Deloitte China Audit Partner Xiao Shi.
On February 8, the China Securities Regulatory Commission (CSRC) issued the Guidelines for the Application of Regulatory Rules - Accounting No. 4, which clarified the equity attributes of infrastructure REITs, and consolidated that the original equity holders should report the shares held by other parties of infrastructure REITs as equity at the level of consolidated financial statements, and the investment of other investors in REITs is an investment in equity instruments.
It is clarified that the investment in REITs is an investment in equity instruments, and according to the provisions of the Accounting Standards for Financial Instruments, at the time of initial recognition, an enterprise may designate the investment in non-trading equity instruments as a financial asset measured at fair value through other comprehensive income ("FVTOCI"). The fair value of the investment REITs, that is, the ** fluctuation of the secondary market of REITs, will not be included in the income statement of the investment institution to affect its net profit, but will be directly included in the owner's equity of the investment institution, and the dividend income distributed by the REITs can be included in the income statement of the investment institution. In order to mitigate the impact of temporary fluctuations in the secondary market on the operating performance of investment institutions, and to adopt accounting treatment that is more suitable for investment purposes and business models, investment institutions that meet the relevant requirements of accounting standards are expected to designate their investments in REITs as FVTOCI classification.
FVTOCI uses different accounting treatments for changes in the fair value of REITs, the principal amount invested** and the distribution of dividends received. The dividends of REITs, whether they are property rights REITs or management rights REITs, actually include the distribution of principal and dividends, and how to reasonably distinguish the two is expected to be the next key accounting treatment in the REITs market.
1. Why is it attracting attention now?
In fact, how to reasonably distinguish the dividends of REITs into the distribution of principal and dividends has always existed. In August 2023, I focused on this matter in my article "Research on Financial Accounting Issues for Investing in Public REITs", which pointed out that the lack of unified standards and methods for investors to split the dividends of public REITs into "the ** of the principal" and "the distribution of income", "there is an impairment risk of the original equity holder's investment in the ** share of REITs" and "the accounting of the investment income of REITs by the REITs investor is inaccurate" The impact of this matter has been analyzed from three perspectives, but it has not been paid attention to by market participants before. Why is this issue a cause for concern after being classified as FVTOCI? Let's look at the following scenario.
On January 1, 2023, the investor purchased 1 million REITs** shares at a share of 10 yuan**. On May 10, 2023, REITS** will pay a dividend of 08 yuan **share (assuming that the principal amount ** is 0.)5 yuan ** share, dividend distribution is 0$3 **share). On June 30, 2023, the secondary market price of the REITS** was 95 yuan, the investor to 95 yuan **share**100,000**share. On December 31, 2023, the secondary market price of the REITS** was $9.
We use FVTPL and FVTOCI to consider whether to split REITs dividends and conduct a comparative analysis of the accounting treatment results in different situations.
1.On January 1, 2023, 1 million REITs** shares were purchased at a share of 10 yuan**
2.On May 10, 2023, REITS** will pay a dividend of 0$8 **Share
3.On June 30, 2023, the investor ended with 95 yuan **share**100,000**share, and the remaining 900,000** share will be subsequently measured according to the fair value according to the secondary market **price of the day.
4.On December 31, 2023, the secondary market price of the REITS** was $9.
Summarize the impact of the above different treatments on the investor's 2023 financial statements:
According to the analysis and comparison of the above results, under the FVTPL classification, although the amount of investment income and fair value change profit and loss recognized in the investor's 2023 income statement will also affect the amount of investment income and fair value change profit and loss, since both affect the net profit and affect the opposite direction and the amount is the same, whether the dividend is split has no impact on the net profit of the investment institution in 2023. Under the FVTOCI classification, whether the dividends are split or not will affect the investor's current net profit, and the affected amount is the principal amount included in the current REITs dividends. In other words, under the FVTOCI classification, if the dividends of REITs are not reasonably distinguished, it will lead to a deviation in the current net profit of the investor. This is why after being classified as FVTOCI, this matter will attract widespread attention in the market.
2. Is it only the REITs that have the right to operate to be involved in this matter?
As long as there is a limited term, not a perpetual existence, and the principal cannot be ** or needs to pay more funds to continue the operation at maturity (similar to paying the principal again), in essence, the principal of the investment and the income of the investment will be recovered through REITs dividends during the duration of the REITs. Therefore, whether it is a management right REIT or a property rights REIT, this matter will be involved.
Whether the impact of this event is significant depends mainly on the length of the remaining term of the underlying asset. The shorter the remaining term of the underlying asset, the higher the dividend rate of REITs, and the higher the proportion of "** of principal" included in REITs dividends; The longer the remaining maturity of the underlying asset, the lower the proportion of "** of principal" included in the dividends of the REITs. Since the term of management rights REITs is generally shorter than that of property rights REITs, the impact of this matter on management rights REITs is more obvious. In the first batch of REITs pilot projects issued and listed, there are already some REITs with short remaining operating periods, and after more than 2 years of dividends, due to the lack of consideration of the reasonable distinction of investment costs in dividends, there is an "inversion phenomenon" in which the investment cost is significantly higher than the discounted value of cash flow in the remaining term of the underlying assets. However, it is not only management REITs that are involved in the issue of dividend splitting. In fact, we have calculated that the "principal **" included in the dividends of the former is lower than that of the latter for operating rights REITs with a longer remaining term and property rights REITs with a shorter remaining period. This is another way of proving that all infrastructure REITs are involved in the matter.
3. How to make a reasonable distinction between REITs dividends?
Based on my observations and discussions with market participants, there are currently three suggested ways to distinguish dividends in the industry.
