Educational guidance "Financial reporting considerations for closing out 2021"

STANDARDSETTINGMARCH 2022Financial reportingconsiderations for closing outCONTENTSForewordIntroductionSection I – New and revised HKFRSs mandatorily effective from1 January 2021Section II - Agenda decisions issued by the IFRS Interpretations Committee(IFRS IC) in 2021 that are relevant to Hong Kong entitiesSection III - Key COVID-19-related financial reporting remindersSection IV - Topical issue – climate-related reportingAppendix – New and revised Hong Kong Financial Reporting Standards,and Agenda Decisions issued by the IFRS ICForewordThe micro- and macro-economic conditions at the 2021 financial year-end continue to bechallenging.More than two years into the COVID-19 pandemic, different jurisdictions have adopteddifferent strategies in dealing with it. The ensuing global supply chain disruptions, escalatinggeopolitical uncertainties, ongoing extreme weather phenomena and the global capitalmarket’s focus on climate change and sustainable development have taken centre stage inthe past year. The resilience of global trade is being tested like never before. Against thisbackdrop, an entity’s suppliers, customers, peers, competitors and distribution channels areall subject to different types and levels of restrictions to their operations.As uncertainties mount, one thing is clear: corporates, large and small, have had to adapt tothe new normal in order to survive with some embracing permanent changes to their businessmodels. For some businesses, the conditions at the 2021 financial year-end and the futureoutlook at this date may be significantly different from what they were a year ago. Cash flowforecasts developed a year ago may no longer be relevant.All these have an impact to an entity’s financial position, performance and cash flows to agreater or lesser extent. This is true even for a local business given the interconnectedness ofglobal trade. Readers should bear this bigger picture in mind when preparing their 2021financial statements.We hope you will find this publication useful.Cecilia KweiDirector, Standard SettingMarch 2022IntroductionThis educational guidance highlights key financial reporting considerations for entitiespreparing their December 2021 financial statements but is also relevant for financial yearsending after that date.This guidance is divided into four parts:

I.New and revised HKFRSs mandatorily effective from 1 January 2021II.Agenda decisions issued by the IFRS Interpretations Committee (IFRS IC) in 2021 thatare relevant to Hong Kong entitiesIII.Key COVID-19-related financial reporting remindersIV.Topical issue – climate-related reportingThis educational guidance is not intended to be comprehensive nor does it necessarily coverall the potential issues relevant to an entity’s 2021 financial statements. Readers should referto the HKFRSs in the Institute’s Members’ Handbook for further reference.Section I – New and revised HKFRSs mandatorily effectivefrom 1 January 2021Two amendments to HKFRSs are mandatorily effective for entities with a December year-endfrom 1 January 2021: (i) amendment to HKFRS 16 Covid-19-Related Rent Concessions and(ii) phase 2 of the amendments relating to the interest rate benchmark reform.The amendment to HKFRS 16 Covid-19-Related Rent Concessions was issued in 2020 andis mandatorily effective for annual periods beginning on or after 1 June 2020. The discussionsbelow focus on the subsequent extension to this amendment issued in 2021 which, althoughonly mandatorily applicable to annual periods beginning on or after 1 April 2021, will likely beearly adopted by entities given the persistent COVID situation.

1.Amendment to HKFRS 16 Covid-19-Related Rent Concessions beyond 30 JuneHKFRS 16 Leases was amended inJune 2020 to provide practical relief tolessees in accounting for qualifyingCOVID-19-related rent concession1 (the2020 Amendments), under which alessee is not required to assess whetherthe qualifying COVID-19-related rentconcessions are lease modifications, butinstead account for them in accordancewith other applicable guidance as if they were not lease modifications.The 2020 Amendments only apply to rent concessions for which any reduction in leasepayments affected only payments originally due on or before 30 June 2021 (EligibilityPeriod). However, due to the continued economic challenges brought by the COVID-19pandemic, more lessors and lessees renegotiated the rent concessions that extendbeyond 30 June 2021. In order to cope with these circumstances, the InternationalAccounting Standards Board (IASB) issued the Amendment to IFRS 162 Covid-19-Related Rent Concessions beyond 30 June 2021 in March 2021, to extend the EligibilityPeriod for one year, i.e. from 30 June 2021 to 30 June 2022. The Institute approved theequivalent amendments to HKFRS 16 in April 2021 (the 2021 Amendments). A lesseeshall apply the 2021 Amendments for annual periods beginning on or after 1 April 2021.Earlier application is permitted, including in financial statements not authorized for issueat the date of issuing the 2021 Amendments (i.e. 9 April 2021).1 The practical expedient is not available to lessors. The conditions required to be fulfilled before the lessee could apply thepractical expedient in the 2020 Amendments are set out in HKFRS 16.46B(a) to (c).2 HKFRS/HKAS are fully converged with IFRS/IAS.Under the Amendments, lessees would generally account for the changes in leasepayments due to qualifying COVID-19-related rent concessions as “negative variablelease payments” by debiting the lease liability and crediting the same amount in profit orloss, as opposed to accounting for them as a lease modification which would haverequired adjustments to the lease liability determined at a revised discount rate and theright-of-use asset. The Amendments require retrospective application, with thecumulative effect of their initial application as an adjustment to the opening balance ofretained earnings.We highlight below a few areas which entities should consider when applying the 2021Amendments.(i)

