AFRC reprimands MnO CPA Limited and its two directors for audit deficiencies and imposes fines of HK$600,000

The Accounting and Financial Reporting Council (AFRC) has sanctioned the following corporate practice and two of its directors for negligence and multiple breaches of auditing standards in relation to the audit of the consolidated financial statements of a Hong Kong listed company, New Concepts Holdings Limited and its subsidiaries (collectively, Group), for the year ended 31 March 2017 (2017 Audit):

• MnO CPA Limited (formerly known as Wellink CPA Limited) (registration no. M0472) (MnO);
• Ms Chan Yan Ting (Chan), the engagement partner for the 2017 Audit (collectively with MnO, the Auditor); and
• Mr Ngan Hing Hon (Ngan), the engagement quality control reviewer for the 2017 Audit.

The AFRC found multiple deficiencies in the Auditor’s work on the valuation of technology assets and the testing of goodwill impairment, involving repeated failures to critically assess the work of valuation experts and apply professional scepticism to management’s assumptions. The AFRC has consequently issued a public reprimand to MnO, Chan and Ngan, and imposed pecuniary penalties totalling HK$600,000, comprising penalties of HK$300,000 for MnO, HK$210,000 for Chan, and HK$90,000 for Ngan.

At the time of the 2017 Audit, the Group was seeking to expand its relatively new environmental protection business in the Chinese Mainland. This expansion included the acquisition of a majority interest in Clear Industry Company Limited and its subsidiaries (CIG) in December 2016, at a price which far exceeded the fair value of CIG’s identifiable net assets (including significant technology assets). During the 2017 Audit, the Auditor agreed with management that CIG’s technology assets had a value of HK$25.9 million at acquisition, and that the goodwill of HK$90.98 million arising from the acquisition was not impaired at year-end. However, during the subsequent financial year ended 31 March 2018, the vast majority of those technology assets and the entirety of that goodwill were written off as an impairment loss.

The AFRC found that during the 2017 Audit, the Auditor failed to obtain sufficient appropriate audit evidence to support the reported value of CIG’s technology assets at the date of acquisition, and its conclusion that there was no impairment of goodwill at 31 March 2017, despite both assets being material to the Group’s balance sheet. Most significantly:

• The valuation of CIG’s technology assets, as prepared by management’s expert, was heavily reliant on several key assumptions made by management (such as a projected 605% increase in the relevant revenue to be generated by CIG). The Auditor failed to identify that these assumptions apparently had not been critically reviewed by either management’s expert or the Auditor’s own expert.
• Management’s testing of goodwill impairment was heavily reliant on several key assumptions made by management, including projected revenues. Despite knowing that the testing of goodwill impairment was a key audit matter, the Auditor failed to properly evaluate those assumptions – for example, by identifying whether management had entered into contracts for new projects after the date of acquisition, which would demonstrate their ability to secure new projects and therefore generate the projected revenue. The Auditor instead relied on management representations and poorly-designed analytical procedures.

In addition to the deficiencies in the work of the Auditor, the AFRC also found deficiencies in Ngan’s engagement quality control review, in that he failed to adequately evaluate the engagement team’s significant judgments and conclusions. For example, despite being aware that testing of goodwill impairment was a key audit matter and having reviewed the main audit work paper on this topic, Ngan failed to identify the engagement team’s over-reliance on management representations and the deficiencies in their analytical procedures.

MnO, Chan and Ngan therefore failed to observe, maintain or otherwise apply the Hong Kong Standards on Auditing, and were also negligent in the conduct of their profession.

Ms Hester Leung, Head of Discipline, said, “Valuations often involve specialised knowledge, and may require an auditor to engage their own expert for assistance. However, the responsibility for exercising an appropriate level of professional scepticism always remains with the auditor – this cannot be simply delegated to the auditor's expert.”

In deciding the appropriate disciplinary sanctions, the AFRC has considered all relevant circumstances, including:

• the fact that the misconduct involved multiple audit deficiencies;
• the moderately serious nature of those deficiencies;
• the fact that the misconduct was limited to a single audit engagement;
• the absence of any finding of intentional, dishonest or deliberate misconduct; and
• the clean disciplinary records of all three regulatees.

For details of the decision, please refer to the Statement of Disciplinary Action .