Differences in financial reporting standards

The Hong Kong Institute of Certified Public Accountants (HKICPA) announced that Hong Kong would adopt new accounting standards, which would fully comply with the International Financial Reporting Standards (IFRS), and be effective for financial reporting periods beginning on or after January 1, 2005.

Below are the key changes in International Financial Reporting Standards and Hong Kong Financial Reporting Standards and their impact on initial public offerings (IPOs) in Hong Kong.

Share-based payment is a new standard, which requires the recognition of all share-based payment transactions in financial statements. In particular, shares or share options granted to employees as remuneration should be recognized as an expense and included in the operating results, using a fair value measurement basis. Previously, such share options were not expensed in the financial statements. Management will need to assess the impact on financial statements when planning to introduce share options schemes to the employees or other parties.

Business combinations is another important standard. It requires all business combinations within its scope to be accounted for using the purchase method. Under the purchase method, the results of operations of the acquiree can only be incorporated into the consolidated income statement of the acquirer from the date of acquisition. However, business combinations involving entities under common control are outwith its scope. As the restructuring of State-owned enterprises for IPOs involves reorganizations of entities under common control, in practice, under IFRS, many of such restructurings will be treated as if the group structure existed at the beginning of the reporting periods. But under the new standards, such transactions may be within the scope of SSAP 27 Accounting for Group Reconstructions, in which case, merger accounting (i.e. the financial statement items of the combining enterprises should be included in the financial statements of the combined enterprises as if they had been combined from the beginning of the earliest period presented) could only be used when certain strict criteria are met.

Under the new standard, "goodwill" will no longer be subject to periodic amortization, but instead will be subject to an impairment test at least annually. And "negative goodwill" will be recognized in the income statement immediately, instead of deferred and amortized over a period of time.

Although previous versions of financial instruments are already effective under IFRS, the standards are very complex and are difficult to implement. For Hong Kong, they are new accounting standards and represent a fundamental change to the accounting treatment on financial instruments. All financial assets and liabilities, including derivatives, are required to be recognized on the balance sheet, and many of them are based on fair value measurement. Changes in the fair value of financial instruments held for trading and others designated should be recognized in income statement. There may be significant implementation issues in practice. Banks, other financial institutions, and companies with various financial instruments (including derivatives, such as forward contracts, futures, swaps, and options) will be affected with more volatility to their earnings.

Source: China Daily