Extract of SME-FRS: Paragraphs 46-52:
Realized profits and Realized Losses
46. Consistent with section 79A of the predecessor CO (Cap. 32), section 297 of the new CO states that a company may only make a distribution out of profits available for distribution and that, for the purposes of this section, a company’s profits available for distribution are its accumulated, realized profits, so far as not previously utilized by distribution or capitalization, less its accumulated, realized losses, so far as not previously written off in a reduction or reorganisation of capital. Such distributable profits are to be computed at the company-level, irrespective of whether the company prepares consolidated financial statements.
47. Also consistent with section 79A of the predecessor CO, section 291 of the new CO states that a reference to realized profits or losses of a company is a reference to those profits or losses of the company that are regarded as realized for the purposes of any financial statements prepared by the directors in accordance with principles generally accepted, at the time when the financial statements were prepared, with respect to the determination for accounting purposes of realized profits or realized losses.
48. In accordance with Accounting Bulletin 4 “Guidance on the Determination of Realised Profits and Losses in the Context of Distributions under the Hong Kong Companies Ordinance” issued by the HKICPA, a profit shall be treated as realised only when realised in the form of:
(a) cash; or
(b) other assets, the ultimate cash realisation of which can be assessed with reasonable certainty.
49. Most transactions recognised under the SME-FRS in company-level financial statements would satisfy this test. For example, a sale of inventory on normal credit terms will still give rise to a realized profit at the point of sale if the debtor is capable of settling the receivable within a reasonable period of time and there is a reasonable certainty that the debtor will be capable of settling when called upon to do so.
50. However, if the sale was in exchange for an illiquid asset, such as a property, the profit could not be regarded as realized until the property itself was sold in a cash or near-cash transaction, because the property would not be regarded as readily convertible to cash without a period of marketing. Similarly, unrealized profits might also arise if the sale was to, for example, a subsidiary, and the subsidiary had no independent means of settling the inter-company payable without assistance from the parent. As a result, care should be taken when computing profits available for distribution for the purposes of section 291 of the new CO, to exclude from the company-level retained earnings any amounts relating to profits which are still unrealized.
51. With respect to realized losses, in general, where amounts are charged against profit or loss (and hence recorded in company-level retained earnings), the charge should be regarded as being “realized” irrespective of whether it arose on re-measurement of the carrying value of an asset or liability, or the charge has crystallised, for example on settlement of a law suit. Adjustments should not therefore be made to add back any expenses or other charges when computing profits available for distribution for the purposes of section 291 of the new CO.
52. Further guidance on the concept of realized profits and realized losses can be found in Accounting Bulletin 4 and the accompanying Staff Summary issued by the HKICPA. However, it should be noted that this guidance is primarily intended to address a wide variety of differences between recognition requirements under full HKFRSs and the concept of realized profits or losses. Although the same principles for defining realized profits and losses will apply whether a company follows full HKFRSs or SME-FRS, in practice as the SME-FRS does not permit upwards revaluation of assets and does not contain specific requirements relating to more complex financial instruments, many of the differences identified in the Bulletin between recognised profits and losses and realized profits and losses will not be applicable to financial statements prepared in accordance with the SME-FRS. This guidance will therefore only be of relevance when the nature of consideration received in a transaction recognised under the SME-FRS gives rise to a potentially unrealised profit. For example, the guidance in section 9 on intra group transactions and in section 10 on asset swaps may be relevant in such situations.