Problem 5.2 Before 2005, the hotel properties of Shangri-La Asia Limited were cl
ID: 2578607 • Letter: P
Question
Problem 5.2 Before 2005, the hotel properties of Shangri-La Asia Limited were classified as investment properties, which are stated at annual professional valuations at the balance sheet date. After the introduction of IAS 40 as HKAS 40 in Hong Kong, Shangri-La Asia Limited announced on 17 December 2004 that its hotel properties "will no longer be accounted for as investment properties" from 2005. It would adopt the following accounting policies retroactively . The underlying buildings and integral plant and machinery will be stated at cost . The underlying leasehold land will be stated at cost and subject to annul Evaluate the financial reporting implication on these changes in the accounting policy less accumulated depreciation and impairment; The underlying freehold land will be stated at cost less impairment: and operating lease rental charge (amortisation of land cost).Explanation / Answer
As per IAS 40,Accounting for Investment Properties, Investment Property is a property (land or a building—or part of a building—or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for :
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
This standard also distiguishes between investment property and owner-occupied property. Investment property is held to earn rentals or for capital appreciation or both. It generates cash flows independently of the other assets held by the entity. Whereas in case of an owner occupied property, the production or supply of goods or rendering of servicesgenerates cash flows that are attributable not only to property, but also to other assets used in the production or supply process.
Thus, if an entity owns and manages hotels, services provided to guests are significant to the arrangement as a whole. Therefore, an owner managed hotel is an owner occupied hotel rather than being an Investment property.
Thus HKAS 16, Property, Plant and Equipment applies to the hotels owned by Shangri-La Asia Limited.
As per Para 29, HKAS 16, An entity shall choose either the cost model in paragraph 30 or the revaluation model in paragraph 31 as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.
In the cost model, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.
In the revaluation model, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.
Moreover, If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which the asset belongs shall be revalued.
Also, As per IAS 8, If a change in accounting policy is required by a new IASB standard or interpretation, the change is accounted for as required by that new pronouncement or, if the new pronouncement does not include specific transition provisions, then the change in accounting policy is applied retrospectively. Therefore, the entity is correct in applying the changes retospectively
In the given case, if the entity applies the abovementioned changes in its accounting policies, following reporting requiments shall have to be complied with-
Disclosures as per HKAS 8, Accounting policies
Disclosures as per HKAS-16, Property Plant and Equipment
As per HKAS-17, Leases, Lease payments under an operating lease shall be recognised as an expense on a straight line basis over the lease term.
Thus, the entity's decision to record operating easehold land at cost and amortising the annual rental charge is incorrect.
The entity shall make following disclosures in respect of the underlying leasehold land: