Chapter 12

Due Diligence Guidelines –

Financial

8. Audit Review Process

8.1 Standards

8.1.1 As a reporting accountant performs audit procedures on information received from a listing applicant under applicable professional standards, a sponsor is not expected to carry out any further due diligence on this information. [Note 1 to Paragraph 17.7(b) of the Code of Conduct]

8.1.2 Nevertheless if a sponsor is aware of any matters which raise concerns relating to the information underlying the accountant’s report, the sponsor should conduct further enquiries necessary to satisfy itself that these concerns are addressed; these enquiries may involve obtaining relevant supporting information and documents. [Note 1 to Paragraph 17.7(b) of the Code of Conduct]

8.1.3 Paragraph 14(d) of Practice Note 21 stipulates that where the sponsor is aware that the listing applicant has made formal or informal representations to an expert (i.e.: the Reporting Accountant in this context), in respect of an expert section or in respect of a report made in connection with the listing document, due diligence inquiries include assessing whether the representations are consistent with the sponsor’s knowledge of the listing applicant.

8.2 Guidance

8.2.1 Key Objectives of the Audit Review Process are:

(a) To confirm formal matters pertaining to the independence, qualifications and experience of the Reporting Accountant.

(b) To confirm the scope and prima facie integrity / sufficiency of the audit.

(c) To confirm similar prima facie integrity / sufficiency of the review process undertaken with respect to any interim financial statements for a recent “stub” period which have not been audited (including where the interim financial statements have been examined by the Reporting Accountant under standardised “review” procedures and reported as such under letterhead of the Reporting Accountant within the listing document).

(d) To identify any material unusual matters arising (including any material issues which required rectification).

8.2.2 Again, effective interaction with the Reporting Accountant is generally regarded as an important component of due diligence, and an area where the sponsor is significantly dependent upon the Reporting Accountant’s preparedness to embrace the process.

8.3 Recommended Steps

8.3.1 Audit / auditor due diligence is the subject of separate due diligence guidance (Chapter 20 “Due Diligence Guidelines – Accountants”)], and detailed reference should be made to that chapter.

8.3.2 Audit due diligence is also closely interrelated with the Internal Controls review (Chapter 13 “Due Diligence Guidelines – Internal Controls”), and detailed reference should also be made to that Chapter.

8.3.3 In all cases it will be important to arrange an interview meeting with the Reporting Accountant. For guidance on holding such meetings, reference should be made to Chapter 20 “Due Diligence Guidelines – Accountants” and Chapter 9 “Due Diligence Guidelines – Interviews of Major Business Stakeholders”.

8.3.4 The sponsor should prepare a detailed written agenda ahead of the meeting (see Chapter 20 “Due Diligence Guidelines – Accountants”).

8.3.5 Discussion items should normally encompass:

(a) The questions concerning the Reporting Accountant contained in section 1 (“Qualifications, Independence, Background / Relationship with the Company”) of the schedule of Sample Questions For Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”;

(b) The questions on the listing applicant contained in section 2 (“Audit Committee and Internal Controls”) of the schedule of Sample Questions For Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”; and

(c) The questions on the audit contained in sections 3 (“Audit Matters”) and 7 (“Accountants’ Report and Comfort”) of the schedule of Sample Questions For Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”.

8.3.6 In cases where the listing document will include unaudited interim financial statements, questions to be raised with the Reporting Accountant should generally include the questions contained in section 5 (“Interim Financial Information”) of the schedule of Sample Questions For Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”.

8.3.7 The sponsor should obtain copies of all management letters issued by the Reporting Accountant and all audit committee reports (if any) during or subsequent to the track record period, to be obtained either from the listing applicant or Reporting Accountant.

8.3.8 The sponsor should also obtain from the listing applicant copies of all representation letters issued to the Reporting Accountant during or subsequent to the track record period, and consider if any representations are materially inconsistent with information known to the sponsor (or the sponsor’s expectations from its general due diligence).

8.3.9 In the case of PRC enterprises, the sponsor should enquire of the Reporting Accountant and the listing applicant’s management whether any audit papers are state secrets of the PRC. If so, the sponsor should consult legal advisers and consider any appropriate disclosure to the Exchange and/or in the listing document.

8.4 Reliance on Another Firm’s Audit Work

8.4.1 The sponsor should enquire as to any significant reliance on other auditors.

(a) In particular, the sponsor should establish whether any part of the audit is based or significantly reliant upon work carried out by audit firms other than the Reporting Accountant?

(b) See section 3 (“Audit Matters”) of the schedule of Sample Questions For Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”.

8.4.2 If this is the case then:

(a) The sponsor should assess materiality through discussion with the Reporting Accountant;

(b) Materiality should normally be assessed in terms of (i) entity contribution and (ii) level of reliance placed by Reporting Accountant; and

(c) Depending on materiality, the sponsor should consider conducting due diligence interviews with the other auditors.

8.5 Investigation of any Prior Resignations

8.5.1 The sponsor should seek to ascertain if to the knowledge of the Reporting Accountant any other audit firm has resigned during the track record period or at any time preceding it.

8.5.2 In any case where this is so, the sponsor should further enquire as to:

(a) What discussions / investigation the Reporting Accountant has held as a consequence; and

(b) Are they aware of any material disagreements with previous auditors, and, if so, how has this been addressed?

8.5.3 See section 7 of Chapter 20 “Due Diligence Guidelines – Accountants” and section 1(e) of the schedule of Sample Questions For Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”.

8.6 Special situations

8.6.1 Special considerations may arise in other cases where there are multiple accountants, or where underlying accounts of some group companies have been prepared according to differing accounting standards. It is also necessary to be aware when audit working papers may be proprietary to the audit firm.

8.6.2 Reference should be made to section 7 of Chapter 20 “Due Diligence Guidelines – Accountants”.