HK’s AFRC releases 2024 Report: 5 key takeaways & recent regulatory activities highlighted.
Hong Kong’s Accounting and Financial Reporting Council has issued the 2024 iteration of its Annual Investigation and Compliance Report. This update will highlight five key takeaways from the report and recent regulatory activities.
1. Large backlog of investigations
The number of investigations initiated has remained high. In 2023/24, the AFRC initiated 46 investigations against PIE1 auditors (2022/23: 60) and 31 investigations against professional persons, i.e. a certified public accountant or a practice unit (2022/23: 12).
Despite the high number of initiations, the AFRC managed to conclude only seven investigations during the reporting period, five of which were against PIE auditors and the remaining two were against professional persons.
There is therefore a large backlog of cases being carried over to the following year. The report indicates over 200 investigations being in progress at the end of the reporting period. The corollary is that it could take years for the AFRC to close an investigation, and if recommended, take disciplinary action. Regulated persons may find themselves having to deal with enforcement actions many years after the occurrence of the alleged irregularity.
In the report, the AFRC talks of initiatives in operational optimisation: prioritisation, proportionality, specialisation and enhancement of the efficiency of the evidence gathering process. It is anticipated that, going forward, the AFRC will pivot its investigation efforts and prioritise severe, complex and high profile cases with significant public interest.
2. Key areas of misconduct
Several key areas of concern across different types of engagements can be distilled from the newly initiated investigations.
• For PIE auditors: failure to obtain sufficient appropriate audit evidence, failure to exercise professional judgement and maintain professional scepticism, and failure to properly perform engagement quality control reviews.
• For professional persons: non-compliance with the Code of Ethics for Professional Accountants and the assurance standards, and non-compliance with AFRC Ordinance provisions.
As for enquiries about accounting non-compliance, which potential targets would include preparers of financial statements of listed entities, the key areas of concern were revenue recognition, impairment assessment and fair value measurement, and fraudulent financial transactions and reporting.
3. Selection criteria of financial statements review
It is worth taking note of the AFRC’s financial statements review programme. Aside from complaints referred by other regulators and the public, the financial statements review programme is another source of investigations and enquiries. In 2023/24, the AFRC selected 130 sets of financial statements for review, which resulted in the initiation of seven investigations and two enquiries.
The AFRC explains it adopts a risk-based approach to the selection of financial statements for review; the selection criteria are reviewed and set annually in response to changes in the economic and regulatory environment. In 2023/24, the following criteria were added: fair value measurement and disclosures of financial instruments which require significant judgement and estimation, and impairment assessment of assets; while industry-specific criteria have been removed.
One criterion worth singling out is that of late auditor resignation, which contributed to the initiation of 11 investigation and two enquiry cases. The AFRC explicitly notes that it is sceptical of generic explanations such as fee disagreement or auditor rotation, as they may be used to disguise the true reasons for auditor resignation.
4. Collaboration with mainland regulators
The AFRC’s collaboration with mainland authorities has always been a matter of interest to stakeholders, in particular with regard to gaining access to audit working papers located in the Chinese Mainland. Earlier in the year, the AFRC’s Chairman said in a media interview that the AFRC would work closely with mainland regulators to seek documents from mainland accounting firms to conduct its investigations. The 2023 Report had a small section outlining the AFRC’s cooperation with the Supervision and Evaluation Bureau of the Ministry of Finance regarding audit working papers located in the Mainland. The absence of a similar section or an update on this aspect in the 2024 Report is notable.
Whatever the reason for the omission, it would appear collaborative efforts with the Ministry of Finance persist. In a press statement made on 2 August 2024, the AFRC publicised the mainland regulator’s finding against a Hong Kong registered PIE auditor in respect of the annual audits of mainland enterprises listed in Hong Kong.
5. Recent enforcement action
As for the disciplinary side of things, in our round-up of 2023 AFRC disciplinary decisions, we reserved judgment on the sanctions imposed in negligence-type cases. In the first three quarters of 2024, the AFRC has publicised disciplinary actions in respect of three cases, and the most recent case, which was against the PIE audit firm Ting Ho Kwan & Chan, is worth a mention. The regulator issued reprimands for breaches of auditing standards in the firm’s audits of a Hong Kong listed company, REXLot Holdings Limited, for the financial years ended 31 December 2013 and 2014. The AFRC imposed fines on the firm, the engagement partner and the engagement quality control reviewers of over HK$1.7 million in total.
The deficiencies found by the AFRC included multiple failures to obtain sufficient appropriate audit evidence, excessive reliance on management representations without corroborative audit evidence, and an overarching lack of professional scepticism. The deficiencies were said to have a material effect on the accuracy of the financial statements of the audited entity, including an overstatement of profits by 7% in 2013, and an overstatement of losses by 39% in 2014. The firm issued unmodified audit opinions for both years.
The reprimand and pecuniary fines are significant. Being one of the first negligence-type cases in which the AFRC has imposed sanctions, we expect this case will inform the regulator’s sentencing approach going forward. 1 PIE means a public interest entity, which in turn means a listed corporation (equity) or a listed collective investment scheme (section 3 of the Accounting and Financial Reporting Council Ordinance).