1.IRR (Internal Rate of Return) is used as the basis to split REITs dividends into principal and income. I call it the "IRR method".
Principle and basis:IRR can truly reflect the return level of investors' full-cycle investment REITs. IRR is designed to make the discounted present value of future cash flows generated by investors investing in REITs equal to the rate of return on costs. For investors, similar to spending a sum of principal, the holding period can be gradually ** "principal" and "income" per period, so with IRR as the benchmark, the split of investment principal and investment income can be realized.
Here's how:Based on the IRR of infrastructure REITs, for each dividend of REITs**, the investment cost is multiplied by the amount of IRR as the investment income, and the remaining part is used as the investment principal**.
Features:This method is to determine the investment income for the dividends of each REITs, and the remaining part is the ** of the investment principal. The amount of investment income in each period is relatively stable, and the investment principal shows a trend of first low and then high.
2.Based on the "proportion of asset usage", REITs dividends are split into principal and income. I call it the "asset usage method".
Principle and basis:: The investment principal of REITs, which can be understood as the purchase of infrastructure assets**. An important basis for the issuance of infrastructure REITs** is the appraised value of the underlying assets using the income method, and when the income method is used, the use of the underlying assets is the main source of cash inflows and asset losses generated by the assets**. According to the proportion of the actual use of the underlying assets to the estimated total usage at the time of the evaluation of the underlying asset income method, the ** of the current investment principal is calculated, and the investment principal and investment income are split.
Here's how:Taking expressway REITs as an example, the actual traffic volume of the expressway in the current year is used as the numerator, and the total traffic volume of the whole cycle in the prospectus of the expressway REITs is used as the denominator to calculate the proportion of the actual traffic flow in the current year to the total traffic flow of the whole cycle. The ** amount of the principal is the proportion of the actual traffic volume in the current year to the total traffic volume of the whole cycle multiplied by the investment cost of REITs, and the ** amount of the REITs dividend amount minus the principal is taken as investment income.
Features:This method is to determine the first amount of the investment principal for the dividends of each REITs, and the remaining part is used as investment income. Under this method, the amount of investment principal in each period is closely and positively correlated with the use of assets in the current period, because the use of assets is often an important factor affecting the current operating income and distributable amount of infrastructure REITs, therefore, the proportion of the ** amount of investment principal in each period to the current distributable amount and dividend amount is relatively stable.
3.Split into principal and income based on "depreciation and amortization amount of the underlying asset per period as the principal amount". I call this the "depreciation and amortization reconciliation method."
Principle and basis:The investment principal of REITs can be understood as the purchase of infrastructure assets**. Without taking into account the net residual value of the asset, the value of an infrastructure asset is zeroed out through depreciation and amortization of each period over its remaining life. The depreciation and amortization of infrastructure assets reflects the expected realized amount of the asset's use wear and tear and economic benefits, so the depreciation and amortization amount of the underlying asset per period is used as the principal of the REITs investment**, and the REITs dividend is split into principal and income.
Here's how:Divide the amount of infrastructure depreciation and amortization in the calculation table of the distributable amount on which the dividend amount of REITs is based, divided by the amount of REITs dividends, as the proportion of "principal**" in the distribution, multiplied by the initial investment cost as the amount of ** of the investment cost, and the remaining part of the REITs dividend is used as investment income.
Features:This method is to determine the first amount of the investment principal for the dividends of each REITs, and the remaining part is used as investment income. For REITs that use the average life method to calculate depreciation, the ** amount of the investment principal in each period is a fixed amount, and the investment income shows a trend of low and then high; For REITs that use the workload or usage method to calculate depreciation and amortization, the proportion of the ** amount of investment principal in each period to the dividend amount of REITs is relatively stable.
Let's compare the three methods as follows:
According to the above analysis and comparison, the depreciation and amortization reconciliation method is relatively simple to operate, and both management rights and property rights REITs have data** and basis as the calculation basis under the existing information disclosure rules. However, unlike property rights REITs, which basically use the average life method to calculate depreciation, operating right REITs have different depreciation methods for the same type of assets, and if the investment return rate of the same type of REITs assets is quite different due to different depreciation methods, it is neither comparable nor in line with the actual business situation.
The IRR method is the most comparable, based on the information publicly disclosed by the management rights REITs, and is comparable not only for the same type of assets, but also for different types of assets. However, at present, property rights REITs do not have IRR data and cannot be applied.
The asset usage method requires more basic data to be used for calculation, and the calculation is relatively complex than different disclosure documents. As with the IRR method, it does not apply to title REITs. At the same time, the different types of operating rights REITs are not comparable.
Taking into account various factors, it is recommended to adopt the IRR method for management REITs; For property REITs, the depreciation and amortization adjustment method can be considered.
4. Recommendations
When more and more investment institutions designate their investment in REITs as FVTOCI, REITs dividends will be divided into "principal **" and "dividend distribution" in a reasonable way, which will become a problem that the REITs market must face.
According to the analysis and comparison of the above methods, each method has its basis and reason, but each method is also imperfect and has its inherent limitations and shortcomings. Since it is a problem that must be faced, thinking, it is a problem; Do it, there is an answer. The pilot of infrastructure REITs in China is itself a process of starting from scratch, crossing the river by feeling the stones, and solving problems in development, and the financial accounting and accounting treatment of infrastructure REITs are the same. In the face of this innovative business and product, when market participants have different proposals for the split of REITs dividends, and each plan has its own advantages and disadvantages, it is recommended not to rush to clarify and standardize the policy, but to encourage REITs and asset types based on different characteristics, choose the appropriate method to do it on a pilot basis, find problems, solve problems, listen to feedback, and continuously improve in the process of pilot operation.
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