Quality Assurance Reviews

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Quality Assurance Reviews

August 2021

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The Hong Kong Institute of Certified Public Accountants and

the speakers DO NOT accept any responsibility or liability, and

DISCLAIM all responsibilities and liabilities, in respect of the

contents of this presentation and any consequences that may

arise from any person acting or refraining from action as a

result of any materials in this presentation. Any reliance on the

materials in this presentation is solely at the user’s risk.

DISCLAIMER

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Agenda

Practice Review Programme

Review outcomes for 2020

Audit and assurance quality reviews

AML / CTF compliance monitoring reviews

Professional Standards Monitoring Programme

Resources

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Practice review outcomes

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In 2020, the Quality Assurance Department ("QAD") carried out 431 practice reviews

(2019: 354) and 32 separate AML / CTF compliance monitoring reviews (ACMRs) (2019:

34).

The significant increase in number of reviews was due to utilization of resources

previously used in reviews of listed engagements, the responsibilities of which were

transferred to the Financial Reporting Council in 2019.

The Practice Review Committee ("PRC") met on ten occasions in 2020 and considered

425 practice review reports and 31 separate ACMR reports.


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The PRC may act under the power given by the Professional Accountants Ordinance, to:

• Conclude a practice review with no follow up action required Close case

• Make recommendations and specific requests to ensure appropriate follow up action is taken to address the findings

Require follow up action

• Follow up visit to gauge improvementRequire follow up

visit

• Make a complaint and, if relevant, make a referral to the Financial Reporting Council ("FRC")

Initiate disciplinary action


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All practices


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Direct close288 PRs

29 ACMRs

Follow up actions103 PRs

2 ACMRs

All practices


68% 2019: 65% 24% 2019: 29%

Review results improved slightly in 2020

The changes reflect that practices are generally responsive to practice review findings

Communications with members (including e-learning, webinars, annual reports, alerts and

FAQs, etc.) were effective to improve members’ understanding and application of

professional standards and raise the quality of auditing and financial reporting.

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Follow up visits19 PRs

Complaintsincluding 1 referral to FRC15 PRs

All practices


What led to the complaints raised in 2020:

Issues on the professional conduct, competence and / or integrity of practitioners

(e.g. having fabricated work papers, issued compliance report without work and

provided false information during practice review process)

Failure to obtain sufficient evidence or perform sufficient appropriate audit work on

significant items / issues in audits of listed entities

Failure to comply with the PRC’s directions to appropriately address deficiencies

identified in last review to improve audit quality

4% 2019: 2% 4% 2019: 4%

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Audit and Assurance

Quality Reviews

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Agenda

I. Firm level inspection findings

II. Engagement inspection findings

III. Overview of some key changes

PN 810.1 (Revised) – Licensed insurance brokers

PN 820 (Revised) – SFC licensed corporations

IV. Some new / revised standards

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I. Firm level inspection findings

1. Engagement management and human resources

2. Auditor’s independence

3. Failure to cooperate

4. Professional conduct

5. Monitoring

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Engagement management and human resources

Issues:

Practices did not evaluate nor take steps to address sufficiency of resources despite

taking up an increasing number of audit engagements. Where practitioners had a large

portfolio with many clients having the same financial reporting deadlines, questions would

arise whether audit quality could have been compromised by matters such as pressure

from clients to meet the reporting deadlines.

Practitioners did not adequately supervise the audit process of the engagements nor

effectively carry out file reviews, resulting in many engagement deficiencies being

identified. If the time charged by engagement partners over total engagement hours was

minimal, it would give an indication that their time involvement in engagements was not

sufficient.

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Engagement management and human resources

Issues:

Practitioners and audit staff members did not have sufficient and relevant experience nor

receive training on relevant requirements before undertaking compliance work on

regulated client engagements.

Practices were over-reliant on subcontractors who were not their staff or a member of

their network firm’s staff and did not exercise adequate control over the audit work

performed by subcontractors nor take steps to ensure that subcontractors were

competent and up-to-date on professional standards when handling assigned audit work.

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Ways to improve engagement management

Putting more emphasis on audit quality

Arranging training and updates for engagement teams

Workload monitoring and rebalancing on a continuous basis

Enhancing practitioners’ and managers’ supervision and review at key audit stages

Addressing issues earlier to minimize deadline pressures

Not to accept or re-accept any engagements for which it lacks resources and knowledge to adequately handle

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Auditor’s independence

Issues:

No documentation of the evaluation of the threats to independence arising from the

provision of non-assurance services to an audit client by the practice or its affiliated

service companies and no appropriate safeguards in place to mitigate the threats.

Failure to assess the significance of self-interest or intimidation threats due to relative

sizes of audit and non-audit fees that represented a significant portion of the practice’s

total revenue.

Clients referred by service companies contributed significantly to the total revenue of the

practice. No consideration was given to the potential independence threats created by

business relationships with the service companies and safeguards required.

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Issues:

Referral fees were paid to another professional accountant for referral of audit clients, but

no safeguards were applied to address such a self-interest threat. Paragraphs 330.5 A1

to 330.5 A2 in Chapter A of the Code of Ethics (“COE”) set out examples of safeguards,

including disclosure to the clients any referral fees paid in such circumstances.

An audit team member was the key management of an audit client. Despite this close

business relationship, the practice did not take actions to eliminate the self-interest,

familiarity or intimidation threats (such as to remove the audit team member from the

relevant engagements) as suggested by Section 521.7 A2 in Chapter A of the COE.

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Failure to cooperate

Issues:

Refusal to provide required information for the practice review.

Refusal to accommodate a practice review.

Intentionally disregard or ignore all communications and PRC's direction in respect of the

practice review.

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Professional conduct

Issues:

Provision of false or misleading information in the electronic self-assessment

questionnaire and the health screening checklist submitted in relation to practice reviews.

Deliberate attempts to mislead the practice review teams by making untrue statements

during the course of practice reviews.

Provision of false representations to the practice review teams and retrospectively

creation of documents in an attempt to support his/her false representations.

Intentional under-reporting of audit clients in the client list.

Integrity issues

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Professional conduct

Issues:

Compilation /creation /alteration of certain working papers after the audit report dates and

knowingly misrepresenting to the practice review teams that those working papers were

prepared, and documented procedures performed, before the audit reports were issued.

There was no / little / back dated audit evidence / documentation to support the audit /

compliance reports issued.

Collusion with a client to backdate the audit report to mislead the relevant party to believe

that a valid report existed on the audit report date, even though the audit is still in

progress.

Misuse of modified opinions to circumvent necessary audit procedures, indicating failure

to diligently carry out audits in accordance with professional standards.

Integrity issues

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Monitoring

Issues:

Monitoring review reports were boilerpate (e.g. same generic findings on all engagements

reviewed).

No follow-up work to address findings identified in monitoring reviews.

A monitoring review was not performed according to the timeframe required by HKSQC 1,

i.e. annually for the quality control system and at least once every three years for

completed engagements.

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Monitoring

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II. Engagement inspection findings

1. Significant accounting and auditing estimates and judgements

2. Impact of COVID-19 on financial reporting and auditing

3. Alerts: Ways to enhance audit work and audit documentation quality

4. Findings – Insurance brokers

5. Alerts: Ways to enhance compliance work quality

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Significant accounting and auditing estimates and judgements

Issues:

Failure to adequately challenge management’s assumptions in relation to cash flow

forecasts for (i) impairment assessment of a cash generating unit or (ii) going concern

assessment. Key assumptions included the length of the forecast period, estimated

production volume, sales growth rate, selling price, unit cost and operating expenses.

