Policy Statement & Submission

Consultation on Accounting and Auditing Provision in the Companies Ordinance
Response by the HKGCC, September 2007


1. We acknowledge the need to update legislation on accounting and auditing provision in the Companies Ordinance to enhance Hong Kong's competitiveness and attractiveness as an international business and financial centre. The purpose of this paper is to provide a Chamber response to the consultation on Accounting and Auditing Provision in the Companies Ordinance.

2. With regard to the provision on SMEs, we wish to take up three issues, namely, definition of SME, the audit process, and transparency.

Definition of SMEs

3. While we support a simplified audit process for SMEs, we have observed a potential issue on the criteria for SME. The proposed definition is to set a threshold of HK$50 million turnover. While this is not uncommon in some circumstances where revenue is the main consideration (e.g. the Inland Revenue Department exempts small businesses with gross income not exceeding $500,000 from providing supporting documents when lodging tax return), for the purpose of understanding a business, such a threshold is over-simplistic. For instance, for the same turnover of HK$50 million, there could be a big difference in profit margin between a trading company and a consultancy firm. Likewise, a Hong Kong company may be small if its only turnover is dividend, say, not exceeding HKD1 million, but it may hold substantial investment in China in the form of Wholly Owned Foreign Enterprise (WOFEs). Such a narrowly-based definition to justify a Section 141D audit has given rise to the concern that a risk may be created for investors seeking to acquire genuine SMEs.

4. Unless the purchaser appoints its own accountant to perform due diligence, the simplified audited account may be misleading and may create a risk for firms (especially smaller foreign firms) who wished to buy into a small company in Hong Kong. Given that Hong Kong is now a platform for holding investments in China, foreign investors are keen on buying equity interest in Hong Kong intermediate holding companies rather than buying the equity interest in China companies direct (due to the uncertainty of mainland China's existing commercial law). Defining SMEs by turnover may be expedient, but this must be weighed against the potential impact arising from a reduced level of protection on investors.

The audit

5. On the audit itself, although 141D requires a profit and loss account to be prepared and attached to its balance sheet, the auditors' report covers only the balance sheet and the accompanying notes, with no requirement for the auditors to report on the profit and loss account, which is relegated to "other information". Although the same procedure may be adopted, there is a difference in the extent of disclosure. Thus 141D gives an impression that it is not a traditional audit. This is reinforced by the “true and correct” rather than “true and fair” conclusion. Since there is no statutory definition of what is a "true and fair view" as against a "true and correct view", the equivalence or otherwise of 141D with traditional audit is an open issue which may lead to confusion. The SME may become the loser if additional audit (and hence additional cost) is necessitated by apparent inconsistency between audit report and financial information in other parts of the annual report. Such potential problems should be alleviated through more informed use of 141D, which would require more publicity on this and related aspects of the Companies Ordinance.

Transparency and disclosure of information

6. On inspection of records, it is understandable to enhance the right of auditors to obtain additional information in performing their audit. On the other hand, we are concerned if the same right of access to company records is given to staff, thus resulting in SME employers having to explain to staff and possibly revealing confidential information such as their asset and estate, or income of directors or staff members. Misinterpretation of such information may breed ill-founded allegations by staff to government departments such as Labour, Inland Revenue, Police or ICAC, which would affect innocent SMEs unnecessarily.

7. While we appreciate the rationale of transparency, it should perhaps be nurtured through a culture-change, such as that in Europe, rather than hurried through legislation. In the case of Europe, a more educated and better-informed workforce, with the backing of the social safety net, are much less likely to misread financial statements or draw wrong conclusions about an SME's financial health and thereby generating unnecessary anxiety about their job security, with potentially disruptive impact on the SMEs.

Other concerns

8. Besides, we have also identified a number of issues which require more direction and clarity. Key issues of concern include,

- An unnecessary shifting of responsibility from auditors to directors (the latter are already required to declare to auditors that they have provided all relevant information);
- Questionable requirements to include more forward-looking statements in company accounts, which by their nature will not meet rigorous standards;
- Overly broad terminology regarding disclosure;
- Expansion of the right to inspect accounting records to include senior non-director management (a concern shared with SMEs);
- Efforts to expand the powers of the Companies Registry;
- Restrictions on (re)aligning accounting reference dates;
- Discrepancies between accepted accounting standards and proposed Companies Ordinance amendments (e.g., accounting guidelines require publicly traded debt instruments be consolidated into group accounts, whereas the proposed amendments waive such a requirement); and
- Unnecessary efforts to include current – and evolving – accounting standards in the Ordinance (such issues are best left to accounting standards bodies).