HKFRS News 

As many businesses in China are controlled by the state, it can be difficult and onerous for state-controlled entities to identify and aggregate transactions with other businesses under state control.  For example, how would a state-controlled railway company be able to capture and record which passengers were travelling on business while working for other state-controlled entities?  Would this information be relevant if the charges paid by state-controlled entities were no different from amounts paid by the general public?  Similar example can be formed in other economies where many major enterprises remain under government ownership, including post, banks, petrol companies and others.
  
The proposals aim to give relief from the excessive disclosure of such transactions between state-controlled entities, since the cost of complying with HKAS 24 is likely to outweigh the benefits of the disclosures to users of the financial statements.  However, the exemption would not apply when influence actually exists between these entities.  An indicator approach is proposed to determine whether influence exists in such relationships.
     
The exposure draft also proposes to amend and clarify the definition of a related party to remove inconsistencies and improve readability.  The proposed changes include that:

• an associate and a subsidiary of a same entity (or a same person) are related parties, in the individual or separate financial statements of both the subsidiary and the associate.
   
• for two entities where one is an investee of a member of key management personnel (KMP) and the other is a company managed by the person that is a member of KMP, these entities are defined as related parties in the financial statements of both the company and the investee.  Under current HKAS 24 paragraph 9(f), these entities fall within the definition of related parties only in the financial statements of the company, but not in the financial statements of the investee.
   
• two entities are no longer considered related parties if a person has a significant influence over an entity and a close member of the family of that person has significant influence over another entity.  Under current HKAS 24 paragraph 9(f), these two entities fall within the definition of related parties.

While such changes may be minor for some companies, it could mean onerous disclosure requirements for others.  As such, management should be aware of the other changes before concluding that the proposals are not relevant.
 
In response to requests for urgency from constituents, and given the nature of the proposed amendments, the comment period would be 90 days rather than the 120 days originally proposed.  The HKICPA is expecting to receive the comments on or before 4 May 2007.

HKFRS 8 introduces the management approach to segment reporting and emphasises the disclosures of the measures used to manage the business in place of the rigidly defined disclosures required by HKAS 14 Segment Reporting.  A single set of operating segments replaces the primary and secondary segments.

There is a new concept, the chief operating decision-maker (CODM).  This is the function within an entity that allocates resources and monitors performance.  The information reviewed by the CODM is the key driver of external segment reporting and is used to determine both the segments and the measure of segment performance reported in the financial statements.  This approach will be unfamiliar to many companies and will require management to think carefully about the implications of the existing management reporting structure.  Management should also be aware that HKFRS 8 may have implications beyond segment reporting.  For example, a consequential adjustment to HKAS 36 Impairment of Assets could affect the asset groupings used to test for impairment.
 
PwC supports the introduction of HKFRS 8 and many companies will welcome the new guidance because it aligns management and external segment reporting and HKFRS with US GAAP.
 
Key implications
 
HKFRS 8 changes the emphasis of segment reporting.  The drivers are now the way businesses are run and the information used by key decision-makers.  There is less direct focus on products, geographies and GAAP measures unless they are used for internal reporting.  While some of the changes will have little impact on some companies, others will have to make radical changes to the way they identify reportable segments and present segment information.
 
HKFRS 8 disclosures focuses on the information that management believes is important and should therefore provide more meaningful segment reporting.  There is sometimes a boilerplate feel to HKAS 14 disclosures, and HKFRS 8 should lead to greater diversity in reporting.  For example, some companies might report a combination of business and geographical segments, while others that were previously a matrix organisation will identify a single set of segments.
 
HKFRS 8 should simplify financial reporting for companies that currently report different segment information for internal and external purposes.  This may also be good news for foreign private issuers as they will no longer have to maintain two sets of segment records to provide the information required by HKAS 14 and FAS 131 Disclosures about Segments of an Enterprise and Related Information.
 