Professional skepticism was not sufficiently applied in assessing the reasonableness of

key inputs and assumptions used in critical valuation calculations, such as: (i) valuation of

an intangible asset (e.g. estimated unit prices and quantities of products sold, discount

rate, royalty rate); (ii) fair value less cost of disposal and value-in-use of hotel properties

(e.g. forecast room and occupancy rates, operating costs, and the discount rate); (iii)

valuations of unlisted investments; and (iv) fair value of the share options granted.

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Issues:

Failure to perform work to determine whether the comparable transactions used by the

valuer to determine the asset valuation were reasonable and appropriate.

Failure to identify inconsistencies in respect of the basis of valuation set out in the

valuation report (e.g. the market value) and the notes to the financial statements (e.g. the

recoverable amount was determined based on value-in-use) and assess the implications

for the calculation of the recoverable amount.

Lack of professional skepticism to assess the reasonableness of the inventory provision

policy or the appropriateness of the basis of production overheads absorption in work-in-

progress and finished goods.

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Reminders:

Practices should take note of the enhancements in HKSA 540 (Revised) - effective from the

financial year ended 15 December 2019, including but not limited to:

an introduction of a separate assessment of inherent risk and control risk for accounting

estimates.

a requirement to “stand back” and evaluate the audit evidence obtained regarding the

accounting estimates, including both corroborative and contradictory audit evidence.

use of stronger language, such as “challenge”, “question” and “reconsider”, to reinforce

the importance of exercising professional skepticism.

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Impact of COVID-19 on financial reporting and auditing

Issues:

Practices did not consider the audit implications arising from the COVID-19 pandemic,

including:

ability of the client entity to continue as a going concern. Consideration should be given to

the scenarios and assumptions that client management had used in their going concern

assessment and the nature of material uncertainties.

valuations of non-financial assets, which should require additional levels of judgements

and uncertainty because of COVID-19.

completeness and accuracy of disclosure in the financial statements concerning the

possible impact of the pandemic.

the level of evidence obtained by practices, including third party evidence, which might

have been impacted by travel restrictions.

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Reminders:

Practices are advised to:

proactively discuss with clients to understand whether there is an impact on the client’s

reporting timetable and the impact on the audit processes;

reassess whether the audit risks which the initial risk assessment was based may have

changed;

consider performing alternative audit procedures to gather sufficient appropriate audit

evidence to support, or modify the audit opinion;

consider the impact of events after the reporting period on asset valuation or impairment

assessment and management’s disclosure of relevant risks; and

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Reminders:

consider related financial reporting issues, including:

(i) the availability of working capital and accuracy of cash flow forecasts, and

consequently impact on the appropriateness of the going concern assumption;

(ii) the possibility of impairment of non-financial assets;

(iii) the availability of observable market transactions or information, and consequent

difficulties in fair value measurement;

(iv) the possibility of fraudulent sale transactions and impact on the amount and timing of

revenue recognition; and

consider customers’ liquidity, and measurement of expected credit loss of trade

receivables.

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Alerts: Ways to enhance audit work quality

Staff

training

Staff

hiring

In general aspects:

Practices should:

exercise and heighten professional skepticism and be skeptical all the time;

carefully consider the relevance of evidence (e.g. audit objectives vs

sample selection direction);

carefully consider the reliability of evidence;

give consideration to data integrity and completeness; and

properly identify and assess risks of material misstatements at the

assertion level and design audit procedures responsive to assessed risks.

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Alerts: Ways to enhance audit work quality

Staff

training

Staff

hiring

In detailed aspects:

Practices should:

avoid undue reliance on: (i) client management’s representation; (ii)

component auditors’ work; (iii) subcontractors’ work; and (iv) work of

experts;

perform work on a replacement item when the audit procedure was found

not to be applicable to a selected item; and

consider or follow up on audit evidence obtained which contained

inconsistent features or caused doubts over its reliability.

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Alerts: Ways to enhance audit documentation quality

Staff

training

Staff

hiring

Practices should document:

details of work done (e.g. procedures, sampling basis, items tested and

coverage);

nature of the supporting documents inspected;

details of auditors’ work to appropriately assess the client accounting

treatment or critical matters;

auditors’ justification for different areas (e.g. basis for determining the

sample size and selection in a test); and

details of auditors’ professional judgement and thought process in arriving

at conclusions.

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Alerts: Ways to enhance audit documentation quality

Staff

training

Staff

hiring

Practices should:

avoid putting repetitive or inconsistent information in different working

papers;

not use sample documentation without addressing specific circumstances

of the client;

remember to record what was determined as abnormal or unusual items in

an audit test;

remember to record what and how journals were reviewed; and

remember to record the names of the preparers and reviewers and the

dates of preparation and reviews (not just date and month).

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Findings – Insurance brokers

Issues:

Capital and net assets

Auditor did not perform compliance work procedures for a minimum of three dates for the

purpose of the auditor's reporting on compliance with the minimum requirements of capital

and net assets by the insurance broker.

Auditor did not perform work to assess reliability of the management accounts used to

support the insurance broker’s net assets.

Regulated entities!

These three dates should be the year end and two other dates in the year, and the intervening periods

between those dates must not be shorter than three months.

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Issues:

Professional indemnity insurance (“PII”)

Auditor did not compare the PII coverage with two times the aggregate amount of the

insurance brokerage income in the 12 consecutive months immediately before the

commencement date of the policy period where the period of PII cover did not coincide

with the financial year.

Auditor did not obtain written evidence (such as bank statements, and correspondence

between the insurers and the insurance broker) to check whether there had been any

material claims during the year.

Auditor did not assess whether the deductible amount under the PII policy was not more

than 50% of the insurance broker's net assets at the end of the year preceding the

commencement date of the PII cover.

Regulated entities!

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Issues:

Keeping of separate client accounts and proper books and accounts

Auditor did not select a sample of transactions both from the bank statements and from

the ledgers to establish whether those transactions fell within the scope of permitted

deposits and withdrawals.

Auditor did not test the client monies reconciliation statements and relevant supporting

documents on a sample basis to determine whether comparison and reconciliation of

client monies were properly performed.

Auditor did not physically inspect a sample of accounting records to ensure that the

insurance broker had retained accounting records for at least seven years.

Regulated entities!

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Issues:

Commission income recognition

Auditor did not perform work to assess whether the policy placement services and the

claims handling services provided for the policyholders were two separate performance

obligations in contracts under HKFRS 15.

Auditor did not assess the appropriateness of accounting for variable commission under

HKFRS 15, in particular whether it was highly probable that a significant reversal of

revenue will not occur by the end of the clawback period.

Regulated entities!

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Alerts: Ways to enhance compliance work quality

Staff

training

Staff

hiring

Specific compliance procedures should be performed and adequately

documented to support each of the specifications of the practices’

opinions / conclusions / reports given in the relevant compliance /

regulatory reports.

Take the findings from the QAD report as a checklist to avoid the

deficiencies from occurring.

Using the programmes in the PNs is not mandatory, but practices would be

expected to explain why not use / follow the programmes and what

alternative work performed.

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Alerts: Ways to enhance compliance work quality

Staff

training

Staff

hiring

Failure to carry out the procedures as suggested in the PNs without

reasonable explanation would generally be considered as a serious

matter.

Failure to provide a file or other evidence of basic compliance work to

support the specific conclusions in compliance / regulatory reports would

raise serious doubts about not only the competence but also the integrity of

the practitioners and would likely result in regulatory action.

Helping clients to meet the deadlines imposed by the regulators is not an

acceptable excuse for dating the compliance / regulatory reports at a date

before the completion of work. This would likely result in regulatory action.

