Key Analysis for Directors and Auditors
In response to the Joint Statement1 issued by the Hong Kong Securities and Futures Commission (SFC) and the Stock Exchange of Hong Kong Limited (Exchange), the Financial Reporting Council (FRC) and the Hong Kong Institute of Directors (HKIoD) also issued advice and guidance to directors and auditors on company audit and corporate reporting of financial statements under the special circumstance amid the novel coronavirus outbreak.
Following the release of the FAQ article of the Joint Statement, EY team has summarized key messages from the FRC and the HKIoD for directors, non-executive directors, audit committees and auditors of listed companies.
Important message from the FRC and the HKIoD to directors and auditors of Hong Kong listed companies.
Advice to directors:
1. The whole board has collective responsibility which is not limited to the audit committee.
2. The board must put in place necessary internal control to enable the preparation of financial statements that are free from misstatement.
3. Directors should exercise extra due care when releasing unaudited financial information without agreement with the auditor. Directors do not need to be too worried about subsequent actions from the regulators as long as they have faithfully performed and discharged their duties.
4. Pay attention to key audit and accounting issues.
5. Ensure proper documentation of all board deliberations.
6. Ensure timely disclosure of inside information.
7. Directors should contact the regulators in case of real difficulty in publishing financial information on time.
Results available without consensus with the auditor
The Joint Statement by its wording would require issuers to publish preliminary results by the deadline if such results are available but without an agreement from the auditor. To avoid doubt, the issuer will still have to consult the Exchange.
To publish without an agreement with the auditor would mean publishing information when the auditing team has not completed its work. The issuer’s board may have missed or misunderstood the latest changes in accounting standards. The auditor may have a valid reason to challenge the treatment of certain assets or liabilities. The lack of agreement with the auditor pose directors reasons to be worried.
Based on the understanding of the HKIoD, if the issuer’s board has been diligent and reasonable in their treatment of the accounts and the interpretation of applicable standards, that the auditor may later disagree would not subsequently attract regulator’s actions unless there is evident fraud or other serious wrongdoing.
In all other cases, the Joint Statement would require issuers to consult with the Exchange on what information is available, and to describe uncertainties and state how they may affect the numbers so the SFC and the Exchange can assess whether the information available is “accurate and complete in all material respects” and, if published, would facilitate an informed investment decision.
The nature and scope of uncertainties that may be present could well be material and will involve much value judgment. The audit process is a means to provide assurance on the validity and credibility of the information eventually published. Without audit, an issuer’s board may steer conservative and, out of liability reasons, become inclined to put out many disclaiming and qualifying statements to reduce the utility of the information published.
The regulators indeed do not want a flood of cautionary statements as to make disclosure not useful. The regulators are more interested in knowing whether the board has put in a good faith effort to understand the issuer’s financial information available, the key audit matters that would more likely involve judgment (and, in normal times, actual discussions with auditor), how the board has come down to the position taken as to these key audit matters and then succinctly inform investors the rationale. Based on the understanding of the HKIoD, a good faith effort that has gone through this deliberation process would not subsequently attract regulator actions unless there is evident fraud or other serious wrongdoing.
Advice to non-executive directors
1. Obtain written affirmations from the management that there has been no failure in internal control, no material inconsistency in financial record keeping, and that there has been no unusual event or occurrence at relevant times.
2. Be proactive in board proceedings to question and check on the information, assumptions and assurances given by the management. Non-executive directors who are not audit committee members may consider sitting in audit committee sessions.
3. If face-to-face communication is better than video conferencing, the director should request directly.
Advice to audit committees
1. The audit committee should focus its effort on emerging risks and challenge the management’s judgement and assumptions which may have significant impact on financial reporting, such as changes in internal control; challenges, risks and opportunities facing the entity; key judgements and estimates made in preparing the financial statements (e.g., forecasts and underlying assumptions used in impairment and going concern assessments); and significant subsequent events.
2. Ensure audit fees are appropriate to safeguard audit quality.
3. Initiate discussion with auditor in the absence of management, if necessary, to ensure that the auditor is not under undue pressure from management to complete the audit.
Advice to auditors
1. Be mindful of professional integrity and do not succumb to pressure
2. Ensure active partner involvement and sufficient time to undertake the audit
3. Be prepared to challenge the management and undertake additional work
4. Maintain effective quality control
Reminder of key audit and accounting issues from the FRC
1. Impairment of assets
Uncertain economic environment globally and locally increases the likelihood of impairment of both financial and non-financial assets. The management should prepare cash flows/profit forecasts which are reasonable and supportable and represent the management’s best estimate of the economic circumstances. Auditors are reminded to exercise professional skepticism and challenge the management on key assumptions, in particular, when the management’s judgements and estimates appear to be “too good to be true”.
2. Breach of bank covenants and going concern
When assessing the entity’s ability to continue as a going concern, directors should take into account all the available information (e.g., the global and local economic slowdown, the novel coronavirus, operating losses, suspension of operations, working capital deficiencies, loan defaults or denial of credit from suppliers) about the future which is at least 12 months from the end of the reporting period. This assessment should be based on realistic but not overly optimistic assumptions.
In the event of breach of bank covenants, the related borrowings may be reclassified under current classification on the balance sheet date, which will impair the entity’s ability to continue to use the going concern basis of accounting in the preparation of the financial statements. Auditors should robustly challenge the assumptions underlying the management’s assumptions and should not be biased toward obtaining audit evidence that may be corroborative to the management’s representation.
Reminder of key audit and accounting issues from the FRC
In particular, audit procedures should cover whether the management’s plans in relation to debt repayment is feasible under the entity’s circumstances; and whether such assumptions are consistent with related assumptions used in other areas of the entity’s business activities (e.g., impairment of assets) based on auditors’ knowledge obtained in the audit. Auditors should evaluate the overall audit evidence obtained and modify the auditors’ report where appropriate.
3. Revenue recognition
A revenue recognition should reflect the substance of business transactions. Where the entity has complex revenue arrangements, for example license arrangements for intellectual property, barter transactions, contracts with multiple elements, and contracts with milestone payments, auditors should perform an in-depth analysis to understand the substance of the arrangements to ensure that revenue recognition of these transactions are properly accounted for in accordance with HKFRS 15 “Revenue from Contracts with Customers”.
4. Unusual transactions
Significant transactions that are outside the normal course of an entity’s business may provide opportunities for the management to engage in fraudulent financial reporting or conceal misappropriation of assets. Auditors should exercise professional skepticism in evaluating the business rationale for such transactions and the appropriateness of accounting treatment and disclosure in financial statements. Where appropriate, auditors should communicate with audit committees about such transactions on a timely basis so that audit committees can act accordingly.
For full article, please see Key analysis for directors and auditors of Hong Kong-listed companies in response to the coronavirus outbreak
Article courtesty of Ernst & Young Global Limited
Posted on 2020/03/16