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 –
6.1.1 The accountants are often hesitant in answering questions which, in the accountant’s view, pertain to matters not properly relating to a strict interpretation of their engagement. This often can lead to the accountant declining to comment on 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).
6.1.2 In such circumstances the sponsor should generally:
(a) ask (and record) the reason why the 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.
Guidance in HKSIR 400 Regarding Accountant’s Responses to Interview Questions
6.1.3 HKSIR 400 provides guidance regarding the matters that an accountant will normally consider in responding to interview questions. Sponsors should bear and take principles and limitations in mind when formulating questions for accountants.
Questions that the accountant is usually able to answer:26
6.1.4 Some questions such as the accountant’s length of engagement with the listing applicant, professional standing and experience, any change of significant accounting policies, full and open access to materials, ability to deliver reports, consents, comfort letters and any other letters or reports in connection with the listing document and any delay to the completion of the accountant’s work should command brief factual answers. Set out below are some of the questions that the accountant may have more to consider or may restrict their answers:
(a) Nature, duration and scope of the accountant’s work – the accountant will usually refer the sponsor to the accountant’s report with respect to the scope of their examination and any limitation imposed on such scope. Sometimes, the accountant may describe the examination procedures performed on certain financial information in forming their opinion in the accountant’s report but no assurance will be provided on such items beyond that conveyed by the report.
(b) Independence of the accountant – the accountant may refer the sponsor to comments on independence in the written comfort letter, a draft of which may have been provided to the sponsor prior to the due diligence meeting.
(c) Discussion on pending litigation, commitments, contingent liabilities, guarantees, indebtedness and off-balance sheet items – the accountant will normally state that, other than what the sponsor already knows, no such item has been identified. They may point out that they rely to a large extent on the listing applicant in identifying outstanding contingencies. The accountant may give a brief outline of the procedures they have applied to contingencies, commitments and other such items, work performed in gathering evidence to determine whether any such contingent items require accrual or disclosure in the historical financial information.
(d) Potential write-downs in the current year – the accountant may inform the sponsor that they have ongoing dialogue with the listing applicant’s management and identify some of the accounting matters on which such discussion have taken place. They may highlight any disclosures regarding historical financial information items where there is a reasonable possibility that the recognised amount of such item could change by a material amount in the near term.
(e) Unusual items in the historical financial information – the sponsor should define what is meant by “unusual” given its ambiguous meaning in accounting terms.
(f) Access to and meeting with audit committee or board of directors – meetings with audit committee will involve a review and approval by the committee of the accountant’s examination plan and discussion of accounting and financial presentation issues. The accountant may state whether meetings were held at the request of the committee or the accountant. Meetings with the full board are less common and will usually relate to special assignments undertaken by the accountant.
(g) Disagreements with management – the accountant will usually state that the management is cooperative and they have always been able to resolve issues with senior management satisfactorily. Otherwise, the accountant will include a reservation in the accountant’s report.
(h) Significant weaknesses in internal control – the accountant will state whether such weaknesses have been reported to the listing applicant and may identify areas of weakness. They may also comment on changes that have been effected since the time when the weaknesses were reported. The accountant is not normally in a position to comment on the effectiveness of any action that has been taken by the management to address any weaknesses that have been reported. The accountant may also outline the limited nature of the review of internal controls with respect to their examination of the historical financial information.
(i) Related party transactions – the accountant may outline the procedures applied by it to identify significant related party transactions.
(j) Significant areas of audit risk – the accountant may identify the most critical audit areas and issues discussed with the audit committee. They may further explain that the assessment of audit risk is in relation to the fairness of presentation of historical financial information and not to provide comfort on individual elements within the historical financial information.
Questions that the accountant may refuse to respond to:27
6.1.5 The accountant will generally have difficulties answering the following questions and will typically explain the reasons why they are not able to provide the information requested:
(a) Is the listing document fairly presented? – there is no accepted standard by which the accountant can judge whether a listing document is fairly presented and except for the historical financial information in the listing document, the accountant is not in a position to make any representations as to the completeness or adequacy of disclosures in the listing document.
(b) Are there any matters that may affect the value of the securities offered under the listing document? – the accountant does not have the competence to express a view since this is within the province of the underwriters.
(c) Are provisions for losses adequate? – the examination by the accountant is to assess the presentation of the historical financial information as a whole and not to provide assurance on specific financial information items. The accountant may answer that they will not give an opinion without reservation if in their opinion the historical financial information did not give a true and fair view. They may describe the procedures performed by them in order to assess the adequacy of loss provisions in the context of the examination of the historical financial information as a whole. To the extent the accountant is able to comment on the adequacy of loss provisions, the accountant should provide an objective view on such matter.
(d) Are the accounting policies and methods used appropriate? – it is the responsibility of the listing applicant’s management for the selection and application of accounting policies. While the accountant is not required to assess the preferability of an accounting principle or method when acceptable alternatives exist, to the extent the accountant is able to comment on the accounting policies, the accountant should provide an objective view on such matter. In dealing with the sponsor, the accountant is very cautious about answering any question about the relative conservatism of the listing applicant’s accounting policies, as any answer is likely to be based on the accountant’s personal experience and not on any generally accepted criteria. However, the accountant may be able to address the relationship of the listing applicant’s accounting principles or practices compared with any other companies (including other companies in the listing applicant’s industry) if it has an adequate basis for providing such comments.
(e) What was the extent of the accountant’s involvement with the preparation of financial information in the listing document? – the responsibility for the preparation of financial information in the listing document rests with the listing applicant’s management and not the accountant.
(f) Are the allocations made to derive segment information appropriate? – where accountants are requested to comment on the acceptability of methods of analysis or allocation used in deriving figures not reported in the segment disclosures in the historical financial information, the accountant’s response will depend on the extent to which such allocation is made in, or can be derived directly by analysis or computation from, the listing applicant’s accounting records and any response will be subject to the following:
(i) allocations are to a substantial extent arbitrary;
(ii) the method of allocation used is not the only acceptable one; and
(iii) other acceptable methods of allocation might produce substantially different results;28
Questions that should be addressed to the listing applicant’s management:29
6.1.6 These questions include:
(a) Is the financial information contained in the listing document accurate in all material respects?
(b) What is the reason for the increase or decrease in certain historical financial information items from period to period?
In some cases, the accountant may have a basis to believe that management’s response might be inaccurate or incomplete. The accountant should discuss such concerns with representatives of the listing applicant’s management following the conclusion of the due diligence meeting with the sponsor and as timely as practicable. If, based on those discussions, the accountant concludes, in its judgment, that the response from the listing applicant’s management was inaccurate or incomplete, the accountant should request the listing applicant’s management to correct or supplement its response to the sponsor. If the listing applicant’s management declines to do so, the accountant is likely to consider discussing the matter with its lawyer and consider the appropriate course of action.30
6.2 Other Interview Considerations
For further guidance on interview practices, please refer to with respect to interview timing and preparation, arranging and conducting interviews, establishing the identity and authority of interviewees, the interview and follow-up, irregularities during interviews and records of interviews. A list of questions for accountants that may serve as a useful starting point in the preparation of questions for accountants is attached as Appendix II. Although additional questions may be called for based on the unique circumstances in particular transactions, if the sponsor has asked these questions and received responses it considers to be satisfactory, it should, as a general matter, have done sufficient work to address the issues raised.
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.