Due Diligence Guidelines –
7. Accounting Review Process
7.1.1 Regarding the preparation of a listing document, a sponsor should examine and consider the accuracy and reliability of the financial information, including reviewing the financial statements of major subsidiaries, internal financial records, tax certificates, regulatory filings and public records. [Paragraph 17.6(d)(v) of the Code of Conduct].
7.1.2 Paragraph 12(b) of Practice Note 21 similarly provides that typical due diligence inquiries in relation to the new applicant’s compliance with the qualifications for listing include reviewing material financial information, including:
(a) financial statements of the new applicant;
(b) financial statements of all subsidiaries of the new applicant and other companies that are material to the group’s financial statements; and
(c) the internal financial records, tax certificates and supporting documents to the tax certificates for the trading record period.
7.1.3 Paragraph 12(b) of Practice Note 21 further provides that such review would in most cases include interviewing the new applicant’s accounting staff and internal and external auditors and reporting accountants and, where relevant, obtaining comfort from the new applicant’s external auditors or reporting accountants based upon agreed procedures.
7.2.1 Key objectives of the sponsor’s accounting due diligence are to understand the relationship between:
(a) financial presentation of the listing applicant in the listing document; and
(b) the listing applicant’s financial performance and position underlying this presentation.
7.2.2 This necessitates an understanding of accounting technicalities and related judgmental decisions of the listing applicant’s management which affect presentation of the listing applicant’s financial statements.
7.2.3 Accounting aspects should form part of the sponsor’s overall financial review, and should normally involve:
(a) Preliminary desk-top review by the sponsor, normally covering:
(i) Review of the listing applicant’s accounting policies;
(ii) Identification of any disclosed departures from applicable accounting standards;
(iii) Consideration of critical / significant accounting policies;
(iv) Comparison to peers and competitors (so far as feasible); and
(v) Identification and consideration of any changes upcoming as a result of published proposals etc;
(b) Discussions with management (see above sections 4 “Financial Review Process (Overview)” and 5 “Detailed Financial Review Process”);
(c) MD&A discussions / drafting meetings (see section 5 above (“Detailed Financial Review Process”)); and
(d) Due diligence interview(s) with the Reporting Accountant.
7.3 Reporting Accountant Interviews
7.3.1 The primary purpose of the Reporting Accountant interview (from an accounting perspective) is to obtain informed, objective expert input (based on information obtained from the audit exercise and, where applicable, broader relationship and history with the listing applicant), against which to measure the sponsor’s internal analysis and its discussions with management. The Reporting Accountant’s presence and input at MD&A drafting meetings is beneficial to this process, and it is recommended that they are requested to attend.
7.3.2 Audit / auditor due diligence is the subject of a separate Chapter (Chapter 20 “Due Diligence Guidelines – Accountants”), and detailed reference should be made to that chapter.
7.3.3 The accounting discussion with the Reporting Accountant should (subject to the Reporting Accountant’s preparedness to embrace the process consistent with prevailing industry practices and its terms of engagement) be a detailed discussion with a prepared written agenda tailored to the sector and circumstances of the listing applicant. (Again, see Chapter 20 “Due Diligence Guidelines – Accountants”).
7.3.4 Although the detailed agenda will vary, consistent with overall objectives of the financial due diligence exercise the discussion will normally (and should wherever applicable) encompass the questions contained in sections 4 (“Accounting 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”.
7.3.5 In practice, the Reporting Accountant’s interaction with the sponsor will normally be governed by a detailed professional reporting standard, usually Hong Kong Standard on Investment Circular Reporting Engagements 400 “Comfort Letters and Due Diligence Meetings” issued by the Hong Kong Institute of Certified Public Accountants (and related Technical Bulletin – AATB 3). (Again, see Chapter 20 “Due Diligence Guidelines – Accountants”).
7.3.6 Reporting Accountants are often guarded about answering questions which, in the Reporting Accountant’s view, pertain to matters not properly relating to the strict engagement. This can lead to the Reporting Accountant declining to comment on some questions of interest to the sponsor, or providing comments which do not contain substantive additional information (for example, by referring to the unqualified audit opinion without specific information).
7.3.7 In such circumstances the sponsor should generally:
(a) ask (and record) the reason why the Reporting Accountant is unable to respond to the question in the form asked; and
(b) if practicable (which often may not be the case), seek to determine an alternative formulation of question which may address the issue.
7.3.8 Effective interaction with the Reporting Accountant is generally regarded as an important component of due diligence, but an area where the sponsor is significantly dependent upon the Reporting Accountant’s preparedness to embrace the process.
7.4 Internal Audit Function
7.4.1 As part of the sponsor’s overall due diligence, the sponsor will wish to ascertain whether the listing applicant has an internal audit function and, if so, to understand the staffing, organisation, responsibilities, authority and reporting practices of the internal audit team.
7.4.2 This aspect of due diligence is primarily a part of the sponsor’s investigation of the listing applicant’s internal systems and controls.
7.4.3 The sponsor should also enquire of the Reporting Accountant with respect to the Reporting Accountant’s evaluation and opinion of the internal audit function. (See section 8 “Audit Review Process – Recommended Steps” below).
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.