Whether the entity (lessee) can choose to apply the 2021 AmendmentsThe 2021 Amendments do not provide a new choice to a lessee as to whether toapply the practical expedient. If the lessee has applied the practical expedient inthe 2020 Amendments, it must also apply the extended scope of the practicalexpedient in the 2021 Amendments. This is because an entity shall consistentlyapply the practical expedient to account for leases (including those newly enteredinto in 2021) with similar characteristics and in similar circumstances in accordancewith its accounting policy (HKFRS 16.2).Likewise, if the lessee has previously decided not to apply the practical expedientin the 2020 Amendments to account for its qualifying COVID-19-related rentconcessions, it cannot apply the extended scope of the practical expedient in the2021 Amendments. In this case, the 2021 Amendments would have no impact onthe lessee.(ii)

Whether a rent concession that was not a qualifying COVID-19-related rentconcession in terms of the 2020 Amendments can apply the 2021 Amendments;

and if so, how they should transition to the 2021 AmendmentsIt depends on why those rent concessions did not qualify for the practical expedientin the 2020 Amendments.For example, if they were rent concessions which did not meet the relevant criteriaonly because they resulted in reduced lease payments beyond 30 June 2021, suchrent concessions would now meet the practical expedient criteria in the 2021Amendments as long as the reduction in lease payments do not go beyond 30 June

2022.If the entity has elected to apply the practical expedient in the 2020Amendments to similar rent concessions, the entity should also apply the practicalexpedient in the 2021 Amendments to the rent concession under review.In this situation, the lessee should first reverse the relevant effects of accountingfor such rent concessions previously as a lease modification and then account forthe rent concessions as variable lease payments in profit or loss by applying thepractical expedient in the 2021 Amendments. Entities are also reminded to adjustfor the corresponding effect on depreciation of the right-of-use assets given thatapplying the practical expedient in the 2021 Amendments would result in a higherdepreciation expense from the date of the rent concession (assuming there wereno adjustments to the right-of-use asset e.g. impairment) as compared to theprevious accounting for the rent concessions as a lease modification.(iii)

Impact of when the rent concession is agreedThe timing of when the rent concession is agreed between the lessor and thelessee is not one of the conditions in assessing whether the practical expedientunder the 2021 Amendments can be applied. For example, an agreement for rentconcession entered into before 30 June 2022 to reduce or defer lease paymentsoriginally due after 30 June 2022 would not qualify for the practical expedient. Thelessee should instead apply the general requirements of HKFRS 16 to account forthe effects of those rent concessions (e.g. accounting for them as leasemodifications).

2.Amendments to HKAS 39 Financial Instruments: Recognition and Measurement,HKFRS 4 Insurance Contracts, HKFRS 7 Financial Instruments: Disclosures,HKFRS 9 Financial Instruments and HKFRS 16 Leases – Interest RateBenchmark Reform – Phase 2The Phase 1 amendments relating tothe interest rate benchmark reform (orsometimescalledtheinterbankoffered rates (IBOR) reform) (Phase 1Amendments) took effect in 2020 andwere more relevant to entities thatapply hedge accounting.The Phase 2 Amendments becameeffective from 1 January 2021. The Phase 2 Amendments are expected to have a widerimpact on entities of all industries provided that (1) entities have a financial instrumentthat is indexed to an interest rate benchmark that is subject to the IBOR reform (e.g. afloating loan rate that is linked to the London Inter-Bank Offered Rate, or a fixed-ratedebt that is hedged using IBOR-based derivatives); and (2) entities (as lessees) havelease payments that are indexed to an IBOR rate.The Phase 2 Amendments3 address issues that might affect financial reporting when anentity replaces the old IBOR benchmark with an alternative benchmark rate (ABR) as aresult of the IBOR reform. The following are some key reminders in applying the Phase2 Amendments:

(i)

Changes to contractual cash flowsAs a result of the IBOR reform, there might be changes in the basis for determiningthe contractual cash flows of financial instruments and those changes might haveconsequential impact on the accounting treatment of affected financial instruments.Under HKFRS 9, such changes to a financial instrument might require recognizingan immediate gain or loss in profit or loss. The Phase 2 Amendments provide apractical expedient in which entities are required to account for such a change byadjusting the effective interest rate on a prospective basis without the need torecognizing an immediate gain or loss. This is the case provided that bothconditions set out in HKFRS 9.5.4.7 are met, i.e. 1) the change is necessary as adirect consequence of the interest rate benchmark reform; and 2) the new basisfor determining the contractual cash flows is economically equivalent to the basisimmediately preceding the change 4.If there are changes in addition to those required by the IBOR reform, entitiesshould first apply the practical expedient set out in HKFRS 9.5.4.7 to the changesrequired by the IBOR reform and then apply the other applicable requirements inHKFRS 9 to any additional changes to which the practical expedient does not apply(HKFRS 9.5.4.9). If the additional changes result in the derecognition of thefinancial instruments, the derecognition requirements in HKFRS 9 apply. Otherchanges should be accounted for under HKFRS 9.5.4.3 or B5.4.6 as applicable.A similar practical expedient is available in HKFRS 16 to address the accountingfor lease modifications as a result of the IBOR reform. The affected lease liabilitiesshould be remeasured by discounting the revised lease payments using a discountrate that reflects the change in the interest rate, provided the two conditions set outin HKFRS 16.105 are met, i.e. 1) the modification is necessary as a directconsequence of the IBOR reform; and 2) the new basis for determining the leasepayments is economically equivalent to the basis preceding the modification.However, if lease modifications are made in addition to those lease modificationsrequired by the IBOR reform, the lessee is required to apply the relevant HKFRS16 requirements to account for all lease modifications made at the same time,including those required by the IBOR reform (HKFRS 16.106).3 The Phase 2 Amendments are to be applied retrospectively in accordance with HKAS 8 Accounting Policies, Changes inAccounting Estimates and Errors. However, restatement of prior periods is not required if doing so requires the use of hindsight(HKFRS 9.7.2.43 to 7.2.46, HKFRS 16.C20C and C20D). Hedging relationships previously discontinued solely because ofchanges resulting from the reform will be reinstated if certain conditions are met (HKFRS 9.7.2.44).4 HKFRS 9.5.4.8 provides examples of changes that give rise to a new basis for determining the contractual cash flows that is“economically equivalent” to the previous basis.Given different IBORs (in terms of currency and tenure) will be replaced by theirrespective ABRs in phases, entities should continue to actively manage their IBORtransition process, including taking stock of contracts (including lease contracts) toidentify those which will or may be affected by the IBOR reform and those whichdo not have fallback provisions so as to renegotiate with the respectivecounterparties (e.g. banks) ahead of time. Entities may also consider setting up acoordination team consisting of representatives from the affected departments (e.g.legal, accounting, tax and information technology) to ensure a smooth transitionprocess.(ii)