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III. Overview of some key changes

Licensed insurance brokers

Licensed corporations

PN 810.1 (Revised)

issued in

September 2019

PN 820 (Revised)

revised in

December 2020

Please read the whole revised PNs

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PN 810.1 (Revised)Issued in September 2019 – with immediate effect

Financial year end

date of the broker

Requirements and guidance

Cross-

over

financial

years

30 September 2019

31 December 2019

31 March 2020

30 June 2020

Thereafter

For the period up to 22 September 2019:

(1) The pre-amended Ordinance

(2) The Guideline on Minimum Requirements for Insurance Brokers

(3) Pre-amended PN 810.1 for insurance brokers

For the period from 23 September 2019 until the reporting period end:

(1) The Insurance Ordinance

(2) The Insurance (Financial and Other Requirements for Licensed

Insurance Broker Companies) Rules

(3) Amended PN 810.1 for licensed insurance broker companies

Before the

cross-over

financial

years

30 September 2018

31 December 2018

31 March 2019

30 June 2019

(1) The pre-amended Ordinance

(2) The Guideline on Minimum Requirements for Insurance Brokers

(3) Pre-amended PN 810.1 for insurance brokers

Refer to

amended PN

810.1 for

compliance

report

templates for

cross-over

periods

Regulated entities!

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PN 810.1 (Revised)

Requirements for compliance by licensed insurance brokers:

Areas Some key changes Transitional arrangement for

Deemed Licensee

Capital and Net

Assets

Paid-up share capital and net assets of

HK$500K (has been increased from HK$100K)

The amount of net assets must be calculated in

accordance with applicable accounting

standards, and must:(a) exclude intangible assets from the assets; and

(b) exclude from the liabilities, on-balance sheet

liabilities arising from a lease agreement

entered into by the broker company in respect

of any premises, up to an amount capped by

the maximum value of its intangible assets

arising from the same lease agreement

Phased increase:

23.09.2019 to

31.12.2021

HK$100K

01.01.2022 to

31.12.2023

HK$300K

Starting from

01.01.2024

onwards

HK$500K

Regulated entities!

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PN 810.1 (Revised)


Deemed Licensee

Professional

indemnity

insurance (“PII”)

At least one automatic reinstatement

Deducible amount

(a) In general, must not be more than 50% of

the company’s net assets as at the end of

its financial year immediately before the

commencement date of the policy period

(b) If the broker company is in its first 12

months of operation, must not be more than

50% of the company’s paid-up share capital

at the commencement date of the policy

period

N/A

(a) NOT apply for the period

that begins on the

commencement date (i.e.

23.09.2019) and ends on

31.12.2023

(b) N/A

Regulated entities!

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PN 810.1 (Revised)


Deemed Licensee

Client Accounts The broker company may pay into a client

account such monies as may be necessary for

the opening and maintenance of the account

and such monies are taken to be client monies

Monthly reconciliation is required to be

performed by a broker company which holds or

receives client monies.

Auditors should carry out procedures set out in

para 33 of PN 810.1.

NOT apply for 6 months

beginning on 23 September

2019

Regulated entities!

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PN 810.1 (Revised)


Deemed Licensee

Financial

statements

Should disclose:

(a) Insurance brokerage income, distinguishing

between

- general business

- long-term business

(b) Client account balance

(c) Insurance premiums payable

NOT apply for a financial year

beginning before 1 January

2021

Regulated entities!

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PN 810.1 (Revised)

Areas Need to know

Client Accounts Section 71(1) of the Insurance Ordinance requires the licensed insurance broker

company to keep client monies in a client account separate from its own monies.

However, if a broker company which does not hold any client monies is not

required to maintain a separate client account. The broker company should ensure

its business operations will not involve handling of client monies if it does not

maintain a client account.

Source: Q.4 of the FAQ on Insurance Authority’s web site:

https://www.ia.org.hk/en/supervision/reg_ins_intermediaries/files/FAQ_Broker_Rul

es_Enclosure.pdf

Regulated entities!

https://www.ia.org.hk/en/supervision/reg_ins_intermediaries/files/FAQ_Broker_Rules_Enclosure.pdf

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PN 810.1 (Revised)

Areas Need to know

Financial

statements

Financial reporting framework should be adopted by the broker company incorporated

in HK for the purpose of giving a true and fair view of the financial statements:

HK Financial Reporting Standards (HKFRS)

HKFRS for Private Entities

Source: Q.7 of the FAQ on Insurance Authority’s web site:

https://www.ia.org.hk/en/supervision/reg_ins_intermediaries/files/FAQ_Broker_Rules_

Enclosure.pdf

Regulated entities!

https://www.ia.org.hk/en/supervision/reg_ins_intermediaries/files/FAQ_Broker_Rules_Enclosure.pdf

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PN 820 (Revised)

Some key changes:

Audit planning – Understanding the regulated entity and its environment (para 29-35 of

PN):

A thorough understanding and assessment of the risks of material misstatement

(“ROMMs”), whether due to fraud or error, in the financial statements is fundamental to

performing an efficient and effective audit.

The ROMMs are influenced by but not limited to the following factors:

a) The markets and industries in which the regulated entity operates

b) The characteristics of the engagement and of the regulated entity's management

c) Internal control environment of the regulated entity

Regulated entities!

Effective for audits of financial statements for periods ended on or after 31 March 2021

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PN 820 (Revised)

Audit planning – Identifying risks relating to fraud (para 45 of PN):

Additional fraud risk factors for consideration, such as:

a) Exceptionally low level of cash which is inconsistent with the regulated entity’s

business model

b) Exceptionally high level of leverage which is inconsistent with the regulated

entity’s business model (such as a cash broker persistently borrowing exceptionally

high amount of bank loan)

c) exceptionally large amount of past due client receivables

Regulated entities!

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PN 820 (Revised)

Use of information technology (para 62-67 of PN):

When a regulated entity employs IT, the auditor should obtain an understanding on

the regulated entity’s use of IT in the information system and consider the impact of IT

to the risk of material misstatements in the financial statements and to the conclusion

of the compliance report.

The auditor should consider whether the IT control environment meets the control

objectives set out in Appendix 1 of PN 820 when assessing the risk of non-compliance

with client asset rules.

The auditor should consider and assess how the regulated entity’s IT control

environment responds to the increasing risks.

Regulated entities!

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PN 820 (Revised)

Specific application guidance on client assets (para 71-79 of PN):

Negative confirmations

Cannot be used as the sole substantive audit procedures to address an assessed

ROMM at the assertion level unless all of the following are present:

a) The auditor assessed the ROMM as low and has obtained sufficient appropriate

audit evidence regarding the operating effectiveness of controls relevant to the

assertion;

b) The population comprises a large number of small, homogeneous account

balances, transactions or conditions;

c) A very low exception rate is expected; and

d) The auditor is not aware of circumstances or conditions that would cause recipients

of negative confirmation requests to disregard such requests.

Regulated entities!

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PN 820 (Revised)

Financial returns to be submitted to the SFC (para 106 and 111 of PN):

Suggested procedures on the final revised and submitted financial returns made up to

year end date:

a) Check whether the financial returns are prepared from the LC’s books and records

which are prepared in accordance with GAAP;

b) Check whether each of the items reported in the financial returns is prepared in

accordance with the Securities and Futures (Financial Resources) Rules;

c) Check whether the financial returns are mathematically accurate; and

d) Check whether all adjustments made after the first submitted financial returns are

appropriately incorporated into the revised financial returns.

The auditor may include a reconciliation to report discrepancies between the audited

financial returns and the first submitted financial returns in the Audit Questionnaire.

Regulated entities!

A revised financial return form shall be used for accounting periods

starting on or after 1 July 2021

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PN 820 (Revised)

Management representation letter

Refer to Appendix 3 of PN for an illustrative letter which includes additional written

representations that the auditor of a regulated entity would also consider.

