CASE. Company background

Transcription

1 CASE Company background Handsome Group Limited ( HGL ) is the parent holding company of a conglomerate ( the Group ) listed on the Hong Kong Stock Exchange, with significant investments in various business sectors including infrastructure, telecommunications, investment and financing and trading. Mr. William Li, the Chairman, founded the Group in the 1980 s. Mr. Paul Zhang, a high school classmate of Mr. Li, is the Chief Financial Officer ( the CFO ) and the Head of the Treasury Department. Paul is a member of the Hong Kong Institute of Certified Public Accountants and is considered to be a professional accountant in business ( PAIB ). The Group has operations and activities all over the world. All the Group s companies close their books on 31 December. HGL prepares its consolidated financial statements in accordance with Hong Kong Financial Reporting Standards ( HKFRSs ) and presents them in Hong Kong Dollar ( HKD ). The software module used to maintain the recording of journal entries in the Group s financial reporting computer system was upgraded during the year and the upgraded software module has been used since 1 July Audit Matters SMP & Co. ( SMP ) has been auditing the Group for many years. The Group is one of the firm s crown-jewel audit clients. The total of the last year s audit fee received from HGL and the proposed audit fee for the current year audit represents more than 15% of the firm s total fees revenue. The engagement audit partner, Walter Miller, has served HGL for 6 years and the current quality review partner assigned to this engagement will retire one month before the expected report date of the engagement. At the audit planning stage of the current year s audit, Walter learnt from the HGL management that an assessment of the risk that the financial statements may be materially misstated as a result of fraud has not been performed. He also recalled that there was a significant provision for receivables made in the last year based on the specific review of the customers repayment history and assessment of recoverability. The assessment and provision were reviewed and approved by both William and Paul. However, he noted that the provision was reversed in the current year. Sales of HG Products Ms. Amy Lam is the Sales Director of a Group company, HG Glory Limited ( HGG ), engaged in the trading of HG branded products ( HG products ) in Hong Kong. HGG s functional currency and presentation currency is the United States Dollar ( USD ). Amy plans to develop a new HG trading business in the China market. She prefers the HGG trading business be carried out by a BVI (British Virgin Islands) company so as to enjoy certain non-taxable claim in Hong Kong, according to her business associates. Final Examination (December 2014 Session) Paper I 1 of 8

2 BVI company for the China market Based on Amy s proposal, the BVI company, HG BVI Company Limited ( HBC ), will share the office of HGG in Hong Kong and Amy will be appointed as one of the directors of HBC. HBC will not trade with Hong Kong suppliers and customers. Amy s team will travel to Japan and Korea to attend the trade fairs of HG products. They will negotiate and determine the purchase price there and place their purchase orders. During the trips, the team will also decide a pre-determined range of sale price for the China market. The salespersons employed by HBC will spend most of their working time in China to negotiate and solicit distributors during their business travels. The distributors will place their purchase orders with the salespersons in China. The salespersons will have the authority to accept purchase orders if they are within the pre-determined range of sale price. However, the salespersons will not seek approval from Amy for any out-of-range transactions and these orders will be rejected. The salespersons will report their business to Amy during the monthly conference calls or meetings in Hong Kong. Board meetings of HBC will be held in Hong Kong. If Amy is travelling, she will join the meeting via a conference call. The HG products will be shipped from Japan/Korea to the Chinese distributors, without passing through Hong Kong. Letters of credit will be arranged by the back office staff of HBC in Hong Kong to settle the payable to the Japan/Korea suppliers, whether third party suppliers or HGG overseas subsidiaries, via a bank account kept in Hong Kong, which is also used for the settlement of trade receivables. Amy heard about the 60-day visit rule for Hong Kong salaries tax before and she believes that the HBC salespersons are not required to pay any salaries tax in Hong Kong. Development plans for China market The Chief Financial Officer of HGG, Mr. John Doe, is tasked to assist Amy on the new China market development project on the operating side. During the monthly Board of Directors Meeting of HGG for April 2014, the following initiatives have been discussed and tentatively agreed: (1) HBC, a BVI company, will be set up and designated to deal with the new HGG trading business in the China market. (2) Handsome International Limited ( HIL ), a wholly-owned subsidiary of HGG, will hold 100% ordinary shares (denominated in USD) in HBC. (3) HIL will control the strategic and operational activities of HBC and provide additional funding, either in short-term or long-term loans to HBC, if necessary. (4) The Board of HBC will have 3 directors who are also common directors of HGG. (5) HBC will arrange trade finance facilities and open bank accounts with banks in Hong Kong to handle the import/export trading business with parent company guarantees provided by HGG. (6) HBC will purchase HG products from HGG subsidiaries or third party suppliers which are invoiced and settled in USD. (7) HBC s sales of HG products in China will be invoiced and settled in Chinese Yuan (i.e. Renminbi ( RMB )). Final Examination (December 2014 Session) Paper I 2 of 8