Hedge accountingThe Phase 2 Amendments provide specific relief from discontinuing hedgingrelationships. For example, an entity is not required to discontinue existing hedgingrelationships when changes to the hedged risks, hedged items or hedginginstruments arise as a result of changes required by the IBOR reform.Entities that have applied hedge accounting should identify any hedgingrelationships (i.e. cash flow or fair value hedges of interest rate risk) that would fallwithin the scope of the Phase 2 Amendments. In particular, entities should assesswhether there are any changes to the hedged risks, hedged items and hedginginstruments for which the hedge documentation needs to be updated in order toavoid a discontinuation of the existing hedging relationship.(iii)

DisclosuresEntities need to provide specific disclosures to enable users of financial statementsto understand the effect of the IBOR reform on their financial instruments and riskmanagement strategy. HKFRS 7.24I and 24J set out the relevant qualitative andquantitative disclosure requirements.Section II – Agenda decisions issued by the IFRS IC in 20215that are relevant to Hong Kong entitiesThe appendix to this educational guidance provides a full list of agenda decisions issued bythe IFRS IC in 2021. This section highlights those agenda decisions that are more widelyrelevant to companies reporting in Hong Kong. Given HKFRSs are fully converged with IFRSs,entities are advised to consider if any of the agenda decisions have an impact on their currentaccounting policies; and if so, implement any necessary accounting policy changes on a timelybasis6.

1.Costs necessary to sell inventoriesHKAS 2 Inventories requires an entity to measure its inventories at the lower of cost andnet realizable value (NRV). HKAS 2.6 defines NRV as “the estimated selling price in theordinary course of business less the estimated cost of completion and the estimatedcosts necessary to make the sale”. However, HKAS 2 does not provide further guidanceon how to determine the “estimated costs necessary to make the sale”. Therefore,questions arise as to whether an entity should include all costs necessary to make thesale or only those that are incremental to the sale when determining the NRV ofinventories.The agenda decision issued in June 2021 clarifies that the costs necessary to make thesale are not limited to only incremental costs. Entities should apply judgement todetermine which costs are necessary to make the sale taking into account their owncircumstances. This could include the nature of inventories, industry and salesenvironment in which the entity operates. Any significant judgements made in applyingthe accounting policy should be disclosed if material.

2.Software-as-a-Service (SaaS) arrangements or cloud computing arrangementsIn cloud computing arrangements, customers can access and use the underlyingsoftware on an as-needed basis rather than have control or possession over theunderlying software. The IFRS IC published two agenda decisions in 2019 and 2021respectively, clarifying the accounting by customers for a specific aspect of cloud5 Agenda decisions (including any explanatory material contained therein) cannot add or change requirements in IFRSs. Instead,explanatory material explains how the applicable principles and requirements of IFRSs apply to the fact pattern described in theagenda decision. Explanatory material derives its authority from IFRSs themselves and accordingly, an entity is required to applythe applicable IFRSs reflecting the explanatory material in an agenda decision, subject to its having sufficient time to implementthat accounting (Paragraphs 8.4 and 8.5 to the IASB Due Process Handbook).6 See Sue Lloyd’s March 2019 article Agenda decisions – time is of the essence.technology – SaaS arrangement. The agenda decisions do not address the accountingfor other aspects of cloud technology.In the 2019 agenda decision, the IFRS IC concluded that a contract that conveys to thecustomer only the right to access to the supplier’s application software in the future is aservice contract, instead of a lease of the software or a software intangible asset.The 2021 agenda decision goes further to address a specific issue on how a customershould account for the costs of configuring or customizing a supplier’s applicationsoftware in a SaaS arrangement that is determined to be a service contract. The agendadecision explains whether those costs should be recognized as (1) a prepayment asset;

(2)an intangible asset; or (3) an expense when incurred.A prepayment asset will arise if the entity (customer) pays the supplier before receivingthe configuration and customization services and the expenditure does not give rise toan intangible asset.In terms of an intangible asset, the IFRS IC observed that an entity would often notrecognize the configuration and customization costs in a SaaS arrangement as suchbecause (i) the entity does not control the software being configured or customized; and(ii) the configuration or customization activities do not create a resource controlled bythe entity that is separate from the software. However, entities should be mindful ofwhether additional resources (e.g. programming codes) may be created from the SaaSarrangement and assess whether they meet the definition and recognition criteria asintangible assets.If the configuration and customization costs do not give rise to an intangible asset, theentity needs to apply HKAS 38.68 to HKAS 38.70 to account for such costs as anexpense when it receives the related services. It is important to note that an entityreceives the services when the supplier performs them, and not when the entity usesthose services (HKAS 38.69A). HKAS 38, however, does not contain any guidance onthe identification of the services the entity (customer) receives. In this respect, theagenda decision notes that IFRS 15 Revenue from Contracts with Customers containsrequirements that deal with similar and related issues from the supplier’s perspective.Those requirements should be considered by the entity (customer) in determiningwhether the supplier performs a configuration or customization service that is distinctfrom the right to access to the supplier’s application software, and consequently, whenthe entity should recognize the related costs. See diagram below.Notes:

1)

It is assumed that the SaaS arrangement does not contain a lease and therefore HKFRS 16 Leases does not apply.2)

Capitalize as intangible asset and amortize over its useful life under HKAS 38. If the configuration and customizationactivities are carried out by the entity itself, the related costs can only be capitalized if the criteria in HKAS 38.57 aremet.3)

The agenda decision notes that IFRS 15 contains requirements that help an entity determine whether C&C servicesare distinct from the SaaS arrangement. According to HKFRS 15.27, a good or service is distinct from other goodsor services within the contract if both of the following criteria are met:

a)

the customer can benefit from the good or service either on its own or together with other resources that arereadily available to the customer (ie the good or service is capable of being distinct); andb)

the entity’s promise to transfer the good or service to the customer is separately identifiable from other promisesin the contract (ie the promise to transfer the good or service is distinct within the context of the contract).HKFRS 15.29 also includes examples of factors that may indicate that two or more promises within a contract wouldnot be distinct.As can be seen from the above, judgement must be applied in determining whether andwhen configuration and customization costs in a SaaS arrangement should becapitalized or expensed. Collaboration between various departments within an entitymay be needed to obtain a sufficient understanding of the details of each SaaSarrangement in determining the appropriate accounting treatment. Entities shouldreassess whether their current accounting policy is appropriate in light of the agendadecision.4)

Supply chain financing arrangements – Reverse factoringAlert Issue 37 discusses the IFRS ICagenda decision issued in Decemberonsupplychainfinancingarrangementsorreversefactoringarrangements (collectively referred to assupply chain financing arrangements). Asthe agenda decision was issued inDecember 2020 which was near the endof the 2020 reporting period, there might not have been sufficient time for some entitiesto reflect the agenda decision in their December 2020 financial statements. Such entitiesshould consider the agenda decision in their December 2021 financial statements.As a recap, under a typical supply chain financing arrangement, a financial institutionagrees to pay amounts an entity owes to its suppliers and the entity agrees to pay thefinancial institution at the same time as (or on a date later than) when suppliers are paid.The agenda decision explains how an entity presents liabilities that are part of the supplychain financing arrangement on the statement of financial position under such anarrangement. The major points are summarized below:

(i)

The presentation of the liabilities as trade payables, borrowings or other separateline items is not a free choice.Entities making extensive use of supply chain financing arrangements shouldconsider each major arrangement to assess the nature and function of the liabilitiessubject to reverse factoring. This will help determine whether the liabilities shouldcontinue to be presented within trade payables or whether a separate presentation(e.g. as part of other financial liabilities or as an additional line item) would berelevant to an understanding of the entity’s financial position in accordance withparagraphs 55, 57 and 58 of HKAS 1 Presentation of Financial Statements.Applying paragraph 11(a) of IAS 37 Provisions, Contingent Liabilities andContingent Assets and IAS 1.70, the IFRS IC concluded that an entity presents afinancial liability as a trade payable only when it:

a)

represents a liability to pay for goods or services;

b)

is invoiced or formally agreed with the supplier; andc)

is part of the working capital used in the entity’s normal operating cycle.In making the above assessment, entities should consider the nature and extent ofthe changes to the rights and obligations between the entity (purchaser) and thesupplier/bank as a result of the supply chain financing arrangement. It is alsoimportant to understand the purpose of entering into a supply chain financingarrangement and for the presentation of the related liability to reflect the functionof the arrangement within the entity. For example, if the arrangement was enteredinto in order for the entity to obtain extended funding that differs materially from theterms of other trade payables, and the entity provides additional security that wouldnot be provided without the arrangement, these may indicate that the relatedliability may need to be presented separately from a trade payable.(ii)

An entity assesses whether and when to derecognize a liability that is (or becomes)

part of a supply chain financing arrangement by applying the derecognitionrequirements in HKFRS 9. An entity that derecognizes a trade payable to a supplierand recognizes a new financial liability to a financial institution applies HKAS 1 indetermining how to present that new liability in its statement of financial position(see point (i) above).(iii)

The assessment of the nature of the liabilities in (i) above may help in determiningthe classification of the related cash flows in the statement of cash flows. Forexample, if the entity considers the related liability to be a trade payable that is partof its working capital, the entity presents any related cash outflows as an operatingactivity. Any material non-cash transactions should be disclosed accordingly in thenotes to the financial statements.(iv) Any significant judgements applied in determining the presentation of the liabilitiesand cash flows related to the arrangement should be disclosed7.7 The IASB published an exposure draft in November 2021 proposing amendments to IAS 7 and IFRS 7 to (1) require entities toprovide information in the notes that enables users of financial statements to assess the effects of supply chain financingarrangements on their liabilities and cash flows; and (2) specify the qualitative and qualitative disclosure requirements. Thecomment period for the exposure draft is due on 28 March 2022.Section III – Key COVID-19-related financial reportingremindersCOVID-19 continues to have a wide-ranging impact on many entities. While this guidance re-emphasizes some of the key COVID-19-related accounting considerations as discussed inAlert Issue 33 and Alert Issue 37, it also highlights other considerations that warrant specificattention for the December 2021 financial statements.

