HKCFEF Limited and the contributing law firms, accountants and sponsors are not offering these due diligence guidelines as legal, financial or professional advice or services and they should not be relied upon as such. These due diligence guidelines should not be used as a sole basis for any decision, action or inaction and are not meant to serve as a substitute for the advice of qualified professionals.
Due Diligence Guidelines –
Sample Questions for Reporting Accountants
1. Qualifications, Independence, Background/Relationship with the Companyi
(a) Please identify the members of your core team who are responsible for the current transaction and discuss their qualifications and experience and, if requested by the sponsor, provide the CVs of the core team members. Have there been any changes in the core members of your audit team that has worked on the Company’s audit? If so, please explain the changes and how you ensured the continuity of the audit work. If all or a substantial part of the audit work was carried out by an affiliated accounting firm, please describe, in general terms, the qualifications and experience of the team that carried out the audit work.
(b) Please provide information on your experience in auditing other companies in the same industry sector.
(c) Please describe the level of resources allocated to this project and assess the adequacy of the resources. If all or a substantial part of the audit work was carried out by an affiliated accounting firm or firms, please describe the level of resources allocated by such firm or firms and assess the adequacy thereof.
(d) Please confirm your independence from the Company in accordance with Professional Ethics Statement No. 1.203 on Conflict of Interest issued by the Hong Kong Institute of Certified Public Accountants (the “HKICPA”).
(e) Please describe the history of your relationship with the Company. In particular:
(i) How long has your firm been auditing the accounts of the Company? How long has the particular audit partner been involved?
(ii) Please describe the circumstances surrounding the change in accountant during the past five years or if, to your knowledge, any other audit firm has resigned at any time. In particular:
(A) Who were the prior auditors?
(B) Was a professional clearance letter issued?ii
(C) What discussions / investigation have you held as a consequence?
(D) Are you aware of any material disagreements with previous auditors, and, if so, how were these addressed?
(f) Please confirm that the scope of work you performed in connection with the your audit was appropriate in light of the opinion required to be given in the circumstances.
(g) Please describe the scope of any non-audit services your firm has provided (or been engaged to provide) to the Company during and after the Track Record Period.
2. Audit Committee and Internal Controls
(a) To the extent you are aware, please discuss the Company’s Audit Committee (whether historically active or newly / not-yet constituted) and financial literacy, and your interaction with it.
(b) Please describe the Company’s accounting computer systems. Is the entire business operating on the same accounting system? Are you aware of any major changes in the accounting systems during the last five years? Are there any areas where you have recommended (or plan to recommend) the Company’s accounting or other systems should be upgraded?
(c) Please discuss your interaction with the Company’s management and the nature of feedback reporting. For example:
(i) Does the audit partner (or other senior accounting firm personnel) typically meet with senior members of management outside of the audit process? If so, in what circumstances?
(ii) Do you normally discuss with management the preparation of interim financial statements?
(d) Does the Company have an internal audit function? If so, what is your understanding of the internal audit function’s organisation, budget and staffing? Who does the head internal auditor report to?
(e) Did you have access to the internal audit function, and was any reliance placed on the internal audit function for purposes of the audit?
(f) Have you made (or do you plan to make) any recommendations to management regarding the adequacy of the accounting and finance, or internal audit, staff at the Company (in terms of number of people or their qualifications, experience or knowledge)? Does the Company have staff reviewing applicable rules and regulations and those that are expected to come into force?
(g) Are you aware of any investigations conducted by the Company or a third party (i.e. law firm or investigation firm) in the past five years conducted as a result of whistleblower allegations?iii Describe how you took into account the results of such investigations in planning and conducting your engagement.
(h) Please describe any recommendations you have made (or that you plan to make) to the management regarding weaknesses in the Company’s accounting systems and controls (if any).
(i) Have you had access to any internal controls reports about the Company (whether prepared by the Company or a third party)? Were there any issues identified in the internal controls reports or systems which were unexpected based on the audit work? Were there any issues not identified in the internal controls reports or systems which, based on the audit work, you believe should have been identified?
(j) Please describe your observations on the availability, quality and consistency of record or data keeping of the Company. Have you made (or do you plan to make) any recommendations to the management of the Company in this regard?
(k) Please describe the Company’s cash management system. Have you made (or do you plan to make) any recommendations to the management of the Company in this regard?
3. Audit Matters
(a) Please discuss, in general terms, how you planned and conducted the audit. What were the primary areas you concentrated on when conducting the audit? Were there any aspects of the audit that were unique or highly unusual in your experience?
(b) Was any part of the audit based or significantly reliant upon work carried out by audit firms other than your firm? If so, please discuss.
(c) Did your team have full and adequate access to all materials you consider necessary to conduct your audit?
(d) Please discuss any actual or expected qualifications to your audit opinion or any disclaimer to the financial statements of the Company or any of its subsidiaries or associates. Please state whether your firm has, within the past five years, withdrawn from auditing the Company or any of its affiliates.
(e) What did you consider to be significant risk issues? How did you address those risks in conducting your audit of the financial statements of the Company?
(f) Have there been any major variances between the audited figures and management’s internal figures?
(g) Please describe any significant unresolved disagreements with management (in particular, with respect to the scope or conduct of the audit). Were there matters which, while not rising to the level of an unresolved disagreement, were the subject of prolonged or intensive discussions? In each case, please describe the matters, how they were resolved and how long it took to resolve them.
(h) Is it the current practice of your firm to record material recommendations in “management letters”?
(i) Please describe any material recommendations or suggestions raised (or which you plan to raise) with the Company. Were any management letters issued (or are any planned to be issued)? If not, for what reason(s)? For the recommendations you made and discussed with the Company, are you aware of any remedial actions taken by the management?
(j) Have you been informed that any of the audit papers or information provided by the Company are state secrets?
(k) Does your firm (and any affiliated firms that have possession of audit-related documents) have a policy to ensure the retention of audit related documents? Please confirm that the relevant policies comply with applicable professional standards or your firm’s policies (or, if there are no such standards, how the policy was developed). For how long are documents retained under the relevant policies? Where are the documents held?
(l) Have the prior audits (if any) of the Company progressed and been completed on time? Has the current audit been progressing on schedule? If not, why not?
(m) Please describe the procedures undertaken to verify cash balances and available lines of credit. Were there material cash balances or credit lines that were not verified? What procedures were employed to mitigate the risk of collusion between the Company and bank employees?
Note – Depending on the nature of the business, questions regarding procedures for verification of other assets (in particular, inventory, receivables and cash equivalents) may be appropriate.
(n) Please discuss your process for reviewing the Company’s related-party transactions.
(o) Are you aware of any material liabilities or legal proceedings, actual or threatened, against the Company or any of its respective affiliates?
(p) Are you aware of any notices from any regulatory, legislative or environmental authority indicating that the Company or any of its subsidiaries or associates is in violation of any laws regulating their respective businesses?
(q) Have you ever recommended (or do you plan to recommend) that the Company or its management seek legal advice with respect to actual or possible payments by the Company to government officials, government employees, political parties or political party officials? Please describe the circumstances.iv
4. Accounting Matters
(a) Were alternative GAAP choices available to the Company? What alternatives (if any) were discussed with you?
(b) Do the Company’s accounting policies conform in all material respects to GAAP? Please discuss any material deviations.
(c) The Company’s “critical accounting policies” are those accounting policies which are important to the portrayal of the Company’s financial condition and results of operations and which require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Have you read the discussion in the draft prospectus of the Company’s critical accounting policies? Please identify any additional policies or items which you believe management may wish to consider addressing in this disclosure.
(d) Were any of (i) the Company’s accounting policies or (ii) the manner in which they were applied, subject to prolonged or intensive discussions with management? Please identify such items. In particular, please consider the following:
(i) Revenue recognition;
(ii) Expense and capitalisation of expenses;
(iii) Exceptional or non-recurring matters;
(iv) Asset carrying values and impairments (including biological assets);
(v) Off-balance sheet liabilities;
(viii) Related-party transactions;
(ix) Currency exchange rates; and
(x) Employee benefits.
(e) Have the Company’s accounting policies been consistently applied at the end of financial periods (i.e., are there any seasonal effects or potential book closing procedures which may distort the financial statements?) and among the Company and its subsidiaries (i.e., across the consolidated group)? Have any changes to accounting policies or principles been made which would make any inter-period comparison misleading or not meaningful?
(f) Are you aware of any changes in the accounting standards or changes in the interpretation of applicable accounting standards to the Company which would have resulted in a restatement of the Company’s audited financial results for any of the last five financial years had they applied in the changed form at the relevant date such financial statements were published? Are any such changes expected or anticipated in the future? Please describe any changes during the Track Record Period in applicable accounting policies (or their application).
(g) Are there any upcoming changes in accounting standards as a result of published proposals? What about changes under discussion for which no proposal has yet been published?
(h) Please discuss any alternative approaches with respect to segment disclosure that were discussed with the Company. Are you aware of any prospective changes to reporting segments?
Note – depending on Company-specific circumstances, further discussions with the accountants and management regarding the Company’s accounting policies and their application with respect specific matters (including the following matters) may be appropriate:
(i) Revenue recognition, and provisions / reserves relative to accounts receivable;
(ii) Capitalisation of expenses or borrowing costs.
(iii) Exceptional (or other material non-recurring) matters;
(iv) Carrying values of assets and impairments. In this regard it may also be appropriate to enquire about the methodologies employed to determine the carrying values of particular assets, such as, for example, biological assets or assets for which fair value cannot be easily determined.
(v) Off-balance-sheet liabilities (including relationships with non-consolidated entities). In this regard, it may be appropriate to enquire about material undisclosed off-balance sheet items, commitments, guarantees, contractual defaults or other obligations.
(viii) Impact / significance of material related party transactions;
(ix) Impact of fluctuations in currency exchange rates;
(x) Treatment of employee benefits (including pensions and share options where applicable).
(i) Were there any actual write-offs or provisions? Please describe and explain the basis for write-offs, write-downs and adjustments arising from the audit (or which you are aware may be expected in the near future as a result of subsequent developments), as well as any provisions (whether or not made) that were the subject of prolonged or intensive discussions with the Company.
(j) Are you aware of any material related party transactions which should be disclosed in the financial statements which are not disclosed?
(k) Please describe the procedures used by the Company to identify, record and assess the propriety of transactions between related parties and the Company or its subsidiaries.
(l) Please discuss the Company’s funding of its pension plans and retiree health care costs. Are there significant unfunded costs?
(m) Please comment on the amount and adequacy of the Company’s reserves for accounts receivable, litigation and other contingent liabilities. Has bad debt experience changed materially over the past three years? On what basis were reserves calculated or evaluated? Describe any potential liabilities for which the Company does not have reserves because the liability is not yet “probable and estimable”.
(n) In general, what is the Company’s policy for expensing versus capitalising capital expenditures? Have there been any recent changes in such policy?
(o) Does the Company have any hedging or derivatives policies? Please describe the hedging and derivative transactions in which the Company engages? Are there any hedging issues of a material nature that have not been disclosed? Please describe the Company’s un-hedged risks with respect to currency, interest rate and commodity price fluctuations.
(p) Have the carrying values of any of the Company’s material assets been determined using a basis other than historical cost or fair value?
(q) [Note – depending on the company’s structure and history,] were there any material fair value adjustments?
Note – if there are unusual or non-recurring transactions reflected in the accounts or the note which are not clear, it may be appropriate to discuss these with the accountants and the Company’s management.
5. Interim financial information
(a) Did you perform any review of interim financial information during the Track Record Period? Do you expect to do so going forward?
(b) What standard has been or will be used by your firm to conduct the review? Please discuss in general terms how you planned for and conducted the review. Were there any aspects of the review that were, in your experience, unique or highly unusual?
(c) In the course of your review, did anything come to your attention that causes you to believe that the interim financial information is not prepared, in all material respects, in accordance with the applicable standard?
(d) Are you aware of any significant changes in the Company’s internal controls? If so, what is the potential effect of such changes on the preparation of interim financial information going forward?
(e) Are you aware of any uncorrected misstatements that are material (singly or in the aggregate) to the interim financial information?
(f) Did you encounter any significant difficulties in the course of the review?
(g) Are there any issues which currently remain unresolved?
(h) What matters relating to the interim financial information were the subject of prolonged or intensive discussions with the Company?
(i) Was the review completed on time? If not, why not?
(a) Please describe the role and work you have performed or will perform with regard to the Company’s profit forecast and working capital forecast. What Professional Standard or Guidelines govern this work ?
(b) What were the important assumptions made in the profit forecast and working capital forecast.
(c) Are you aware of any important assumptions that have not been identified and described in the profit forecast and cash-flow memorandum?
(d) Are there any significant disagreements with the Company’s management regarding the assumptions?
(e) Were any of the assumptions the subject of prolonged or intensive discussions with the Company’s management? Please elaborate.
(f) Were there any prolonged or intensive discussions with the Company’s management regarding any items ultimately included in, or excluded from, the profit forecast and working capital memorandum, or as to the level of detail included? If so, please elaborate.
(g) Please discuss, to your knowledge, the historic consistency of performance compared to budget/forecast.
(h) From an accounting perspective, how do the Company’s share schemes or derivatives potentially impact profits?
(i) Are you aware of any accounting rules or practices which might significantly impact profits (for example, any fair value adjustments or other non-cash items)? Are you aware of any planned or possible changes in accounting rules which could, if adopted, materially impact profits?
(j) What are the key sensitivities inherent in the forecasts and underlying assumptions which you discussed with management? Are they fairly reflected in the Company’s profit forecast and cash-flow memorandum?
(k) Do you have any reason to believe that the forecast revenues and profits are not based on realistic assumptions?
(l) Do you have any reason to believe the working capital projections in the profit forecast and cash-flow memorandum are not based on realistic assumptions?
(m) In your opinion, is the directors’ statement of sufficiency of working capital for the 12 months following listing, based on the assumptions in the cash-flow memorandum, made after due and careful enquiry? How would your answer differ if the Company did not have the listing proceeds available to it?
(n) Please confirm that you anticipate issuing your report(s) and comfort letters on the working capital statement and (where applicable) profit forecast in conventional form without unusual qualification or assumptions.
7. Accountants’ report and comfort
(a) Do you anticipate being able to deliver the required comfort letters, unqualified audit/review reports and consent letter in connection with this transaction?
(b) Is there any factual information which you have not verified to the extent required by auditing standards or to the extent you otherwise consider appropriate?
(c) Will there be a Statement of Adjustments? If so, what is the reason for each adjustment?
Are there any other matters which you would like to bring to the attention of the sponsor which would be material to the listing or the sponsor’s due diligence exercise?
i All references to the “Company” are to the listing applicant and its subsidiaries or, where the context so requires in respect of the period before the listing applicant became the holding company of its present subsidiaries, the present subsidiaries of the listing applicant and the businesses carried on by such subsidiaries or (as the case may be) their predecessors.
ii In certain circumstances, it may be appropriate to seek to obtain a copy of the Professional Clearance Letter as well as copies of the Company’s correspondence with the prior auditor.
iii If the answer to this question is yes, further due diligence with the Company’s management may be appropriate.
iv If the answer to this question is yes, further due diligence with the Company’s management may be appropriate.
HKCFEF Limited and the contributing law firms, accountants and sponsors are not offering these due diligence guidelines as legal, financial or professional advice or services and they should not be relied upon as such. These due diligence guidelines should not be used as a sole basis for any decision, action or inaction and are not meant to serve as a substitute for the advice of qualified professionals. See here for the full terms and conditions.