The Hong Kong Exchanges and Clearing Limited (HKEX) published on 20 January 2023 a report on its annual review of listed issuers’ annual reports for the financial year ended between January and December 2021 (the Report). The Report covers thematic reviews on specific areas based on the results of previous years as well as emerging trends or matter to be of higher risks. This article summarizes HKEX’s findings, focusing on (i) financial reporting and related controls, (ii) material asset impairments, and (iii) issuers’ compliance with annual report disclosure requirements.
Financial reporting and related controls
Directors of a Hong Kong listed issuer are responsible to prepare the issuer’s accounts and present a balanced, clear and comprehensive assessment of its performance. They should ensure the effectiveness of the issuer’s risk management and internal controls and the adequacy of resources and experience of staff for the financial reporting functions. The audit committee monitors the integrity of the issuer’s financial statements, has oversight of the issuer’s financial reporting system, risk management and internal controls, and reviews the effectiveness of the audit process.
Material differences between audited and unaudited financial statements
HKEX found that in 2022, approximately 200 issuers published unaudited financial statements before the disclosure deadlines due to disruption caused by the COVID-19 pandemic. Of these, about 40 issuers subsequently published audited financial statements that reported material adjustments. A large majority of these material adjustments were related to asset impairments due to:
(i) failure by issuers to make impairment assessments on their assets in their unaudited financial statements, as they relied on their auditors to ascertain the impairment loss amounts;
(ii) insufficient impairment loss provision made by management due to failure to collect or consider sufficient information to substantiate the assumptions for the preparation of valuations; and
(iii) failure to conduct the valuation processes as the valuers were unable to perform site visits.
In a minority of cases, material adjustments were made to reclassify items or correct misapplication of accounting standards. Some adjustments arose from human errors such as erroneous calculation of disposal gains, or under-provision for interests and other expenses.
Auditors’ modified opinions
HKEX found that for the 2021 financial year, 125 issuers received modified audit opinions on their published financial statements, including 44 issuers with modified opinions for the first time. Going concern qualifications remained the most common audit modifications. Other common audit modifications included valuations of assets and limited access to accounting records.
HKEX also reviewed issuers’ disclosure about the modified opinions, including: details of the modifications and their impact on the financial position; management’s position; audit committee’s view and proposed remedial actions. HKEX found that the vast majority of issuers followed its recommendation to disclose information about modified opinions, and noted improvement particularly on the disclosure of action plans to address the modifications.
Delays in publication of results
HKEX found that for the 2021 financial year, a small number of issuers failed to publish their annual results before the three-month reporting deadline and consequently, were required to suspend their securities trading. Most of these cases were due to the following:
(i) failure to provide sufficient audit evidence or adequately address questions raised by auditors in areas such as impairment assessments, books and records of newly acquired subsidiaries, commercial rationale of new businesses commenced during the year;
(ii) issuers experiencing liquidity issue or under debt restructuring, resulting in management delays in the preparation of the financial statements; and
(iii) identification of possible frauds or accounting irregularities, such as discrepancies in cash balance, unauthorized guarantees, unauthorized payments, unauthorized granting of loans, which required independent investigations.
HKEX has the following recommendations:
(i) Preparation of financial statements: Directors should deploy adequate resources to staffing and maintaining appropriate financial reporting systems. While some factors may be outside their control, directors should incorporate appropriate alternative procedures in their financial reporting process to deal with sudden changes, including those arising from the pandemic… READ FULL ARTICLE
Note: This material has been prepared for general information purposes only and is not intended to be relied upon as professional advice for any cases. Should you need further information or legal advice, please contact us.
By: LI Fai