Brief summary on Amendments to HKAS 17 Leases

The Amendments to HKAS 17 Leases are issued to eliminate the inconsistencies between the existing guidance between the classification of the land element and the general lease classification as laid down in the HKAS 17.

The Amendments to HKAS 17 are applicable for annual accounting periods beginning on or after 1 January, 2010.  Early adoption is permitted and should be disclosed in the financial statements of that fact.

Classification of leases of land and buildings

The guidance previously laid down in paragraph 15 of the HKAS 17 was deleted.  The deleted paragraph stated that if land had an indefinite economic life and the title of which is not expected to pass to the lessee by the end of the lease term, the land element is normally classified as an operating lease. Under the amendments, the classification of land and buildings as a finance or operating lease should still be separately assessed.  However, the classification guidance is limited to that stated in paragraphs 7-13, which apply to all leases.  In addition, the characteristic of land which has an indefinite economic life remains an important consideration.

Classification of interests in leasehold land situated in Hong Kong

In response to questions on the effect of these amendments affecting the classification of interests in leasehold land situated in Hong Kong, the HKICPA has issued additional guidance in the form of Question and Answer (“Q&A”) in November, 2009.   

The Q&A describes that in Hong Kong the transferable ownership interests in land is granted by the Government to occupy a designated portion of land for a specified period of time without passing the title of the land.  However, the Hong Kong property market normally has the following characteristics:-

1.      The lease premium on the initial lease term is paid in full at the beginning and the price paid by the buyer in the secondary market is in substance the minimum lease payments to acquire the right to use the land for the remaining period of the lease.

2.      In accordance with the land policy published by the Hong Kong Government, it is normally believed that the lease term stated in the land lease is capable to be extended at a nominal amount.

These indicate that at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all the fair value the land; and the lessee under the lease will in practice have the ability to continue to lease the land for a secondary lease term at a rent that is substantially lower than market rent unless there is no expectation of renewal.  If the market behaves that the interest in land is in substance the same as a freehold interest, in such circumstances, the lessee of such a lease is in effect having all the risk and rewards of ownership of the land.  The accounting for the land element as a finance lease would be therefore, consistent with the economic position of the lessee.  Therefore, in determining whether the land element is an operating or a finance lease, the consideration of whether the present value of the minimum lease payments equates to at least substantially all the fair value of the land as if it is a freehold is important.

Transitional provisions

Land elements of unexpired leases need to be reassessed at the date of the adoption of the amendments based on the information available at the inception of those leases.  Lease newly classified as a finance lease shall be recognized retrospectively in accordance with the HKAS 8 Accounting Polices, Changes in Accounting Estimates and Errors.  However, if the information necessary to apply the amendments retrospectively is not available, an entity shall apply the amendments based on the facts and circumstances existing at the date it adopts the amendments.  Any difference between the fair values of the asset and liability of the land lease is recognized in retained earnings.

Disclaimer:

The publication contains information in summary form and is therefore intended for general guidance only.  This publication is not intended as legal, accounting or other professional advice and should not be relied upon as such.  If legal, accounting or other professional advice or expert assistance is required, the services of a competent professional should be sought.  Neither Reanda Lau & Au Yeung Limited nor any related entity shall have any liability to any person or entity that relies on the information contained in this publication.

For details, please refer to the Amendments to HKAS 17 Leases and the related Q&A issued by the HKICPA in May and November 2009 respectively.