business accounting financial analysis surveyors in … · business accounting & financial...

Sr Benny K B Kwok BSc MBA CTA FCA FCPA(Practising) MCIJ MCIOB MHKIS MRICS

Wednesday 23 Nov 2016 - 7:00 pm to 8:30 pm

The Hong Kong Institute of Surveyors

Surveyors Learning Centre

Room 1207, 12/F, Wing On Centre

111 Connaught Road Central, Hong Kong

BUSINESS ACCOUNTING &

FINANCIAL ANALYSIS FOR

SURVEYORS IN HONG KONG

Business Accounting & Financial Analysis

for Surveyors in Hong Kong

IMPORTANT NOTES

The materials of this seminar are intended to provide general information and

guidance on the subjects concerned.

Examples and other materials in this seminar are only for illustrative purposes and

should not be relied upon for technical answers.

The speaker and the firm(s) that the speaker is representing take no responsibility

for any errors or omissions in, or for the loss incurred by individuals or companies

due to the use of, the materials of this seminar.

© BENNY K B KWOK FORENSIC EXPERT, 2016

2 2


for Surveyors in Hong Kong Materials of this seminar have been sourced primarily from:

Hong Kong Financial Reporting Standards (“HKFRS”) -

issued by The Hong Kong Institute of Certified Public

Accountants (“HKICPA”), which comprise Hong Kong

Accounting Standards (“HKAS”)

Hong Kong Standards on Auditing (“HKSA”) - issued by the

HKICPA

Business Terms & Phrases for Surveyors, Engineers &

Facilities Managers in Hong Kong (“Textbook 1”) - published

by Knowledge Conservation, written by Benny K B Kwok and

sponsored by The Hong Kong Institute of Surveyors, 2016

Financial Analysis in Hong Kong (2nd ed) (“Textbook 2”) -

published by The Chinese University Press and written by

Benny K B Kwok, 2013

Forensic Accountancy (2nd ed) (“Textbook 3”) - published by

LexisNexis and written by Benny K B Kwok, 2008 3 3



Relevant applications of accounting and finance for surveyors

Companies Ordinance (Cap 622)

– Section 373: Company must keep accounting records

– Section 376: Form of accounting records

– Section 377: How long accounting records to be preserved

– Section 379: Directors must prepare financial statements

– Section 380: General requirements for financial statements

– Section 388: Directors must prepare directors’ report

4 4




Building Management Ordinance (Cap 344)

– Section 27: Accounts of Corporation

– Schedule 5: Annual Budget

– Schedule 6: Accounts

– Schedule 7: Mandatory Terms in Deeds of Mutual Covenant

Lands Resumption Ordinance (Cap 124)

− Sections 10(2)(d) and 10(2)(e)(i): Determination by Tribunal of

Compensation payable by Government

5 5




Quantum assessment of losses of assets, stocks or

inventories (attached article)

Calculation of liquidated damages in contracts

Business valuation for corporate transactions of equity

interests between shareholders

Cost estimate for employers to compile preliminary cost

plans or for contractors to prepare tenders

Preparation / assessment of interim payment applications

and final accounts

6 6



Overview of:

Financial statements

Financial reporting framework

Accounting ratios

Audit reports

Business valuation

Budgets

Internal controls

Costs

7



FINANCIAL

STATEMENTS

8 8



Components of Financial Statements

9

Building

Management

Ordinance (Cap

344)

Section 27

Note (a)

Predecessor

CO (Cap 32)

Section 122

New CO (Cap 622)

Section 380

Note (b)

HKAS 1

Balance sheet Balance sheet “true and fair view of

the financial position”

Statement of financial

position

Income &

expenditure account

Profit & loss

account

“true and fair view of

the financial

performance”

Statement of profit or loss

and comprehensive

income

Statement of cash flows

Statement of

changes in equity

Notes to financial

statements



Note (a)

Section 27 (Accounts of corporation) of the BMO

states that “… a management committee shall

maintain proper books or records of account and …

financial statements … The financial statements …

shall include: (a) an income and expenditure

account which gives a true and fair view of the

financial transactions of the corporation for the period

to which it relates; and (b) a balance sheet which

gives a true and fair view of the financial position of the

corporation as at the date to which the income and

expenditure account is made up …”

10



Note (b)

Section 380 (General requirements for financial

statements) of the CO states that “(1) The annual

financial statements for a financial year: (a) must give

a true and fair view of the financial position of the

company as at the end of the financial year; and (b)

must give a true and fair view of the financial

performance of the company for the financial year …”

11



Statement of Financial Position

A financial snapshot of assets, liabilities and equity at

a particular point in time, and an indication of the

creditworthiness and financial strength of an

organization.

Generally listing out what an organization owns or

controls and those that the organization owes or is

obliged to pay.

Source: Textbook 1

12



Statement of Financial Position

Accounting Equation : Assets – Liabilities = Equity

Current vs non-current distinction for all assets and liabilities

Property, plant and equipment

Deposits

Inventories Assets

Trade and other receivables

Cash at bank and in hand

Trade and other payables

Provisions Liabilities

Share capital / general fund / contingency fund

Accumulated surpluses / reserves Equity

Source: Textbook 2 13 13



Statement of Profit or Loss and Comprehensive Income

A financial camcorder or score-sheet showing the flows of

resources and their net results during an accounting

period, and an indication of the viability and financial

performance of an organization

Generally reporting an organization’s revenue, gain, cost,

expense and other items

Source: Textbook 1

14




Accounting Equation :

Assets – Liabilities = Equity

Equity = Share Capital + Reserve

Reserve ~ Surpluses / profits in current year plus those

undistributed and brought forward from previous years

15



16


Classification by function or by nature

Revenue / sales / turnover

Cost of sales

Gross profit

Other income

Distribution costs

Administrative expenses

Finance costs

Other expenses

Surplus / profit before tax

Tax

Surplus / profit after tax / profit for the year

Source: Textbook 2

16



Statement of Cash Flows

A financial camcorder showing the flows of cash and

their net results during a particular period

Statement of Changes in Equity

A reconciliation between opening and closing

balances of equity during a particular period

Source: Textbook 1

17



Notes to Financial Statements

Basis of preparation and compliance with HKFRS

Significant accounting policies

Supporting information for items presented in the

other four components of financial statements

Other disclosures, e.g. directors’ emoluments,

auditor’s fee, financial instruments, contingent

liabilities, related parties’ transactions and events

after the end of reporting period

18



FINANCIAL

REPORTING

FRAMEWORK

19 19



Financial reporting frameworks in Hong Kong

HKFRS

HKFRS for Private Entities (“HKFRS-PE”)

Small and Medium-sized Entity Financial Reporting

Framework and Financial Reporting Standard

(“SME-FRS”)

20 20 20




HKFRS

For all general purpose financial statements

towards the common information needs of a

wide range of users

Listed companies

28 HKFRS and 16 HKAS

Convergence of HKFRS with International

Financial Reporting Standards

Members of HKICPA to follow HKFRS 21 21 21




HKFRS-PE

As a financial reporting option for companies

which:

– Do not have public accountability; and

– Publish general purpose financial statements

for external users.

Simplified version of HKFRS, and having

285+77+56 pages

22 22 22




SME-FRS

As an optional reporting exemption under the

Companies Ordinance for certain private

companies and companies limited by guarantee

which satisfy the conditions set out in s359 of the

Companies Ordinance (i.e. no subsidiary and not

a subsidiary; or passing 3 sets of size tests)

Not for banking, insurance and some regulated

businesses

Reduced and simplified contents, and having

128 pages

23 23 23




Other mandatory requirements

Companies Ordinance

Inland Revenue Ordinance

Listing Rules / GEM Rules

Building Management Ordinance, Banking

Ordinance, Insurance Companies Ordinance,

… etc

24 24 24




Regulators

Government of the HKSAR

Stock Exchange

SFC (Securities & Futures Commission)

HKICPA

FRC (Financial Reporting Council)

HKIA (Hong Kong Insurance Authority)

HKMA (Hong Kong Monetary Authority)

