 3 4 5 6 7 8 9 10
An
nu
al
Pre
-Ta
x E
xp
en
se
Proposed Model
Current model
Cash Rents
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Redeliberations — Lessor accounting (Tentative)
Derecognition
model
2010 ED IAS 17
Finance Lease
Operating Lease
2013 Re-ED
Type A
Type B
Tentative
Decision
Performance Obligation model
Symmetry with lessee’s P/L approach
Finance Lease
Operating Lease
IASB & FASB: Unchanged from
current lessor model!
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Section VIII
Revenue from contracts with customers
- Will significantly impact timing of revenue and profit of developers!!
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Steps to apply new revenue recognition standard
Step 1: Identify the contract(s) with the customer (e.g. pre-sale contracts in advance of development)
Step 2: Identify the separate performance obligations in the contract(s) – “deliverables” (e.g. apartment and communal clubhouse)
Step 3: Determine the transaction price (rebates, discounts etc. ??)
Step 4: Allocate the transaction price
Core principle Revenue recognised to depict transfer of goods or services
Step 5: Recognise revenue when (or as) a promise to transfer a good or service is satisfied
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Real estate sales – “point in time = × ” or ‘over time = √ ’ assessment
Right to payment for asset
Legal title to asset
Physical possession of asset
Customer has significant risk and
rewards
Customer has accepted the asset
... over time if customer controls the asset in practice
• customer has sole title to land on which asset is constructed
• customer has legal title to WIP
• customer can take possession if contract cancelled
... Point in time if customer only has contractual control as protective rights
• prevent access for others
• customer can borrow against asset
Indicators …
√
√
√
× ×
Very rare to transfer control for apartment blocks during construction!
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2015 PwC Asia Pacific Real Estate Conference
Real estate sales – ‘over time’ assessment Alternative exit for asset and developer’s right to payment?
No alternative use
Must have both…….
Right to payment for performance
to date
• Entity is unable contractually or practically to readily direct for another use during the creation/enhancement
• e.g., cannot contractually sell to another customer
• Compensation for performance completed to date is an amount that approximates the selling price
• e.g., recovery of the costs plus a reasonable profit margin
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2015 PwC Asia Pacific Real Estate Conference
Other practical issues….
2
40% are at the Impact Assessment stage
Contract costs
Non-refundable upfront payment
Licenses and royalties
Financing component
Principal versus agent Variable consideration
Customer options
Contract modification
How to determine stand alone selling price?
What is a contract?
How many separate performance obligation?
and probably more…
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Appendix 1
Continue the conversation…
Presenter CVs
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Presenter CV
Paul Walters
Partner – Asset Management Industry Group Asia-Pacific Real Estate Assurance Leader
TEL: +852 2289 2720 E-mail: [email protected]
Paul is PwC’s Asia-Pacific Real Estate Assurance Leader, and serves as a regional representative on the PwC Global Real Estate Leadership team and industry technical committees, bringing a strong link into the global network of experience. Paul’s principle clients include public and private real estate funds and real estate entities. Paul also looks after other alternative asset class private funds. Paul has extensive experience on audit and advisory services, and also on advising clients on fund start-ups, fund listings, regulatory and compliance matters and internal controls around the investing, monitoring and operational functions. Paul sits on the Professionals Standards Committee of the Asia Association for Investors in Non-Listed Real Estate (“ANREV”), and authors the PwC & ANREV Review of Investor Reporting Trends Report, and co-authors the PwC & ULI Emerging Trends in Real Estate Survey.
[Photo here]
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