accounting & transaction … & transaction series: selected accounting issues (ifrs)...

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

PwC

IFRS covered today – Hurray!!!!!!!!

December 8, 2015 2015 PwC Asia Pacific Real Estate Conference

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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


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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13

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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2015 PwC Asia Pacific Real Estate Conference December 8, 2015

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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.


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.


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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2015 PwC Asia Pacific Real Estate Conference

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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

2015 PwC Asia Pacific Real Estate Conference December 8, 2015 32

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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


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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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

December 8, 2015 44

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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…

December 8, 2015 45

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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.

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