Chapter 12

Due Diligence Guidelines –

Financial

10. Unaudited Financial Content

10.1 Standards

10.1.1 Paragraph 13(a) of Practice Note 21 provides that typical due diligence inquiries in respect of each new applicant and the preparation of its listing document and supporting information include assessing the financial information to be published in the listing document including:

(a) obtaining written confirmation from the new applicant and its directors that the financial information (other than that already reported upon by a reporting accountant) has been properly extracted from the relevant underlying accounting records; and

(b) being satisfied that the confirmation referred to at paragraph (a) has been given after due and careful inquiry by the new applicant and its directors.

10.2 Guidance

10.2.1 The information contained in a Hong Kong listing document will typically include a range of operational and financial data some of which will be (or will be directly derived) from the audited financial statements (for example, figures for annual revenue used in the MD&A section) and some of which will be strictly operational (not financial) in nature (for example, customer numbers, or units of product sold or produced).

10.2.2 Some information may be more difficult to categorise as purely operational or financial in nature (for example, revenues by top 10 customers, or average rentals per square foot), and some financial information will not be capable of simple direct derivation from the audited financial statements (for example, a breakdown of non-performing loans or other assets into commercial sub-categories which are not split out in the applicable Notes to Financial Statements).

10.2.3 All statistical information of this nature needs to be substantiated objectively to a suitable standard, and the methods by which this is accomplished vary according to the nature of each particular category of information and the circumstances of the particular case.

10.2.4 Audited Financial Data

(a) Information extracted or capable of direct derivation from audited financial statements is typically treated on (effectively) the same basis as the audited financial statements. That is to say (i) it is considered to be audited information (so that sponsors are not normally required to carry out any further due diligence) and (ii) this is evidenced and recorded in a section of the primary auditor “comfort letter” commonly known as “circle-up” (which refers to the copy pages annexed showing the “circled” data which has been checked).

(b) Data re-computed from information extracted or capable of direct derivation from audited financial statements is typically treated (and evidenced and recorded) on the same basis.

(c) Sponsors should always understand the concept and substance of any ratios or derivations re-computed from audited financial information in order to be satisfied as to the suitability of such content. Beyond that (subject to general considerations noted in section 12 below (“Red Flags and Similar Irregularities”) with respect to concerns arising from such discussions and enquiries), sponsors are not normally required to carry out any further due diligence.

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

10.2.5 Unaudited Interim Financial Statements

(a) A listing document will sometimes contain interim financial statements for a recent “stub” period which have not been audited (for example, where a new listing applicant or any of its subsidiaries is listed on another exchange and has published unaudited quarterly/ interim financial statements in accordance with the other exchange’s rules and regulations that covers a period more recent than that required under the Listing Rules, the listing applicant’s Hong Kong listing document must include such unaudited information, see Exchange Guidance Letter GL82-15). Normally such financial statements will be examined by the Reporting Accountant under standardised “review” procedures (i.e., Hong Kong Standard on Review Engagements 2410 “Review of Interim Financial Information Performed by the Independent Auditor of the Entity”). This review would normally be formally reported under letterhead of the Reporting Accountant within the listing document.

(b) Sponsors would normally be expected to conduct discussions and enquiries with respect to such interim financial statements as part of the detailed Financial Review Process (see section 5 above).

(c) As part of the Audit Review Process (see section 8 above), discussions with the Reporting Accountant should extend to the interim financial statements, with the primary objectives (i) to confirm prima facie integrity / sufficiency of the review process and (ii) to identify any material unusual matters arising (including any material issues which required rectification). (See paragraph 8.3.6 above). Reference should be made to the Sample Questions for Reporting Accountants in Appendix II to Chapter 20 “Due Diligence Guidelines – Accountants”.

(d) Subject to general considerations (noted in section 12 below “Red Flags and Similar Irregularities”) with respect to concerns arising from such discussions and enquiries:

(i) Interim financial statements which have been reviewed and are presented in this way are considered generally suitable for inclusion in a listing document; and

(ii) (Similarly to audited data) information extracted or capable of direct derivation from such interim financial statements is typically evidenced and recorded as such in the “circle-up” section of the primary auditor “comfort letter” and treated on (effectively) the same basis as the interim financial statements (so that sponsors are not normally required to carry out any further due diligence).