3 (8) HBC s Hong Kong or local expenses, such as staff costs and administrative expenses, will be settled in HKD. (9) HBC will adopt a simple set of treasury policies which stipulates that borrowings or debts are in USD and cash reserves are in RMB or USD. (10) HBC will use treasury products, such as cross-currency swaps or currency forward contracts for hedging purposes, in accordance with HGL Group treasury and risk management policies. Treasury activities HGL is subject to significant foreign currency risk because it has a large amount of revenues, expenses, investments, assets, liabilities and cash flows in foreign currencies (other than HKD). HGL disposed of an investment in Thailand last year. According to the sales and purchase agreement, the last instalment of the sales consideration, being Thai Baht ( THB ) 50 million, will be due in three months time. This receivable has been booked at THB4.1600:HKD1, the exchange rate for THB/HKD in the last financial year end date. The THB exchange rate has been rather volatile recently. The CFO is eager to quantify the foreign currency risk exposure of this receivable. HGL has made a commitment to invest in an infrastructure project in Spain in the amount of Euro Dollars ( EUR ) 200 million in a year. Having recognised the exposure to foreign currency risk, the CFO would like to fix the HKD/EUR exchange rate when the investment commitment has to be met in one year s time. He was advised that this can be achieved by way of a money market hedge, where some borrowing and depositing arrangements are to be transacted with a bank. The relevant money market data are as follows: Spot rate HKD/EUR: / Interest rate: Deposit Borrowing Hong Kong (HKD) 0.2% p.a. 5% p.a. Spain (EUR) 1.5% p.a. 3.5% p.a. Banking affairs of the Group The Kowloon Banking Corporation Ltd ( KBC ) has been the principal banker of the Group for many years. As such, the CFO has established a good working relationship with Gary Ng, the managing director of KBC who covers the Group. Knowing that Paul s son has just graduated overseas and is interested in pursuing a career in the finance industry, Gary suggested to Paul that he could help secure a position in his Bank for Paul s son. Final Examination (December 2014 Session) Paper I 3 of 8

4 SECTION A CASE QUESTIONS (Total: 75 marks) Answer ALL of the following questions. Marks will be awarded for logical argumentation / calculation and appropriate presentation of the answers. Question 1 (25 marks approximately 45 minutes) Assume you are the audit manager of SMP. Required: (a) (b) (c) Identify the independence and quality control issues to be considered in the audit planning stage and propose the relevant actions to address the issues. (6 marks) Explain to the HGL management the audit issue in relation to their responsibilities in assessing the risks that the financial statements may be materially misstated as a result of fraud and propose the relevant risk assessment procedures to be carried out by the audit team to address the audit issue identified. (6 marks) For the significant reversal of provision for receivables made in the last year: propose the specific audit planning procedures for the assessment of the risks of material misstatement for accounting estimates in relation to the provision for receivables; and list three general substantive audit procedures in relation to the assessment of provision for receivables. (3 marks) (d) Discuss the impact on the HGL audit plan in relation to information technology general and application controls as a result of the upgrade in the journal entries software module and list two typical audit procedures that should be performed. Final Examination (December 2014 Session) Paper I 4 of 8

