Convergence of accounting and auditing standards - impacts on preparers and auditors

 

 

by Mabel Cheung

 

　 　

The accounting and auditing arena in Hong Kong saw some significant changes in 2005. As part of the International Standards Convergence Project, the Hong Kong Financial Reporting Standards (HKFRS) have now been fully converged with the International Financial Reporting Standards, and the Hong Kong Standards on Auditing and Assurance (HKSAA) now largely conform to the international standards on auditing and assurance.

Companies with a financial year-end commencing on or after 1 January 2005 are required to comply with the new or revised HKFRS which came into effect on 1 January 2005. All companies preparing their financial statements under the HKFRS are affected by the changes, irrespective of whether the companies are privately held or publicly listed. The extent of the impact of the new and revised standards is likely to vary according to the nature and operations of each individual company. At the same time, the changes to the HKSAA have affected the way that auditors have performed audits of companies in accordance with Hong Kong Standards on Auditing (HKSA) for the financial year which began on or after 15 December 2004.

Let's focus on the HKFRS first. The Hong Kong Institute of Certified Public Accountants (HKICPA) released the Financial Reporting Standards for Small and Medium-sized Entities (SME-FRS) in mid-2005 which have relieved certain small and medium-sized companies of a complex reporting burden. However, companies which are not eligible to prepare their financial statements under the SME-FRS rules are obliged to continue to apply the full HKFRS regime.

Private companies may question whether the new or revised HKFRS have actually had any significant impact on their financial statements if they are not involved in complex operations and have not entered into any complicated transactions or financial instruments. It is clear that disclosure is an area which affects all companies and preparers will see an increase in work when applying the new or revised HKFRS. In general, additional and extensive disclosure requirements have been introduced. For example, in relation to accounting policies, companies are now required to disclose:

• any significant judgements made in applying accounting policies and key assumptions or uncertainties affecting the estimates;
　 　
• the adoption of new standards, changes to accounting policies or correction of material prior to period errors, including the amount of the adjustment made and the financial statement line item affected;

Furthermore, the principle of fair value accounting, as set out in various standards within the HKFRS, implies that expert valuation assistance may be needed for the application of certain standards (e.g. HKFRS 2 Share-based payments, HKFRS 3 Business combinations and HKAS 39 Financial instruments: recognition and measurement) to enable companies to establish fair values for items such as share options, new intangible assets and contingent liabilities.

From the perspective of private companies, some of the changes to the HKFRS which are likely to have a more significant impact include the following:

• all companies are now required to prepare cash flow statements. There is no longer an exemption for companies with a turnover of less than HK$20 million.
　 　
• a wholly-owned private parent is no longer exempt from preparing consolidated accounts unless the parent company of the wholly-owned private parent produces consolidated financial statements available for public use that comply with HKFRS or International Financial Reporting Standards.

In summary, as some new standards have been introduced while other existing standards have been revised during the HKICPA convergence project, preparers of financial statements are advised to carefully consider and assess the implications of each individual standard on their financial statements when they prepare their financial statements for the year ending on or after 31 December 2005.

The release of the new HKSA on audit risk and fraud consideration, in particular, HKSA 315 "Understanding the entity and its environment and assessing the risk of material misstatement"; HKSA 330 "The auditor's procedures in response to assessed risk"; and HKSA 240 "The auditor's responsibilities to consider fraud in an audit of financial statements", effectively give rise to a change in audit approach. These standards are fundamental to the way audits are conducted.

Auditors are now required under HKSA 315 and HKSA 330 to obtain a broad and thorough understanding of the entity and its environment including internal controls, to an extent sufficient for the identification and assessment of risks of material misstatement in the financial statements, and to perform more rigorous assessments and design and perform audit procedures that are linked to the assessed risk.

HKSA 240 on fraud consideration establishes basic principles and essential procedures and provides guidance on the auditor's responsibility to consider fraud in an audit of financial statements and expand on how the standards and guidance in HKSA 315 and HKSA 330 are to be applied in relation to the risks of material misstatement due to fraud.

Although it is likely that auditors' workloads will increase and specialist assistance may be required as a result of the implementation of the new standards, it is expected that there will be an enhancement in the quality of audits by improving the link between audit procedures and the risks faced by businesses.

Further information
Further information on updates and changes to the Hong Kong Financial Reporting Standards can be found in Focus and the Spring 2005 issue of Insight.

 

mabel.cheung@gthk.com.hk

 

 

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