Regulated entities!

Examples:

• During the year ended [xxx], the Company has complied with the relevant capital requirements

under the Hong Kong Securities and Futures (Financial Resources) Rules.

• Each of the financial returns as referred to in section 3(1)(b) of the Hong Kong Securities and

Futures (Accounts and Audit) Rules as at [xxx] is correctly compiled from the accounting and non-

accounting records of the Company and prepared in accordance with the Hong Kong Securities and

Futures (Financial Resources) Rules.

• We have read the draft auditor's compliance report and have agreed with the facts and statements

set out in the draft report in respect of your engagement.

• We confirm that no client assets as defined in section 1 in Schedule 1 of the SFO have been

administered, held, handled or processed by us, our staff or any company representative or

appointed representative during the year…

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Professional standards Effective date

CPD Statement 1.500 (Revised) Continuing Professional

Development

March 2021

Quality

management

HKSQM 1 Quality Management for Firms that

Perform Audits or Reviews of Financial Statements

or Other Assurance or Related Services

Engagements (previously HKSQC 1)

HKSQM 2 Engagement Quality Reviews

HKSA 220 (Revised) Quality Management for an

Audit of Financial Statements

15 December

2022

Audit risk

assessment

HKSA 315 (Revised 2019) Identifying and Assessing

the Risks of Material Misstatement

For 31

December 2022

audits

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Professional standards Effective date

Group audit Proposed ISA 600 (Revised) Special Considerations –

Audits of Group Financial Statements (including the

Work of Component Auditors)

The final approval of the standard is now targeted

for December 2021.

December 2023

(expected date)

SME audits Audits of Less Complex Entities

An exposure draft was issued in July 2021.

-

IAASB COVID-

19 Response

The IAASB continues to monitor whether further

support is needed as the pandemic continues.

-

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AML / CTF Compliance

Monitoring Reviews

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Common weaknesses in practices’

AML Guidelines compliance

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1. Insufficient understanding of obligations Section 600.2 of the AML Guidelines sets out the applicability of the sections

Practices can choose not to apply if not providing specified services.

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1. Insufficient understanding of obligations A) Some practices did not understand the scope of specified transactions

Practices should identify whether any of the services they provide involve specified

transaction

If any of the services provided involves specified transactions, all sections of the

AML Guidelines are MANDATORY

Examples of specified transactions engagements include:o a reporting accountant engagement in respect of a major transaction; a very substantial

acquisition or disposal transaction relating to buying and selling of business entities or real

estate;

o an appointment that gives a practice the power to manage a client’s bank, saving or

securities account.

If practices do not provide any specified transaction works, only Sections 640 and

650 are MANDATORY unless they adopt good practices

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1. Insufficient understanding of obligations

B) Some practices that had chosen to apply good practices did not fully comply with all

sections of the AML Guidelines

For practices which do not provide specified transaction works but choose to apply good

practices, they are expected to comply with all sections of the AML Guidelines (including

applying CDD, ongoing monitoring and record keeping measures)

In an AML / CTF compliance monitoring review, review work will be performed to assess

how well a practice has applied the good practices if it has chosen to apply them

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2. Insufficient AML / CTF policies, procedures and controls

Applying good practices on non-specified transaction

works

Yes No

Practices provide services

that involve specified

transactions

Internal policies complying with all sections of the AML

Guidelines

Practices do not provide

services that involve

specified transactions

Internal policies complying

with all sections of AML

Guidelines

Internal polices complying

Sections 640 and 650 of

AML Guidelines

Section 610.1 of the AML Guidelines requires practices to put in place internal policies, procedures and control to address money laundering (“ML”) /terrorist financing (“TF”) concerns

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A) Insufficient policies and procedures in practices’ AML / CTF policy manual


Amongst other requirements, practices should also set out the following in their

AML / CTF policy manual:

The frequency of a periodic review of standard and simplified CDD information

on their clients; and

A definition of what constitutes an event that triggers a review of CDD

information (e.g. material changes in the client’s ownership and/ or activities)

Examples of trigger events can be found in paragraph 620.10.7 of AML

Guidelines

Specified services/

good practices

64


A) Insufficient policies and procedures in practices’ AML / CTF policy manual

For practices which do not provide specified transaction works but choose to apply

good practices, they should ensure their AML / CTF policy manual reflect their

circumstances, including indicating the fact that good practices are to be applied.

If a practice does not intend to apply good practices on clients receiving non-specified services, it may adopt the below Example AML / CTF policies and procedures

Example AML / CTF

policies and procedures for practices

not applying good practice

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2. Insufficient AML / CTF policies, procedures and controlsB) No firm-wide ML / TF risk assessment

Practices should:

Perform a firm-wide ML / TF risk assessment

to understand the risks of practice being used

to launder crime proceeds and facilitate

terrorist financing

Take into account at least the four key areas

in the risk assessment

(see the diagram on the right hand side)

Based on the assessment results, design

appropriate policies, procedures and controls

to address the ML /TF concerns

AML / CTF Guidelines

Section 610.2

Specified services/

good practices

66

2. Insufficient AML / CTF policies, procedures and controlsC) No compliance review

Practices should :

Perform regular compliance reviews to assess

the implementation and effectiveness of their AML / CTF

policies, procedures and controls

Set the frequency and extent of the review to be

commensurate with their ML / TF risks and

size of their business

Based on the review results, update their policies,

procedures and controls

Practices may refer to Form T02 Money Laundering Compliance

Review of the AML Procedures Manual for Accountants for

a template of compliance review


Section 610.3.6

Specified services/

good practices

67

3. Insufficient sanctions screening

Section 650 of the AML Guidelines (financial

sanctions and terrorist financing) is mandatory for

all practices regardless of services provided

Name screening against sanctions and terrorist

list is essential to identify if clients and, their

beneficial owners on a risk based approach, are

sanctioned subjects or terrorists.

Requirement of sanctions screening


Section 650

68

3. Insufficient sanctions screeningNot subscribed to

commercial database

Subscribed to

a commercial database

Initial

screening

Perform screening before establishment of a client relationship

Check the latest United Nations Security

Council consolidated list

Check with the service provider if the

screening facility covers the United Nations

sanctions lists before service subscription

Ongoing

screening

Review for updates of sanctions lists

monthly if there are no clients with high

ML/ TF risk or weekly if there is.

Refer to the United Nations Security

Council press releases (can be assessed

through the Institute’s AML designated

page) to identify updates of the sanctions

lists

Check with the service provider if the

subscription includes ongoing screening and

the frequency of screening

Analyze and appropriately follow up alerts of

potential hits notified by the service provider

Overall Perform screening on all clients and, their beneficial owners on a risk based approach,

regardless of the services provided

Keep evidence of screening

69

United Nations Security Council Consolidated List:

https://www.un.org/securitycouncil/content/un-sc-consolidated-list

The Institute’s AML designated page:

https://www.hkicpa.org.hk/en/Standards-and-regulation/Anti-money-laundering

3. Insufficient sanctions screeningResources on sanctions screening

70

4. Failure to comply with all CDD requirements

A) Client risk assessment

B) Person purporting to act on behalf

of a client

C) Politically exposed person

D) Client not physically present for

identification


Section 620

Specified services/

good practices

71

4. Failure to comply with all CDD requirements A) Client risk assessment

Practices should:

Assess ML / TF risk of each client

Take into account 4 factors in the assessment:1) Client type; 2) Geographical location3) Services offered by the practice, and 4) Mode of delivery of the services

Draw a conclusion on ML / TF risk to determine: o the extent of CDD

(i.e. standard, enhanced or simplified) and o the frequency of ongoing monitoring

Specified services/

good practices

72


B) Person purporting to act on behalf of a person (“PPTA”)

Practices should:

Take reasonable measures to verify the PPTA’s identity, as well as the

person’s authority to act, in all types of CDD, including simplified CDD

At minimum, regard the person who is authorized to act on behalf of a

client to establish a business relationship with the practice (i.e. the

person who has signed or will sign an engagement letter on behalf of

the client) as the PPTA

Specified services/

good practices

73


B) Person purporting to act on behalf of a person (“PPTA”)

Example of a PPTA

A corporate client is represented by a natural person (e.g. a director or an

officer). Each corporate client should have at least one PPTA (e.g. a person

who will sign an engagement letter on behalf of a corporate client).