1.Going concern assessments and disclosuresHKAS 1 requires management to assess an entity’s ability to continue as a goingconcern when preparing financial statements. Given the significant drop in revenue andprofitability experienced by many entities under the COVID-19 environment, the IASBpublished an educational material in January 2021 which provides a helpful reminder onthe application of IAS 1 on the going concern assessment and related disclosures. Theeducational material sets out four scenarios as follows:

(i)

No significant doubts about going concern.(ii)

Significant doubts about going concern but mitigating actions judged sufficient tomake going concern appropriate. No material uncertainties remain.(iii)

Significant doubts about going concern but mitigating actions judged sufficient tomake going concern appropriate. Material uncertainties about going concernremain after considering mitigating actions.(iv) Intends to liquidate or to cease trading, or no realistic alternative but to do so.The second and the third scenarios require more judgement to assess (1) thesignificance of the doubts about going concern; and (2) the sufficiency of mitigatingactions to address the going concern. It is crucial for entities to provide entity-specificdisclosures to explain and support the judgement management has made, in addition tothe disclosures about material uncertainties relating to going concern. Entities arereminded that HKAS 1 requires management to look at a period of at least 12 monthsfrom the end of the reporting period when making the going concern assessment. Theeducational material also states that, considering time periods longer than 12 months isnot inconsistent with the requirements in IAS 1, which establishes a minimum period, nota cap. However, if before the financial statements are authorized for issue,circumstances were to deteriorate so that management no longer has any realisticalternative but to cease trading, the financial statements must not be prepared on a goingconcern basis as required by HKAS 10 Events after the Reporting Period.

2.Judgements and key sources of estimation uncertaintiesMany areas discussed in this guidance may require significant judgements andestimations. While the specific disclosure requirements of judgements and estimates areprovided in the respective HKFRSs, HKAS 1.122 and 125 set out the overarchingprinciples that require an entity to disclose:

(i)

the judgements, apart from those involving estimations, that management havemade in the process of applying the entity’s accounting policies and that have themost significant effect on the amounts recognized in the financial statements; and(ii)

information about the assumptions an entity makes about the future, and othermajor sources of estimation uncertainty at the end of the reporting period, that havea significant risk of resulting in a material adjustment to the carrying amounts ofassets and liabilities within the next financial year.Consistent with prior years, significantjudgements and estimation uncertaintiesare expected in the following areas:

material uncertainty related to goingconcern (HKAS 1), asset impairments(HKAS 36 Impairment ofAssets),determination of useful lives of assets(HKASProperty,PlantandEquipment and HKAS 38), expectedcredit losses on financial assets (HKFRS 7 and HKFRS 9), write-down of inventories(HKAS 2), fair value measurements (HKFRS 13) and estimation of provisions (HKAS 37Provisions, Contingent Liabilities and Contingent Assets) amongst others.On this note, regulators have consistently observed generic disclosures in their reviewof financial statements and have consistently requested entities to improve on this front8.Entities are reminded that meaningful, transparent and specific disclosures ofjudgements and estimates should be made based on the entity’s own facts andcircumstances. Providing such information will help users of the financial statementsunderstand more about the entity and assist them in making investment decisions.

3.Impairment considerations and disclosures(i)

Non-financial assetsImpairment review continues to be an important topic. Non-financial assets,typically property, plant and equipment, intangible assets and goodwill, might beimpaired because of the impact brought by the COVID-19 pandemic, the ensuing8 See, for example, “Review of Issuers’ Annual Reports 2021” published by Hong Kong Stock Exchange.worldwide supply chain disruptions as well as ongoing geopolitical uncertainties. Itis therefore particularly important for entities to ensure that the requirements ofHKAS 36 are properly followed when performing an impairment review of relevantassets. We discussed the application of HKAS 36 in the educational materialissued in June 2020 and Alert Issue 37 with specific considerations given to theimpact of COVID-19. In view of their continued relevance, entities are encouragedto read this guidance, together with the aforesaid materials when preparing theDecember 2021 financial statements.HKAS 36 requires an entity to assess and identify any impairment indicators ateach reporting date. In order to cope with the challenges brought by COVID-19,some businesses might have changed their business models allowing theiroperations to return to pre-pandemic levels or even achieve growth. In such cases,the impairment indicator(s) noted in previous years may no longer exist or theirimpact might have softened this year. Entities should make sure that theassumptions and estimates used in the calculation of the recoverable amount ofpreviously impaired assets are updated to reflect the recent changes in theirbusiness model, economic environment and conditions at the end of the currentreporting period. In particular, those entities which are able to resume businessgrowth should assess whether there is any indication that an impairment lossrecognized in prior periods for an asset other than goodwill should be reversed.The remaining useful life, the depreciation (amortization) method and/or theresidual value may also need to be reviewed and adjusted in accordance with theapplicable HKFRS, even if no impairment loss is reversed for the asset.Adequate disclosures of key assumptions and other information required by HKAS36 shall be made when (1) an impairment loss has been recognized or reversedfor an individual asset or a cash-generating unit (CGU); and (2) when a CGUcontains goodwill or intangible assets with indefinite useful lives the amount ofwhich is significant in proportion to the respective total carrying amount of theseitems, even when no impairment loss is recognized for these items.(ii)

Financial assetsThe matters discussed on HKFRS 9 in our educational material issued in June2020 and Alert Issue 37 issued in last year continue to be applicable. One of themost critical and challenging areas among them is the assessment of whetherthere has been a significant increase in credit risk for a financial asset which mayinvolve significant judgements. An overall evaluation of all available facts andcircumstances in the credit risk assessment is essential. For example, entities mayenter into short-term loan arrangements in terms of which the loans arecontractually due within 12 months but in practice the loans are renewed year onyear, especially for related party loans. Management should take due care whenconsidering whether there has been a significant increase in credit risk in theseloans and whether they are credit impaired. Any significant assumptions, bases forestimations and relevant HKFRS 7 disclosures should be clearly disclosed in thefinancial statements.The HKFRS 7 disclosures including but not limited to key assumptions andestimation techniques used in the estimation of ECL and credit risk assessmentneed to be provided in order to assist users of financial statements inunderstanding how COVID-19 affects the estimations and credit risk assessments.

4.Debt restructuringsSome entities may negotiate with theirlenders to restructure their existing debtobligations in order to maintain or improvetheir cash flows and financial situation. Wehighlight below some of the challengingareas surrounding debt restructurings andother complex issues under HKFRS 9.(i)

Whether the restructuring results in a substantial modification to the debtinstrumentUnder HKFRS 9, an exchange between an existing debtor and lender of debtinstruments with substantially different terms is accounted for as an extinguishmentof the original financial liability and the recognition of a new financial liability.A modification to a financial liability is substantial if the net present value (NPV) ofthe cash flows under the modified terms (including fees) is at least 10% differentfrom the NPV of the remaining cash flows under the original terms, calculated usingthe original effective interest rate (EIR). This is commonly known as the 10% test.A substantial modification of a financial liability is accounted for as a derecognitionof the original financial liability and a recognition of a new financial liability.(ii)

Non-substantial debt modificationsNon-substantial modifications of a financial liability do not result in thederecognition of the financial liability. Instead, financial liabilities measured atamortised cost are remeasured by discounting the modified contractual cash flowsat the financial liability’s original EIR and a gain or loss on modification isrecognized in profit or loss at the date of modification or exchange (HKFRS

9.B5.4.6).(iii)

Treatment of fees and costs incurred as a result of debt restructuring9The treatment depends on whether the exchange of debt instruments ormodification of terms is accounted for as a derecognition event (HKFRS 9.B3.3.6A).If so, any costs or fees incurred are recognized as part of the gain or loss onderecognition. If not, any costs or fees incurred adjust the carrying amount of theliability and are amortized over the remaining term of the modified liability.As can be seen above, it is important for entities to assess properly whether the debtmodification is substantial under HKFRS 9 as it results in different accounting treatments.(iv) Other notable areasEntities may obtain funds through issuing bonds. If the entity (bond issuer)

repurchases its bonds, they are extinguished (i.e. derecognized) even if theentity is a market maker of the bonds or intends to resell them in the nearterm (HKFRS 9.B3.3.2).As part of a debt restructuring, an entity may transfer financial assets (otherthan cash) to settle debts owed to creditors. This may lead to complexquestions as to whether, when and the extent to which the financial assetshould be derecognized. HKFRS 9.3.2.1 to 3.2.23 provides detailedrequirements of derecognition of a financial asset.Some debts may be restructured such that the whole or a part of the debt issettled by issuing the entity’s own equity instruments to the creditor,commonly known as debt to equity swaps. Entities should refer to HK(IFRIC)

Interpretation 19 Extinguishing Financial Liabilities with Equity Instruments tosee if it applies in those cases.Entities within a group should conduct a careful assessment of all facts andcircumstances to understand the substance of an intragroup debtrestructuring arrangement. For example, whether the restructuringtransaction is in substance a capital contribution or distribution if the lenderis acting in its capacity as a shareholder in the transaction.

5.Recognition of deferred tax assetsUnder HKAS 12 Income Taxes, a deferred tax asset is recognized for all deductibletemporary differences and unused tax losses (tax credits) carried forward (with certain9 Amendments to HKFRS 9 issued in June 2020 as part of the Annual Improvements to HKFRS 2018-2020 clarify which feesshould be included in the “10% Test” for derecognition of financial liabilities. The Amendments are effective for annual periodsbeginning on or after 1 January 2022.exceptions), to the extent that it is probable that future taxable profits will be availableagainst which the deductible temporary differences can be utilized. The sufficiency ofestimated future taxable profits therefore has a direct impact on the recognition ofdeferred tax asset.As discussed in the “Going concern assessments and disclosures” and “Impairmentconsiderations and disclosures” sections, many entities suffered from worseningfinancial performance and cash flows under the COVID-19 pandemic, the ensuing globalsupply chain crunch and other geopolitical uncertainties. These will have negativeimpacts on management’s estimation of future cash flows and profitability which will inturn affect the extent to which deferred tax assets may be recognized.Entities should ensure that the estimation of future taxable profits for the purposes ofrecognizing deferred tax assets is revised at every reporting date to reflect the conditionsat that date and that the assumptions used are consistent with those applied in otherareas of financial reporting, e.g. asset impairment assessments and fair valuemeasurements.As required by HKAS 12.82(b), an entity should disclose the amount of deferred taxasset and the nature of evidence supporting its recognition when it has suffered a lossin either the current or preceding period.

6.Provisions and contingent liabilities(i)

Recognition and measurementHere are some key reminders when applying HKAS 37 Provisions, ContingentLiabilities and Contingent Assets in terms of recognizing a provision.Estimated future operating losses cannot be recognized as a provision. Aprovision can only be recognized when all of the following criteria are met: (1)

