Appointment Procedures and Qualification of Auditors after Company Registration Hong Kong

Before getting into the discussion of auditors, lets first get to know what basically is the need to appoint auditors after company registration Hong Kong and is there any necessity to appoint them or its just a formality? So, basically to maintain the proper accounting records and books of the company and to present the accounts of the company to the members, company must appoint auditors or firm of auditors, in compliance with Section 394 of Cap. 622. The primary function of auditor is to make auditors report, in which auditor is supposed to throw light on the financial affairs of the company. By the appointment of external auditors, company paves way to monitor the corporate governance of the company through external monitoring. While the financial statements of the company are prepared by the company, auditors make sure the authenticity and comprehensiveness of these financial reports. Apart from monitoring obligations, it is said that auditor helps in transparency and scrutiny of corporate governance and by way of this obligation, financial statement entails the authentic information, which would further help in establishing investors trust in the organization. Now trust and confidence is the basic obligation expected from the employee and appointee in corporate structure. So same principle applies here, and auditors are expected to maintain the relationship of trust and confidence with company’s director and they owe duties to the company’s members. About the rules and regulations, there are rules which governs and make sure that auditors may govern their duties with independence. As per the script of Cap. 50 also known as Professional Accountants Ordinance; the person who is supposed to be appointed as auditor needs to be a natural person and if firm of auditors is supposed to be appointed then that firm should constitute of natural person(s), also that; appointee should be independent of company.

There have been a lot of discussion on the jurisdiction and regulatory regime for the auditors and auditing practices in company setup in Hong Kong because past indicates of the situation where corporate collapses occurred on account of deficiencies and incompetency on the part of auditors and auditing practices and that there have been spots of involvement of auditors in the corporate wrongdoing such as involvement of auditors to seek personal gain by misappropriating and put a mask on company’s poor financial position. Not only this, but auditors usually pave way for taxation leverages by furnishing fake and fraudulent tax returns and annual financial statements of the company. Situation has not been very different in Hong Kong and there were number of PRC listings which suffered accounting frauds and there were allegations of negligence against the big four accounting firms in relation with largest corporate collapse of Hong Kong’s corporate structure that is; corporate collapse of Akai Holdings.

To stop this, there have been much debate over the issue of regulatory regime of auditors and their auditing practices and thus formal steps were taken to regulate the auditing practices and financial reporting. While the HKICPA retain its regulatory standing to oversee the matters related to accounting and auditing profession, an independent FRC (Financial Reporting Council) was established in 2006. FRC usually have the powers to investigate the irregularities in the financial reporting and auditing practices of the listed companies. To enhance the independence and regulatory standing of the FRC, it was proposed that certain regulatory and disciplinary statures of the HKICPA should be transferred to the FRC so that independence pertaining to the regulatory practices of listed companies should be enhanced. While this discussion was being continued, focus was shifted to the Enron collapse and this corporate collapse raised very serious questions which says that; will auditors be sufficiently independent in their auditing practices, especially in the situation where there has been long term relationship with the company, they audit and where the auditors provide non-auditing services to the company, they audit.

We discussed above that, after establishing company setup in Hong Kong auditors owe duty of care to the members of the company and it has been firmly established that the auditors owe such duties to the members of the company as a body and not only to members, but to every that person, to whom his/her report is addressed to. Such duties will arise where:

  • If auditor was performed negligently and thus there exist the foreseeable damage.
  • There exists sufficient proximity between the auditor and the party, who is relying on the auditor’s report.
  • There is sufficient evidence saying that; there exist duty of care on just and equitable grounds.

Directors are entitled to appoint first auditor of the company and that appointed auditor shall continue to function and hold its office till the annual general meeting of the company. From hereafter, auditor shall be appointed at each annual general meeting and that predecessor shall retire till annual general meeting. While the retired auditor is entitled to be reappointed and thus there is no set limit on the number of years, up to which auditor can be appointed. In case of any casual vacancy, director or the company itself is authorised to fill this vacant position by appointing replacement auditor, in general meeting. This was the general overview, now we shall proceed to the formal and extensive discussion on the procedural formalities regarding the qualification and appointment of auditors.

Qualification of the Auditor

To be eligible to be appointed as an auditor of the company, auditor should satisfy the requirements and eligibility criteria, as mentioned in the Professional Accountants Ordinance or Cap. 50. As per Section 29 (2) of Cap. 50; a person who is to be appointed as an auditor of the company, should hold the valid practicing certificate and must be a certified public accountant. If any auditing firm is to be appointed then, firm can be appointed with the name of firm provided, there exist certified public accountants in the firm hence in this situation, all those partners of the firm who holds the credibility and eligibility to be appointed as auditor of the company, shall considered to be appointed as auditors of the company. Certified public accountants who are not associated with any auditing firm, can practice auditing through the corporate vehicle by registering the company as a Corporate Practice under the Professional Accounting Ordinance and such corporate practice is entitled to be hired or appointed as the auditor of the company, says Section 29 (2) of Cap. 50.