Specified services/

good practices

74


C) Politically exposed person (“PEP”)

In AML / CTF Guidelines:

• PEP outside PRC (including Macau, HK and

Taiwan) = Foreign PEP

• PEP within PRC (including Macau, HK and

Taiwan) = Domestic PEP

including a former PEP

Specified services/

good practices

75

4. Failure to comply with all CDD requirements C) Politically exposed person (“PEP”)

Practices should:

Perform name checks before client acceptance / at the time of regular review

Not to presume all domestic PEPs as non-high risk – assess ML / TF risk of each domestic PEP before drawing a conclusion

For foreign / high risk domestic PEP, perform enhanced CDD procedures by: o Obtaining senior management approval before commencing or continuing the client

relationship;

o Taking reasonable measures to establish the sources of wealth and funds of the PEP;

o Assessing specific risk factors in paragraph 620.12.13; and

o Reviewing CDD information at least annually

Specified services/

good practices

76


C) Politically exposed person (“PEP”)

Examples of risk factors stated in Paragraph 620.12.13 of the AML Guidelines – in

handling a (potential) business relationship with a PEP include:

Any concern over the country where the PEP holds his public office or has been

entrusted with his public functions, taking into account his / her position

Any unexplained source of wealth or income (i.e. value of assets owned not in line

with the PEP’s income level)

Specified services/

good practices

77

4. Failure to comply with all CDD requirements D) Client not physically present for identification purpose

Practices should:

Apply equally effective client identification procedures and ongoing monitoring

standards for a client not physically present for identification purposes as for

those where the client is available for interview

Perform at least one of the following measures:o Further verify the client’s identity by obtaining additional documents, data or

information from a reliable and independent source, that are not previously used to

verify the client’s identity;

o Take supplementary measures to verify the information relating to the client that has

been obtained by the practice (e.g. use of a suitable certifier)

Specified services/

good practices

78

5. Insufficient staff training and hiring

Staff

training

Staff

hiring

Staff training Staff hiring

Practices should:

Provide regular AML / CTF training

to all relevant staff members

Training materials should

cover all essential topics

Implement measures to monitor

training effectiveness (e.g. quiz)

Practices should:

Implement procedures (e.g. name

screening) to ensure integrity of

new employees

Equip new staff members with AML

/ CTF knowledge before they

commence work (e.g. conducting

new joiner AML / CTF training)

Specified services/

good practices

79

Essential topics that should be covered in AML / CTF training

All practices should include the following in their AML / CTF training as appropriate:

Introduction of the background of ML / TF

Identity of the money laundering reporting officer (“MLRO”) and the suspicious transactions reporting procedures

The need to identify and report suspicious transactions to the MLRO

The circumstances that may give rise to suspicion

The offense of tipping off

Policies and procedures of financial sanctions and terrorist financing

5. Insufficient staff training and hiring

80

HKICPA publications and aids

Guidelines on Anti-Money Laundering and Counter-Terrorist Financing for Professional

Accountants ("AML / CTF Guidelines")

Anti-Money Laundering Procedures Manual for Accountants ("AML Procedures Manual")

Designated website on Anti-Money Laundering


Frequently Asked Questions (AML Monitoring) https://www.hkicpa.org.hk/en/Standards-and-

regulation/Quality-assurance/Practice-review/Frequently-Asked-Questions--AML-Monitoring

Quality Assurance Department Report 2020 https://www.hkicpa.org.hk/-/media/HKICPA-

Website/New-HKICPA/Standards-and-regulation/QA/2021/Quality-assurance-department-

report-2020.pdf

AML website AML FAQ

AML compliance

QAD report


https://www.hkicpa.org.hk/en/Standards-and-regulation/Quality-assurance/Practice-review/Frequently-Asked-Questions--AML-Monitoring

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/QA/2021/Quality-assurance-department-report-2020.pdf

81

Risk-based supervision of

accounting professionals

concerning AML / CTF compliance

82

A quick recap

Sep 2019

FATF

published

Mutual

Evaluation

Report on HK

Jun 2020

HKICPA issued

Alert 34

concerning

enhancement

of risk-based

supervision

Jul 2020

HKICPA issued

Chapter G for

consultation

until Oct 2020

Nov 2020

HKICPA

released AML

Questionnaire

for completion

until Dec 2020

Chapter G ED 2020 consultation

Proposed to establish 2 obligations:

1. The obligation to provide information to the Institute for AML /

CTF regulatory purposes

2. The obligation on those acting as those charged with

governance to ensure their relevant HK Network &

Professional Service Entities comply with applicable AML /

CTF laws and regulations as if they were a practice unit

19 written comments were received from 17 members and

organizations

AML Questionnaire 2020

Voluntary

Response rate was 7.9%

Information collected was

not sufficient for the

Institute to perform

appropriate ML / TF risk

assessment

83

What’s next…

Provide data to support effective implementation of risk-based supervision programme for Hong Kong government to submit follow up report to FATF in 2022

Liaise with the FRC on the way forward and transition of AML regulatory function

Next FATF mutual evaluation on Hong Kong will be held in 2024

Members and practice units

will be informed of the latest

development.

84

Professional Standards Monitoring

Programme

85

Today’s Agenda

I. Professional Standards Monitoring Programme

II. Common or significant application issues of the following accounting

standards

• HKFRS 16

• HKFRS 9 (2014)

• HKFRS 15

III. Common disclosure issues

86

I. Professional Standards Monitoring Programme

Background

Selection basis for 2020

Review process and outcomes for 2020

87

Background

• Established in 1988 (over 30 years of history)

• Enhance the quality of financial reporting and application of

professional standards in Hong Kong

• Review financial statements of Hong Kong listed companies and

raise enquiries with auditors on issues identified

• Assist in the Institute’s post implementation review of professional

standards

• Refer to the FRC for investigation if a significant issue is identified

88

Selection basis for 2020

89

Review process and outcomes for 2020

• Reviewed 70 sets of financial statements of Hong Kong listed

companies and followed up 9 cases brought forward from the

previous years.

• Issues were identified in some of the financial statements

reviewed which warranted issuance of enquiry letters or letters

with comments on presentation and disclosures.

• No cases were referred to the FRC in 2020

(NB: Referred 1 case in 2021)

90

1. Issues on initial application of a new accounting standard

• HKFRS 16 Leases

2. Issues on application of other accounting standards

• HKFRS 9 (2014) Financial Instruments

• HKFRS 15 Revenue from Contracts with Customers

II. Common accounting issues

91


HKFRS 16 Leases

92

Right-of-use (“ROU”) assets & lease liabilities

On balance sheet

HKFRS 16 HKAS 17

Off balance sheet

VS


Operating expenses in income statement

93


Lessee

accounting

94

Full retrospective approach

Retrospectively to each prior reporting period presented applying HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

Modified retrospective approach

Retrospectively with the cumulative effect of initially applying the Standard recognised at the date of initial application in accordance with paragraphs C7–C13


[HKFRS 16 paragraph C5(a)] [HKFRS 16 paragraph C5(b)]

Lessee accounting

95


96


97

Components of ROU asset and lease liability

ROU asset

Consisted of:

= Lease liability (see next slide)

+ Lease payments made at or before the commencement date (i.e. Prepaid lease payments)

less any lease incentives received

+ Initial direct costs incurred by the lessee

+ Estimated costs to incurred by the lessee in dismantling and removing the underlying asset,

restoring the site or the underlying asset to the condition required by the lease.