an entity has a present obligation (legal or constructive) as a result of a pastevent; (2) it is probable that an outflow of resources embodying economicbenefits will be required to settle the obligation; and (3) a reliable estimatecan be made of the amount of the obligation (HKAS 37.14).HKAS 37 does not apply to provisions or instruments covered by otherHKFRSs (HKAS 37.5), e.g. penalties resulting from a failure to perform undera revenue contract should be accounted for under HKFRS 15 and not underHKAS 37. However, a provision under HKAS 37 should be recognized if thecontract becomes onerous as a result of the penalty. Regarding leases,HKAS 37 applies to a lease that becomes onerous before thecommencement date of the lease. However, a lease that becomes onerousafter the commencement date should be accounted for under HKFRS 16(HKFRS 16.BC72).Given the current macro-economic conditions, it may be that the unavoidable costsof meeting the obligations under a contract may exceed the economic benefitsexpected to be received under the contract, resulting in an onerous contract underHKAS 37. The unavoidable costs reflect the least net cost of exiting from thecontract, which is the lower of cost of fulfilling it and any compensation or penaltiesarising from failure to fulfil it. Any impairment loss on the associated assets shouldbe recognized before a separate provision for an onerous contract is recognized.Another provision that has become increasingly common under the currenteconomic environment is a restructuring provision. Some entities may need toundergo restructuring e.g. sale or termination of a line of business, closure of abusiness location or relocation of business activities and changes in managementstructure. HKAS 37.14, 72 to 83 provide specific guidance on the nature ofobligations and the types of costs that are eligible for inclusion in the restructuringprovisions. An important point to note is that a public announcement of a plan torestructure does not automatically constitute a constructive obligation. Aconstructive obligation is created only if the announcement is made in such a wayand in sufficient detail that it gives rise to valid expectations in other parties that therestructuring will take place.If the main features of a restructuring are announced after the reporting date, noprovision is recognized at the reporting date. The details of the restructuring shouldinstead be disclosed as a non-adjusting event in accordance with HKAS 10 if theyare material.Other provisions such as those for reinstatement of leased premises, closure of adivision and self-insurance may also be recognized under the current economicenvironment. Relevant illustrative examples are provided in Appendix C to HKAS

37.(ii)

DisclosuresEntities should provide entity-specific disclosures regarding provisions that reflectthe entities’ own facts and circumstances. Potential obligations that did not existbefore the outbreak of COVID-19 and other geopolitical uncertainties may nowhave to be disclosed as contingent liabilities in accordance with HKAS 37. Wherepracticable, information such as an estimate of the financial effect and an indicationof the uncertainties relating to the amount and timing of any cash outflows shouldbe disclosed. Furthermore, contingent liabilities need to be assessed continually todetermine whether an outflow of resources embodying economic benefits hasbecome probable in which case a provision may be needed.Section IV – Topical issue – climate-related reportingClimate change has attracted increasing attention from investors and other stakeholders inrecent years. Many jurisdictions have announced pledges and implemented policies with anaim to limiting the rise in global temperature to less than 1.5°C above pre-industrial levels bythe end of this century. Such pledges and policies include achieving net-zero carbonemissions sometime within this century. The road to net-zero will in turn have an impact toentities especially those that have a high carbon footprint and those that are prone to climaterisks (e.g. transportation, building materials, agriculture, mining and energy etc.). Any changeto an entity’s strategy to achieve net zero, to adapt to or mitigate climate risks will have aconsequential impact on the entity’s financial performance, position and cash flows.Even if an entity were to continue business as usual, it is likely that it will still be affected byclimate change, e.g. more frequent and extreme typhoons in Hong Kong requiring closure ofbusinesses and leading to damage to physical assets; or wild fires and monsoons hittingmanufacturing facilities in other parts of the world from where the entity sources raw materials.Government and regulators may also impose rules on how an entity operates in order toachieve the government’s own goal of achieving net zero.All in all, climate risks will affect an entity to a greater or lesser extent in the coming years. Assuch, regardless of whether the entity is actively managing climate risks, management shouldassess how climate risks will impact its financial statements.Although HKFRSs do not explicitly address climate-related matters, the principles ofidentifying risks and assessing the extent to which they affect the entity’s financial position,performance and cash flows are already embedded in HKFRSs. Climate risks are no differentfrom other risks faced by an entity in this regard. Entities should carry out a robust andcontinual assessment of the impact of climate change on their operations, e.g. from thedetermination of the useful lives, residual values and fair value of polluting assets, changingconsumer preferences on the NRV of inventories, the fair value of financial assets in highclimate risk industries v. green investments, to more drastic actions such as restructuring theentity’s operations. Any significant judgements made in applying accounting policies andsignificant estimation uncertainties should be disclosed in accordance with HKAS 1.122 and

125.In order to address the financial reporting impacts of climate-related matters, we recommendentities refer to the two educational materials published by the IASB in November 2020 andNovember 2019 as a starting point. The 2020 publication supplements the 2019 one to providefurther discussions on the effect of climate-related matters on financial reporting.Under the overarching requirements of HKAS 1.31, entities should consider providingadditional disclosures when compliance with the specific requirements in HKFRSs isinsufficient to enable users of the financial statements to understand the impact of climate-related matters on their financial position and performance.Appendix – New and revised Hong Kong FinancialReporting Standards, and Agenda Decisions issued by theIFRS ICThe following amendments to HKFRS became effective as of 1 January 2021:

StandardsDescriptionAmendmentstoHKASFinancialInstruments: Recognition and Measurement,HKFRS 4 Insurance Contracts, HKFRS 7Financial Instruments: Disclosures, HKFRS9 Financial Instruments and HKFRS 16Leases – Interest Rate Benchmark Reform –Phase 2The amendments addresses issues thatmight affect financial reporting when acompany replaces the old interest ratebenchmark with an alternative benchmarkrate as a result of the interest ratebenchmark reform (Phase 2).Amendment to HKFRS 16 Leases – Covid-19-Related Rent Concessions10The amendment exempts lessees fromhaving to consider individual lease contractsto determine whether rent concessionsoccurring as a direct consequence of theCOVID-19 pandemic are lease modificationsand allows lessees to account for such rentconcessions as if they were not leasemodifications. It applies to COVID-19-related rent concessions that reduce leasepayments due on or before 30 June 2021.The amendment does not affect lessors.The following new and amended standards, interpretation, practice statement and accountingguideline have been issued but are not yet effective. They are available for early adoption.Effectivefromannualperiods beginning on orafter:

New and Amended Standards, Interpretation, PracticeStatement and Accounting GuidelineNew Standard1 January 2023HKFRS 17 Insurance Contracts1 January 2023Amendments to HKFRS 17 Insurance Contracts10 Effective for accounting periods beginning on or after 1 June 2020. Earlier application is permitted, including in financialstatements – interim or annual – not authorized for issue at 4 June 2020.Effectivefromannualperiods beginning on orafter:

New and Amended Standards, Interpretation, PracticeStatement and Accounting GuidelineAmended Standards, Interpretation, Practice Statement and Accounting Guideline1 April 2021AmendmenttoHKFRSCovid-19-RelatedRentConcessions beyond 30 June 20211 January 2022Amendments to HKFRS 3 Business Combinations –Reference to the Conceptual Framework1 January 2022Amendments to HKAS 16 Property, Plant and Equipment –Property, Plant and Equipment – Proceeds before IntendedUse1 January 2022Amendments to HKAS 37 Provisions, Contingent Liabilitiesand Contingent Assets – Onerous Contracts – Cost ofFulfilling a Contract1 January 2022Annual Improvements to HKFRSs 2018-2020:

Amendment to HKFRS 1 First-time Adoption ofInternational Financial Reporting StandardsAmendment to HKFRS 9 Financial InstrumentsAmendment to Illustrative Examples accompanyingHKFRS 16 LeasesAmendment to HKAS 41 AgricultureCommon controlcombinations that occur onor after the beginning of thefirst annual reporting periodbeginning on or after 1January 2022Revised Accounting Guideline 5 Merger Accounting forCommon Control Combinations1 January 2023Amendments to HKAS 1 Presentation of FinancialStatements – Classification of Liabilities as Current or Non-current 1111 In June 2021, the IASB decided to propose further amendments to IAS 1 (which was subsequently issued in November 2021with a comment deadline of 21 March 2022) and to defer the effective date of such amendments to no earlier than 1 January

2024.Effectivefromannualperiods beginning on orafter:

New and Amended Standards, Interpretation, PracticeStatement and Accounting GuidelineShould only be appliedwhen an entity applies theAmendments to HKAS 1 asreferred to in Page 23Hong Kong Interpretation 5 (2020) Presentation of FinancialStatements – Classification by the Borrower of a Term Loanthat Contains a Repayment on Demand Clause1 January 2023Amendments to HKAS 1 Presentation of FinancialStatements and HKFRS Practice Statement 2 MakingMateriality Judgements – Disclosure of Accounting Policies1 January 2023Amendments to HKAS 8 Accounting Policies, Changes inAccounting Estimates and Errors – Definition of AccountingEstimates1 January 2023Amendments to HKAS 12 Income Taxes – Deferred Taxrelated to Assets and Liabilities arising from a SingleTransactionEffective date to bedetermined by the IASB butearly adoption is permittedAmendmentstoHKFRSConsolidatedFinancialStatements and HKAS 28 Investments in Associates andJoint Ventures – Sale or Contribution of Assets between anInvestor and its Associate or Joint VentureThe following agenda decisions were published by the IFRS IC in 2021:

IFRS IC UpdateAgenda decisionsApril 2021Configuration or Customization Costs in a CloudComputing Arrangement (IAS 38 Intangible Assets)

May 2021Hedging Variability in Cash Flows due to Real InterestRates (IFRS 9 Financial Instruments)

Attributing Benefit to Periods of Service (IAS 19Employee Benefits)

June 2021Preparation of Financial Statements when an Entity isNo Longer a Going Concern (IAS 10 Events after theReporting Period)

Costs Necessary to Sell Inventories (IAS 2 Inventories)

IFRS IC UpdateAgenda decisionsOctober 2021Non-refundable Value Added Tax on Lease Payments(IFRS 16 Leases)

Accounting for Warrants that are Classified as FinancialLiabilities on Initial Recognition (IAS 32 FinancialInstruments: Presentation)

December 2021Economic Benefits from Use of a Windfarm (IFRS 16Leases)

About the Standard Setting DepartmentThe Hong Kong Institute of Certified Public Accountants (HKICPA) is the only body authorisedby law to set and promulgate standards relating to financial reporting, auditing and ethics forprofessional accountants in Hong Kong. The due process documents of the Standard SettingDepartment (SSD) explain the processes and procedures for developing local standards andadopting international standards.To find out more about how SSD contributes to international standard-setting, please visit:

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HKICPA SSD@hkicpa.officialThis guidance is developed by the Financial Reporting Standards Committee (FRSC) of the HKICPA and is forgeneral reference only. The HKICPA, FRSC and their staff do not accept any responsibility or liability in respect ofthe guidance or any consequence that may arise from any person acting or refraining from action as a result of anymaterials in the guidance. Members of the HKICPA and other users of this guidance should also read the fullHKFRS Standard, as found in the HKICPA Members’ Handbook for further reference and seek professional advicewhere necessary when applying the references contained in this guidance. The SSD welcomes your comments onthis publication. They can be sent to commentletters@hkicpa.org.hk.Hong Kong Institute of Certified Public Accountants37th Floor, Wu Chung House213 Queen’s Road East, Wanchai, Hong KongTel: (852) 2287 7228Fax: (852) 2865 6603Email: hkicpa@hkicpa.org.hkWebsite: www.hkicpa.org.hk1848_20220321The author would like to thank members of the Financial Reporting Standards Committee of theHKICPA for their input in reviewing this publication.AuthorCarrie LauAssociate Director,Standard Setting,HKICPA