On account of proposed amendments of the Financial Reporting Council Bill 2018, there are some additional regulatory registration requirements imposed, for the auditors of the listed companies. As per the recommendations of Financial Reporting Council Bill 2018, any auditor who is expected to carry out some specific auditing engagements for the listed companies, he/she must be registered as the “PIE Auditor”, before carrying out any such obligation or being engaged in specific auditing obligation.

Conflict of interest is the foremost validation necessity before any appointment and this validation necessity should carefully be done in case of any external appointment because this is where the corporate abuse takes on its journey towards corporate fraud and end up in meeting its destiny of corporate collapse. Thus, to avoid conflict of interest, there is the prohibition to appoint:

  • Officers and executives of the company as the auditors of the company. For example; directors of the company, managers of the company or secretary of the company.
  • Employees of the company as auditors of the company.
  • Employees or partner of any such entity, which is beneficiary or part of transacting business, as the auditor of the company.
  • Any such person who is disqualified to be appointed as the auditor of any subsidiary company, or of a parent company or any other corporate entity then such person would also be considered disqualified as being appointed as the auditor of any company incorporation Hong Kong.
  • Any other restriction imposed by the HKICPA’s code of ethics for Professional Accountants to facilitate the independence and authenticity of auditors. These restrictions are imposed so as to ensure that independence of the auditor should not be compromised, in any sense.

Procedural Matters related to Appointment of Auditors

Directors are entitled to appoint first auditor of the company after starting a business in Hong Kong at any time before the holding of annual general meeting of the company. As we are very well familiar with the fact that annual financial statements of the company are laid before the members of the company in Annual General Meeting of the company, so directors are supposed to exercise their power to appoint auditors before the AGM. Usually practices show that, auditors are normally appointed in the first board meeting of the company’s directors, since company incorporation Hong Kong. Once first auditor has been appointed, members of the company shall appoint new auditor in the first annual general meeting and thus predecessor auditor shall retire but possibility exist that retired auditor may be reappointed as company’s auditors; states Section 396 of Cap. 622. The appointed auditor shall continue to hold its office till the next AGM and thus at every AGM company is supposed to reappoint existing auditor(s) or make fresh appointment. If company fails to appoint auditor in the AGM then member(s) of the company is entitled to apply to the court for the appointment of auditor.

For the situation where company decides through any voting mechanism that, AGM shall not be held then provisions of Cap. 622 devises a procedure to appoint auditor in this situation. For those companies who decides not to hold Annual General Meeting of the company, then there is no need to go into formal procedure to reappoint existing auditor so that existing auditor may continue to hold its office for the next financial year, provided constitution of the company permits so and that this appointment shall be in compliance with Section 403 of Cap. 622. When the members of the company think that auditor should not be reappointed then this reappointment can be barred by simply furnishing the ordinary resolution. If the complaining member holds at least five percent of voting rights, out of total voting rights then such member can simply give notice to the company that; reappointment shall not be made. If this is done, then reappointment shall cease to be taken place and members of the company shall need to appoint auditor is compliance with Section 396 (3) of Cap. 622. If there exist a unanimous consent upon the appointment of auditor then evidence of unanimous consent shall be sufficed and thus there would be no need to comply with procedural requirements. But, where there exist no unanimous consent or agreement then Annual General Meeting of the company shall be called to facilitate the procedure of auditors appointment. It must be noted that appointment of auditor shall be done before the end of appointment period and appointment period is basically that period of 28 days, which commences once, reporting documents has been sent to all members of the company and this liability is specifically for the situation where company decides not to hold Annual General Meeting of the company.

Since permission is given to companies to reappoint auditors but still Cap.622 depreciates such practice on account of very legitimate grounds. if auditor is continuously reappointed then that auditor will establish close relationships with the controlling and management hierarchy of the company and thus there will be serious questions on the independence and credibility of the auditor. This is the reason HKICPA’s code of ethics for Professional Accountants imposes a restriction of continuous appoint of the same auditor for more than consecutive seven years, where there is generally no mandatory requirement on the rotation of auditing firms but still it is done to ensure independence and credibility of the auditors.

For the situation where either auditor resigns from his/her office or there is a casual vacancy of the auditor, directors or the company itself is entitled to fill this vacant position by appointing replacement auditor for the term ending at coming Annual General Meeting of the company.