[HKFRS 16 para 23 and 24]

98

Components of ROU asset and lease liability

Some key factors to consider in lease liability determination

Lease term

= Non-cancellable period

+ Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option

+ Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option

[HKFRS 16 paragraph 18]

Lease payments

= Fixed payments (including in-substance fixed payments) less any lease incentives receivable

+ Variable lease payments based on an index or a rate

+ Residual value guarantees expected to be payable by the lessee

+ Exercise price of a purchase option if the lessee is reasonably certain to exercise that option

+ Penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease


Discount rate

= interest rate implicit in the lease if readily available, or the lessee’s incremental borrowing rate [HKFRS 16 paragraph

26]

99


Cases sharing Topics covered – Lessee accounting

Case 1 Low-value assets

Case 2 In-substance fixed payments

Case 3 Extension and termination options

Case 4 Impairment assessment of ROU assets

100


Case 1 – Low-value assets

101

Low-value assetsCase 1

• Entity A applied the recognition exemption for leases of low-value items.

• Entity A disclosed that low-value items included motor vehicles.

• Can the recognition exemption be applied for motor vehicles?


102



• HKFRS 16 paragraph 5 provides recognition exemption to lessees

that they may elect not to apply the requirements in paragraphs 22

to 49 in HKFRS 16 to (a) short-term leases; and (b) lease for which

the underlying asset is of low value.

• Examples of low-value underlying assets can include tablet and

personal computers, small items of office furniture and telephones.

(HKFRS 16 paragraph B8)

• The exemption for lease of low value asset can be applied on a

lease-by-lease basis. The assessment does not take into account

whether low-value assets in aggregate are material. The exemption

still applies even if the aggregated low-valued assets are material.

103


• Determination of whether an asset qualifies as low value requires judgement and such result of assessment might sometimes change over time.

• A lessee shall assess the value of an underlying asset based on the value of the asset when it is new, regardless of the age of the asset being leased. [HKFRS 16 paragraph B3]

• The assessment of whether an underlying asset is of low value is performed on an absolute basis [HKFRS 16 paragraph B4] reach the same conclusions about whether a particular underlying asset is of low value.


104


• Leases of cars would not qualify as leases of low-value assets because a new car would typically not be of low value. [HKFRS 16 paragraph B6]

• Leases of underlying assets with a value, when new, of US$5,000 or less. [HKFRS 16 BC 100]


105


It is not appropriate to apply

recognition exemption to

motor vehicle which the

value, when new, are

typically not low

106


Case 2 – In-substance fixed

payments

107

In-substance fixed paymentsCase 2

• Entity B was principally engaged in a food retailing business.

• It leased a number of retails stores and units that contained variable payment terms. Some leases included payment terms “minimum or cap clauses”.

• A substantial amount of Entity B’s variable lease payments were NOT included in the measurement of lease liabilities for the year.

• No further information disclosed regarding the “minimum or cap clauses”.

• Whether the “minimum clauses” included in the above clauses were “in-substance fixed payments”?


108


• Under HKFRS 16, fixed lease payments include “in-substance fixed payments”.

• Payments that may, in form, contain variability but that, in substance, are unavoidable.

• E.g. if payments are structured as variable lease payments, but there is no genuine variability in those payments [HKFRS 16 paragraph B42(a)]


109


• The auditor explained that the minimum lease payments specified in the lease contracts under the “minimum or cap clause” had already been considered by Entity B in determining the total lease payments used to calculate the lease liabilities at the commencement date of the lease.


110


• Useful to provide some descriptions of

key clauses in the disclosures

• Disclose the relevant accounting policy

for determining “in-substance fixed

payments”

• Disclose management judgement

exercised

Learning points

111


Case 3 – Extension and

termination options

112

Extension and termination optionsCase 3

• Entity C disclosed that it had lease contracts which included extension and termination options and stated that more information of such options would be provided in the financial statements. However, in fact, no further information was provided in the financial statements.

• An enquiry was raised to ask the auditor to provide more information on (1) the conditions for exercising the extension and termination options; and (2) management judgement applied.

• What consideration should be taken into account when assessing the lease term? How should the extension and termination options affect the assessment?


113


Lease term

[HKFRS 16 paragraphs 18 to 21 &

B34 to B41]

if the entity is reasonably certain

to exercise the extension option /

not to exercise the termination

option

Non-cancellable

period

Periods covered by an option to extend the

lease

Periods covered by an option to terminate the lease

Lease term

114


Examples of factors to

consider whether a lessee is

reasonably certain to exercise

an extension or termination

option

[HKFRS 16 paragraphs B37 to

B40]

115

Extension and termination optionsCase 3

• The auditor clarified the following:

• No termination option was included in the lease contracts entered into by Entity C.

• A renewal option was included in certain lease contracts entered into by Entity C.

• The renewal option in substance provided Entity C with the right to extend the relevant leases.

• Factors considered by management: the expected market rental fluctuations, cost of relocation and the remaining economic life of the non-removable leasehold improvements.

• Lease term included both the non-cancellable period and the period covered by the extension option after consideration of relevant factors.


116


• Preparers should ensure that the

information disclosed in the financial

statements is relevant and factually correct

• Disclose management judgement exercised

Learning points

117


Case 4 – Impairment

assessment of ROU

assets

118

HKFRS 16

HKAS 40

HKAS 36

HKAS 16


Interaction with other HKFRSs If an entity applies the fair value

model to its own investment

property, it must apply the fair value

model to ROU assets that meet the

definition of investment property

If right-of-use assets relate

to a class of property, plant

and equipment to which

the lessee applies the

revaluation model in HKAS

16, a lessee may elect to

apply that revaluation

model to all of the right-of-

use assets that relate to

that class of property, plant

and equipment.



To discuss in the

following slides

119


Interaction with HKAS 36: Recoverable amount determined based on value in use

calculation “after” HKFRS 16 applies

120

Impairment assessment of ROU assetsCase 4

• Entity D’s major assets included ROU assets and property, plant and equipment (“PPE”).

• Entity D had recurring losses for a number of years.

• No information was provided to show that an impairment assessment had been performed on Entity D’s ROU assets and PPE. However, a full impairment loss was recognized on the carrying amount of a substantial intangible asset of a CGU, raising concerns whether the carrying amount of other assets including ROU and the PPE had been impaired.


121


• In its response to our enquiry, the auditor explained that Entity D’s ROU assets and PPE were entirely related to the CGU of which an impairment loss was provided on the intangible asset.

• However, the response did not provide sufficient evidence to show that the impairment assessment of the CGU was properly performed under HKAS 36 requirements after implementation of HKFRS 16, for example having:

• 1) excluded the lease liabilities from the carrying amount of CGU in carrying out the impairment assessment;

• 2) taken out the lease payments included in the lease liabilities in determining the recoverable amount of the CGU; and

• 3) included the cash outflows of expected future variable rents and short-term and low value leases that are not included in the lease liabilities in determining the recoverable amount of the CGU


122


• Other issues identified relating to application of HKAS 36:

• 1) The auditor’s response showed that the value in use calculation was determined based on the cash flow projections using financial budgets covering a 5-year period with a substantially increased average annual growth rate (nearly 40%) as compared to the prior year. Given the Group’s loss making situation and the downward trend of the Group’s revenue over a number of years, it was unclear how it was justifiable to apply a positive and a much higher growth rate in the current year impairment assessment.

• 2) WACC was used as the discount rate. The use of WACC, which is a post-tax discount, appears to be a potential departure from HKAS 36 paragraph 55 which requires a pre-tax rate.


123


• In view of the above concerns and lack of information provided in the auditor’s response, we considered that a review of underlying audit working papers was needed. Therefore the case was referred to the FRC for further assessment of the matters.


124


Ensure that the impacts arising from

HKFRS 16 are adequately considered and

addressed in performing the impairment

assessment of a CGU under HKAS 36, in

particular on the determination of the

carrying amount and the related

recoverable amount of the CGU

Learning points

125

Initial application of a new accounting standard

Amendment to HKFRS 16

Leases - Covid-19 Related

rent concessions

126


• Due to the impact of COVID-19 pandemic, many lessors and lessees agreed to various

types of rent concessions such as deferrals and/or abatement of rent payments.

• In view of the anticipated practical difficulties in applying the HKFRS 16 requirements on

lease modification to a large volume of COVID-19 related rent concessions, the

Amendment to HKFRS 16 was issued to provide relief for lessees in accounting for

qualifying COVID-19 related rent concessions.

• The Amendment to HKFRS 16 is effective for annual periods beginning on or after 1 June

2020. Earlier application is permitted.

127


• The practical expedients in HKFRS 16 paragraph 46A only applies to rent concession

occurring as a direct consequence of the covid-19 pandemic and all the conditions in

paragraph 46B (a) to (c) of the Amendment to HKFRS 16 are met.

• A rent concession meets the conditions in paragraphs 46B(a) to (c) under the Amendment

to HKFRS 16 when (1) it reduces or substantially the same as the consideration for the

lease immediately preceding the change; (2) it is a forgiveness of or reduction in lease

payments originally due on or before 30 June 2021; and (3) there are no substantive

changes to other terms and conditions of the contract.

• If a lessee applies the practical expedient set out in Amendment to HKFRS 16, the lessee

does not need to assess whether a rent concession is a lease modification and does not

need to re-measure the lease liabilities by discounting the revised lease payments using a

revised discount rate, subject to having met all conditions specified under HKFRS 16

paragraph 46B.

128


“(a)[the fact] that it has applied the practical expedient to all rent concessions that

meet the conditions in paragraph 46B or, if not applied to all such rent concessions,

information about the nature of the contracts to which it has applied the practical

expedient (see paragraph 2); and (b) the amount recognised in profit or loss for the

reporting period to reflect changes in lease payments that arise from rent

concessions to which the lessee has applied the practical expedient in paragraph

46A”.

[HKFRS 16 paragraph 60A]

Disclosure requirement

129


Examples of COVID-19 related rent concessions

Examples of commonly seen rent concessions in Hong Kong

that are not COVID-19 related

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-

and-regulation/%20SSD/06_New-and-major-stds/ag_rent.pdf

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-

regulation/%20SSD/06_New-and-major-stds/ie161.pdf

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/%20SSD/06_New-and-major-stds/ag_rent.pdf

https://www.hkicpa.org.hk/-/media/HKICPA-Website/New-HKICPA/Standards-and-regulation/%20SSD/06_New-and-major-stds/ie161.pdf

130


Further development of the Amendment to HKFRS 16: Extension of practical expedient

The IASB published Covid-19 Related Rent Concession beyond 30 June 2021

(Amendment to IFRS 16) on 31 March 2021, that extends, by one year, the May 2020

amendment that provides lessees with an exemption from assessing whether the COVID-

19-related rent concession is a lease modification.

This Amendment permit a lessee to apply the practical expedient regarding COVID-19-

related rent concessions to rent concessions for which any reduction in lease payments

affect only payments originally due on or before 30 June 2022 (rather than only

payments originally due on or before 30 June 2021).

Lessees are required to applying the Amendment for annual periods beginning on or after

1 April 2021. See HKFRS 16 paragraphs 46B and C20BA to C20BC for details.

131


Update No. 258

Covid-19-Related Rent Concessions beyond

30 June 2021 (2021 Amendment to HKFRS

16) and the consequential amendments

arising from the Covid-19-Related Rent

Concessions (2020 Amendment to HKFRS

16).

Effective for annual reporting periods

beginning on or after 1 Apr 2021.

132

2. Issues on recurring application of accounting standards

HKFRS 9 (2014) – Financial

Instruments

133

HKFRS 9 (2014) paragraphs

4.1.2 and 4.1.2A


134

1. Issues on initial application of new accounting standards

Equity Instrument (Note 1, Note 2 to

the above diagram)

Cannot pass the SPPI test

Normally they are measured at

FVTPL

On initial recognition, an irrevocable

option to designate the equity

instruments at FVTOCI (HKFRS 9

paragraph 5.7.5)

Not held for trading

Non-equity Instrument (Note 3 to the

above diagram)

Can be designated and measured at

FVTPL if the fair value option is

applied (HKFRS 9 (2014) paragraph

4.1.5)

135


General approach for

impairment

assessment

136

Cases sharing Topics covered

Case 1 Accounting for structured deposits – SPPI test

Case 2 Determination of “default” and “significant increase

in credit risk since initial recognition”


137

Case 1 – Accounting for

structured deposits (SPPI test)


138

Accounting for structured deposits – SPPI testCase 1

• Entity F classified its structured deposits into “Financial assets at amortized cost” and “Financial assets at FVTPL” at 31 Dec 2019

• On initial application of HKFRS 9 in 2018, Entity F reclassified all its structured deposits from “prepayments, other receivables and other assets” which were previously measured at amortized cost to financial assets at FVTPL because the structured deposits did not pass the SPPI test.

• Entity F’s 2018 and 2019 annual reports provide the same description of the nature of its structured deposits e.g. the structured deposits were investment products issued by commercial banks.

• Was Entity F’s accounting for structured deposits in 2019 appropriate and justifiable?


139


• The auditor explained the following:

• Entity F’s major structured deposits at the 2019 year end were structured deposits entered into with some banks. Their return rates were linked to certain commodity market indexes.

• The structured deposit contracts specified a return rate (“1st return rate”) if the fluctuation of the designated market index fell within a certain range and another return rate (“2nd return rate”) if the fluctuation fell outside the range.

• Based on the historical records of the market index, the contract term of the 2nd return rate was “not genuine” as the occurrence of the specified event (i.e. market index falling outside the range) would be extremely rare, highly abnormal and very unlikely to occur.

• management disregarded the 2nd return rate and arrived at the conclusion that the relevant structured deposits passed the SPPI test.


140


• What we need to know: -

• The “SPPI test” refers to an assessment performed by an entity on whether the contractual cash flows arising from the financial asset represent, on specified dates, solely payments of principal amount and interest on the principal amount outstanding which are consistent with a basic lending arrangement.

• A financial asset that does not meet the SPPI test is always measured at FVTPL, unless it is an equity instrument and that the entity applies the irrevocable OCI option.

• A contractual cash flow characteristic does not affect the classification of the financial asset if (1) it could have only “a de minimis effect on the contractual cash flows” or (2) it could have an effect that is “more than de minimis (either in a single reporting period or cumulatively) but that cash flow characteristic is not genuine” [HKFRS 9 (2014) paragraph B4.1.18]


141


• The contractual features which are “not genuine” or have only a de minimis impact on the contractual cash flows can be disregarded in the SPPI assessment.

• “Non- genuine” contractual features are generally considered as contractual features that do not have commercial substance.

• Based on the above, is it possible for the banks and Entity F to enter into a contract term that did not have commercial substance or for no economic purpose or consequence, such that the 2nd return rate in Entity F’s case was “not genuine” and could be disregarded?