5 Question 2 (25 marks approximately 45 minutes) (a) (b) Suggest to the Group CFO, Paul Zhang, some basic ways of managing the foreign currency risk of the Group through natural hedging. (8 marks) For the THB sales consideration: What will be the 90-day forward rate (or expected future spot rate) of THB/HKD based on interest rate parity? (Note: Show your answer with rounding to 4 decimal points. Assume that the Spot THB/HKD is , the 90-day interest rate in Hong Kong is 0.05% and the 90-day interest rate in Thailand is 0.75%.) (2 marks) Quantify the foreign currency exposure of the THB 50 million receivable with reference to the last financial year end date. (Note: Assuming there is an 80% probability that the future spot rate is the same as calculated in Question 2(b) above and 20% probability that the future spot rate is the same as that on the last financial year end date. Show your calculations with rounding to 4 decimal points and ignore any tax effect.) (2 marks) (c) For the investment in the infrastructure project in Spain: advise on how to transact the money market hedge and show your key steps and calculations in the answers; and compute the effective 12-month forward rate under the money market hedge arrangement. (Note: show your calculations with rounding to 4 decimal points.) (7 marks) (d) (e) Discuss the compliance with the Code of Ethics for Professional Accountants, in particular the fundamental principles thereunder on the part of the CFO, Paul Zhang, if he accepts the offer by Gary Ng. (4 marks) If Paul fails to draw any conclusion as to the compliance with the Code of Ethics, what would you advise him to do before he makes any final decision? (2 marks) Final Examination (December 2014 Session) Paper I 5 of 8

6 Question 3 (25 marks approximately 45 minutes) (a) Assume you are the Chief Financial Officer of HGG, John Doe. Required: Based on the tentative decisions made in the April 2014 HGG Board meeting, explain and analyse the accounting treatments of the following items: determination of the functional currency of the BVI company, HBC; (10 marks) exchange differences of loans or advances made by HIL to HBC for the reporting of HIL s standalone and consolidated financial statements; and (Assume HIL s functional currency is Singapore Dollars) (iii) use of currency forward contracts to hedge highly probable forecast sales. (b) Assume HGL continues to prepare annual financial statements that give a true and fair view of the Group s financial position and performance in accordance with HKFRSs, for compliance with the new Hong Kong Companies Ordinance: Required: Answer the following in relation to exemptions from preparing consolidated financial statements in the context of the new Hong Kong Companies Ordinance: explain under what circumstances a company may exclude any of its subsidiaries from the consolidated financial statements; and (2 marks) state the exemption criteria which must be fulfilled if the parent holds material subsidiaries. (3 marks) * * * * * * * * Final Examination (December 2014 Session) Paper I 6 of 8

7 End of Section A

8 SECTION B ESSAY QUESTIONS (Total: 25 marks) Answer ALL of the following questions. Marks will be awarded for logical argumentation / calculation and appropriate presentation of the answers. Refer to the Case information. Question 4 (25 marks approximately 45 minutes) As the tax director of HGL, write a memo to advise HGG s Sales Director, Amy Lam, on the following tax issues: Required: (a) (b) (c) Discuss whether there are any tax exposures for HBC in Hong Kong and whether the non-taxable claim is likely to succeed, from a Hong Kong profits tax perspective. (12 marks) Discuss whether the activities of the HBC salespersons will create any China Enterprises Income Tax exposures for HBC from a China Tax perspective. Discuss the Hong Kong salaries tax issues of the HBC salespersons assuming they spent 45 days for holidays and meetings in Hong Kong in a year of assessment. In particular, advise Amy: whether the 60-day rule applies to the salespersons; and (4 marks) in case the salespersons are subject to the Hong Kong salaries tax, whether there is any chance for partial income exemption if these salespersons are also subject to Individual Income Tax in the Mainland. (4 marks) * * * END OF EXAMINATION PAPER * * * Final Examination (December 2014 Session) Paper I 8 of 8