HKFRS 8 might also be expected to reduce the volume of segment information because disclosures are required for only one set of segments, but this is not necessarily the case.  For example, a company that reports information about segment interest and taxes to the CODM will make more disclosures; and a company that reports a non-GAAP performance measure will have to reconcile to the GAAP measures reported in the income statement.
 
Some companies might find there is little change between the disclosures given previously under HKAS 14 or FAS 131 and those required by HKFRS 8, but this does not mean that the new guidance has no impact.  For example, operating segments sometimes determine the level at which goodwill is tested for impairment under HKAS 36, so the adoption of HKFRS 8 might cause some companies to reconsider the approach to the impairment test.
 
Actions to take now
 
While HKFRS 8 is not mandatory until 2009 calendar years, the challenge of adopting a new model for segment reporting should not be underestimated and management should begin thinking about implementation sooner rather than later.  Management might usefully consider:

• Early adoption - some companies will choose to adopt the new guidance early to align their HKFRS and US GAAP reporting or because management believes the new disclosures better reflect the performance of the business.
    
• Identification of the CODM - this is the key to identifying the segments and the measures that will be reported and is a new concept for many companies that report under HKFRS. Remember that the CODM may be several different people rather than a single individual.
      
• Required disclosures - will be driven by the performance and balance sheet measures reported to the CODM.  Management should consider whether the internal reporting pack contains all the information used to allocate resources and monitor performance.
     
• External perceptions - the segment disclosures might be different from the information that has been presented before, and the reconciliation to the income statement may be difficult to understand.  Management should consider the actions necessary to ensure the users of the financial statements know what to expect and what the new information means.
    
• Quality of management information - some of the disclosures required by HKFRS 8 may at present be derived from the management information system.  Therefore, management will need to consider whether these systems are sufficiently robust to withstand an external audit.
    
• Systems and controls - some internal reporting information will be made public for the first time and should be subject to the same systems and controls as any other data included in the financial statements.
   
• Impact of disclosing sensitive information - management might consider some of the disclosures required by HKFRS 8 to be commercially sensitive.  There are no exemptions, so the impact of potentially sensitive disclosures should be considered early in the process.
    
• Timetable - what needs to be done to be ready to report in accordance with HKFRS 8 and when.

HKFRS 8 requirements Operating segments are identified using the internal reports reviewed regularly by the CODM to allocate resources and assess performance; an operating segment is a component of an entity that engages in business activities whose results are reviewed regularly by the CODM and for which discrete financial information is available;   The CODM is a role rather than an individual.  The function of that role is to allocate resources to the entity's operating segments and assess their performance.  The CODM could be either a person, such as an entity's CEO (in reality, probably someone lower down the chain), or a group of people, such as a group of executive directors;   Reportable segments are those operating segments for which revenue, profit or assets exceed specified thresholds, and include segments that earn a majority of revenue from internal customers.  Operating segments may be aggregated if they share similar economic and other characteristics.  The number of reportable segments is not specified, but is unlikely to exceed 10;   The measure of profit and total assets that are reported to the CODM for each reportable segment should be disclosed, together with segment revenue, intragroup revenue, interest, depreciation, tax and other material items if they are reported to, or include the profit measure reported to, the CODM;   Segment revenues, profit or loss, total assets, and other amounts disclosed for reportable segments should be reconciled to the corresponding amounts in the financial statements;   The financial statements should explain how segment profit or loss and segment assets are measured, how the operating segments were determined and the differences between the measurements used in the segment disclosures and those used in the entity's financial statements; and   The financial statements should also disclose details of revenues from external customers for each product or service, about the geographical areas in which the entity operates, and about major customers, regardless of whether that information is used by management. HKFRS 8 applies to entities with listed equity or debt securities (or those in the process of issuing equity or debt securities).  The information is required in the entity's: consolidated financial statements; and separate or individual financial statements if the entity is not a parent. HKFRS 8 is applicable for periods beginning on or after 1 January 2009.  Early adoption is permitted, but this should be disclosed with comparative information provided on the new basis.