10.2.6 Unaudited Data

(a) Sponsors are expected to carry out a suitable level of due diligence on financial data which are not directly derived from the audited financial statements.

10.3 Recommended Steps

10.3.1 The methods by which this is accomplished vary according to the nature of each particular category of information and the circumstances of the particular case, but the following principles serve as a general guide:

(a) The sponsor should (i) have a good understanding of how the information has been assimilated and (ii) conclude that the basis of assimilation has been sufficiently substantiated and is sufficiently reliable for the information to be included in the listing document on the basis on which it is described and presented.

(b) Where the data is closely (but not directly) derived from the audited financial statements, it may be taken (or computed) from schedules prepared by the listing applicant’s management which are reconcilable to the listing applicant’s underlying books and records from which the audited financial statements have been prepared. In such cases, it is common (and where possible should be the case) that the data is compared and confirmed by the Reporting Accountant in the “circle-up” section of the comfort letter as having been compared/agreed to the underlying books and records.

(c) In other cases, the information may not be so readily reconcilable to the listing applicant’s underlying books and records, but may nevertheless be taken (or computed) from schedules prepared by the listing applicant’s management which are capable of substantiation to a sufficient level to permit the Reporting Accountant to provide similar comfort in the “circle-up” section of the comfort letter, but on the basis that the schedules have not been traced to the underlying books and records.

(d) In such cases where information is not readily reconcilable, the procedures should be discussed with the Reporting Accountant and understood in the course of settling the applicable “agreed-upon-procedures”.

(e) In practice, reputable audit firms will take care not to be associated with misleading data so where this form of “circle-up” comfort is agreed to be provided (i) the Reporting Accountant can normally be expected to ensure that “comforted” data has been obtained from a satisfactory source and (ii) the reasons why the data cannot be traced to underlying books and records (which will differ from case to case) will never normally relate to unreliability of internal systems. However, the sponsor should not place “blind” reliance on this assumption and these questions should be discussed with the Reporting Accountant (to understand the nature of the Reporting Accountant’s procedures) as part of the exercise through which the comfort letter is settled.

(f) Where the data is derived from other computer generated exercises, the sponsor should (i) discuss the methodology with the listing applicant’s management, (ii) take reasonable steps to substantiate that the methodology as implemented is consistent with the methodology as described, and (iii) on that basis, conclude that the data is sufficiently reliable for inclusion in the listing document on the basis on which it is described and presented.

(In practice, evaluation of methodologies for input and retrieval of data will often form part of the internal controls diligence stream.)

(g) Where possible, the arithmetical accuracy of financial data (and ratios or other data computed from it) may be checked by the Reporting Accountant as part of its “comfort letter” process and recorded as such in the comfort letter. It is normally considered reasonable for the sponsor to rely on this exercise so that the sponsor’s own checks on the “bulk print” proof of the listing document do not extend to duplication of this task.

Reference should also be made to Chapter 20 “Due Diligence Guidelines – Accountants”.

10.3.2 Collectively (and subject to general considerations noted in section 12 below “Red Flags and Similar Irregularities”), these procedures will normally be appropriate and sufficient for the purposes addressed in paragraph 13(a) of Practice Note 21 to the Listing Rules.

10.3.3 Wherever possible, a draft (or provisional version) of the proposed “circle-up” pages should be obtained prior to filing Form A1 (see paragraph 2.5.5(f) of section 2 above (“Overview – Interaction With Accountants”)).

10.3.4 The sponsor should always obtain a written confirmation in support from the listing applicant and its directors in the form stipulated in paragraph 13(a)(i) of Practice Note 21 to the Listing Rules.

10.3.5 Inherently, these procedures do not constitute categoric “proof”, and the inclusion of such information reflects an overall balance whereby the inclusion (as opposed to omission) of information is generally viewed as beneficial to investors provided that a reasonable level of substantiation can be achieved.

10.3.6 The appropriate depth and robustness of substantiation increases proportionally to the level of importance and overall materiality of the information.

10.3.7 It will occasionally be appropriate to consider disclosure of methodology in unusual cases where (i) unaudited data is particularly material and/or (ii) the basis for preparation or capture of unaudited data is unusually uncertain.