142


• Nevertheless, clauses that are “not genuine” are expected to be rare in practice.

• A clause should not be considered “not genuine” just because historically the relevant event has not occurred.

• Therefore, a closer look at the contract terms was needed in order to ascertain whether the SPPI test was met and whether it was appropriate to account for the structured deposits at amortisedcost.


143



Contractual terms that introduce exposure to risks or volatility in the

contractual cash flows that is unrelated to a basic lending arrangement, such

as exposure to changes in equity prices or commodity prices, do not give

rise to contractual cash flows that are solely payments of principal and

interest on the principal amount outstanding.

[HKFRS 9 (2014) paragraph B4.1.7A]

144

1. Issues on initial application of new accounting standard

• Carefully assess the contractual terms

and features that may change the timing

or amount of contractual cash flows

• Understand the nature of any contingent

event covered by the contract terms.

Learning points

145


Case 2 – Determination of

“default” and “significant

increase in credit risk since

initial recognition”

146

Determination of “default” and “significant increase in credit risk since initial recognition”

Case 2

• Entity G’s accounting policy included a presumption that the credit risk of a financial asset had increased significantly since initial recognition when contractual payments were more than 360 days past due.

• Entity G’s accounting policy also stated that default had occurred when a financial asset was more than 360 days past due unless the group had reasonable and supportable information to demonstrate that a more lagging default criterion was more appropriate.

• Can Entity G use the same criterion “360 days past due” to determine whether a financial asset has been “default” or the financial asset has a “significant increase in credit risk since initial recognition”?


147


Case 2


“An entity cannot align the timing of significant increases in credit risk and the

recognition of lifetime expected credit losses to when a financial asset is

regarded as credit-impaired or an entity’s internal definition of default”.

[HKFRS 9 (2014) paragraph B5.5.21]

148


Case 2

• Applying the same benchmark (i.e. 360 days past due) to identify when there had been a significant increase in credit risk and when a default had occurred Suggested that the 3-stage model of the general approach might have been inappropriately applied.

• Under HKFRS 9, it is presumed that there has been a significant increase in credit risk since initial recognition when the contractual payments of a financial asset are 30 days past due [HKFRS 9 (2014) paragraph 5.5.11] and that later on the financial asset is considered to be in default if it is 90 days past due [HKFRS 9 (2014) paragraph B5.5.37].

• In this case, there was no disclosure as required by HKFRS 7 of the reasons for setting the default criterion as “360 days past due”. It was unclear how it was justifiable to revoke the “30 days past due” and “90 days past due” presumptions set out in HKFRS 9 (2014) paragraphs 5.5.11 and B5.5.37, respectively.


149

• An entity cannot align the timing of significant

increases in credit risk and the recognition of

lifetime expected credit losses to when a

financial asset is regarded as credit-impaired or

an entity’s internal definition of default

• If relevant, disclosure should be provided to

explain the justification for the rebuttal of the

“30 days past due” and “90 days past due”

presumptions set out in HKFRS 9 (2014)

paragraphs 5.5.11 and B5.5.37, respectively

Learning points


150

HKFRS 15 – Revenue from

Contracts with Customers


151

Core principle - recognises revenue to depict the transfer of

promised goods or services to customers in an amount that reflects

the consideration to which the entity expects to be entitled.


152


Cases sharing Topics covered

Case 1 Significant deposits received in advance from

customers

153


Case 1 – Significant deposits

received from customers

154

Significant deposits received from customersCase 1

• Entity H is a property developer, recorded in its financial statements material deposits received from customers in connection with construction contracts and sales of properties.

• No information in the accounting policy about how Entity H would identify and assess (1) whether there were financing components in contracts with customers; and (2) if so, whether the financing components were significant.

• The disclosure note of the composition of finance costs also did not show that the group’s finance costs had included any amount which was incurred due to financing provided by customers.


155


• It is common that property developers have a practice to require customers to pay in advance so that they have the necessary funds to cover the construction costs in carrying out the long-term construction projects.

• Given the above, having considered the nature of the deposits received and the principal activities of Entity H, it is questionable whether Entity H had adequately reviewed the contract terms and arrangements with their customers and applied the HKFRS 15 requirements to appropriately account for the significant financing components (i.e. the receipt in advance from the customers).


156



A contract that has a financing component is comprised of two transactions – one for the

sale of goods and/or services and one for financing.

The amount of promised consideration is adjusted for the effect of financing only if the

timing of payments specified in the contract provides the customer or the entity with a

significant benefit of financing.

[HKFRS 15 BC229]

[HKFRS 15 paragraph 60 and BC229 to BC233]

Key concepts

157


When an entity concludes that a financing component is significant to a contract,

the entity should:

• determine the transaction price by discounting the amount of promised

consideration; and

• use the same discount rate that would be used if the entity were to enter into

a separate financing transaction with the customer at contract inception.


158

• When there is a substantial timing

difference between the payments of

goods or services and their delivery,

to understand whether there is a

significant financing component in the

contract, or whether it is due to a reason

other than a significant financing

component

Learning points


159

An evaluation based on the overall facts and

circumstances of the arrangement is needed

Judgement shall be applied in the evaluation

process.

• Disclose clear and adequate information of

management’s consideration of the key factors

when identifying and evaluating the existence of

a significant financing component

Learning points


160

III. Common disclosure issues

HKAS 12 Income Taxes

HKFRS 7 Financial Instruments: Disclosures

HKFRS 12 Disclosure of Interests in Other Entities

HKFRS 15 Revenue from Contracts with Customers

HKFRS 16 Leases

Details please refer to QAD 2020 annual report

https://www.hkicpa.org.hk/en/Standards-and-regulation/Quality-assurance/Professional-

standards-monitoring/Publications-and-Reference-Materials

https://www.hkicpa.org.hk/en/Standards-and-regulation/Quality-assurance/Professional-standards-monitoring/Publications-and-Reference-Materials

161

Resources

162

Quality Assurance Report 2020

Resources

163

A. QAD publications, including quality assurance reports and alerts

https://www.hkicpa.org.hk/en/Standards-and-regulation/Quality-assurance/Practice-

review/Publications-and-Reference-Materials

B. FAQ – Practice Review (Audits)

https://www.hkicpa.org.hk/en/Tools/FAQ/Quality-assurance/Practice-review---Audits

C. FAQ – Practice Review (AML/CTF)

https://www.hkicpa.org.hk/en/Tools/FAQ/Quality-assurance/Practice-review---AML-

Monitoring

Resources

A B C

https://www.hkicpa.org.hk/en/Standards-and-regulation/Quality-assurance/Practice-review/Publications-and-Reference-Materials

https://www.hkicpa.org.hk/en/Tools/FAQ/Quality-assurance/Practice-review---Audits

https://www.hkicpa.org.hk/en/Tools/FAQ/Quality-assurance/Practice-review---AML-Monitoring

164

D. COVID-19 – CPA Information Centre

https://www.hkicpa.org.hk/en/News/COVID-19-CPA-Information-Centre

E. Technical resources on the Institute's web site

https://www.hkicpa.org.hk/en/Standards-and-regulation/Standards/Resource-centre

F. CPD learning resource centre

https://www.hkicpa.org.hk/en/Professional-development/Continuing-professional-

development/Continuing-professional-development-programmes

Resources

D E F

https://www.hkicpa.org.hk/en/News/COVID-19-CPA-Information-Centre

https://www.hkicpa.org.hk/en/Standards-and-regulation/Standards/Resource-centre

https://www.hkicpa.org.hk/en/Professional-development/Continuing-professional-development/Continuing-professional-development-programmes

165

Thank [email protected]

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