Source: Textbook 2 25 25 25



ACCOUNTING

RATIOS

26 26



Accounting ratios

The proportional relationship between two or more items

from an organization’s accounts or financial statements,

expressed in terms of numbers or percentages

Generally focusing on certain key aspects of an

organization’s financials, e.g. profitability, solvency,

efficiency and stability, and revealing the meaning and

significance from figures which are not readily apparent

from financial statements

Source: Textbook 1

27 27 27



Accounting ratios

Current ratio

= Current assets / Current liabilities

Debtor turnover days

= 365 days x Average receivables / Revenue

Inventory turnover days

= 365 days x Average inventories / Costs of sales

Creditor turnover days

= 365 days x Average payables / Purchases

Source: Textbook 2

28 28 28



Accounting ratios

Interest coverage

= Profit before interest expenses / Interest expenses

Profit margin

= Profit / Revenue

Return on equity

= Profit / Equity

Source: Textbook 2

29 29 29



AUDIT

REPORTS

30 30



Auditor

An external or statutory auditor is an independent

professional who, under the Professional

Accountants Ordinance (Cap 50), is qualified to

conduct audit and to issue audit opinion

An internal auditor is part of an organization in

charge of evaluating the effectiveness of internal

controls and conducting the value-for-money

reviews

Source: Textbook 1

31 31



Audit report

A report prepared and issued by an auditor in

respect of his opinion on certain financial

statements in the context of the applicable

financial reporting framework

Generally setting out the nature of an audit, the

responsibilities and the audit opinion

Source: Textbook 1

32 32



Audit report

New standards for periods ending on/after 15

Dec 2016

HKSA 700: Forming an opinion and reporting

on financial statements

HKSA 701: Communicating Key Audit Matters

in the Independent Auditor’s Report

HKSA 705: modifications to the opinion in the

independent auditor’s report

HKSA 706: Emphasis of matter paragraphs

and other matter paragraphs in the

independent auditor’s report

33 33


for Surveyors in Hong Kong New format of audit report (in Dec 2016)

Title

Addressee

Auditor’s Opinion – “fair presentation framework” vs “compliance framework”

Basis for Opinion

Going Concern

Key Audit Matters

Other Information

Responsibilities of Directors for the Financial Statements

Auditor’s Responsibilities for the Audit of the Financial Statements

Name of the Engagement Partner

Signature of the Auditor

Auditor’s Address

Date of the Auditor’s Report

34 34



Audit opinion

Audit opinion may be unmodified, or modified in

three possible ways:

‐ Qualified opinion;

‐ Adverse opinion; and

‐ Disclaimer opinion

Source: Textbook 1

35 35



BUSINESS

VALUATION

36 36 36 36



Business valuation

An act or process of determining the value of a

business or its ownership interest by assessing the

price that a hypothetical buyer would pay for the

business under a given set of circumstances

Source: Textbook 3

37 37 37 37



Business valuation

Income approach

Market approach

Cost approach

38 38 38 38



Income approach

Present value of the business = V0

FCFF1 FCFF2

V0 = ----------------------------------- + ------------------------------- + ----------- ……

(1 + WACC)1 (1 + WACC)2

∞ FCFFt

=

∑ ------------------------

t = 1 (1 + WACC)t

FCFF = Cash flows to all debt and equity investors

WACC = Weighted Average Cost of Capital 39 39 39 39



Market approach

Market / fair value of a business

= Maintainable profit x Capitalisation rate

i.e. to capitalise a sustainable level of profits into value.

40 40 40 40



Maintainable profit

Possible adjustments to audited financial statements:

Non-recurring items

Inconsistent basis of preparation

Non-operating items

Non-economic items

Capitalisation rate or multiple

P/E

EV/EDIT

EV/EDITDA

41 41 41 41



BUDGETS

42 42 42



Budget

An itemized listing of the amounts of estimated

revenue, along with the amounts of estimated

costs and expenses which will be incurred in

obtaining those revenue during a given period of

time

Source: Textbook 1

43 43 43



Budget

a detailed plan of action for an upcoming period,

quantified in money

translating the overall objectives and strategies

into detailed plans of action

for the whole entity (sales forecasts, KPIs, SLAs,

…materials/production budgets, payroll budgets,

cash budgets, …)

for a sub-unit within the entity (a department, a

machine, a property, …)

short-term vs long-term 44 44 44



Types of Budgets

Incremental budgets

Zero-based budgets

Fixed budgets

Flexed budgets

45 45 45



Benefits of budgeting

focus on overall objectives

planning mechanism

motivation

means of communication

co-ordination of activities

expenditure authorisation

performance measurement

budgetary controls 46 46 46



Budgetary controls

One of the many types of internal controls

Cost centre, profit centre and investment centre

Budget preparation

Recording of actual results (as part of book-keeping)

Comparison between budget and actual results

Calculation of variances

Interpretation of variances

47 47 47



INTERNAL CONTROLS

48 48 48 48



Internal Controls

The process designed, implemented and maintained by an

organization to provide reasonable assurance about the

achievement of its objectives with regard to reliability of

financial reporting, effectiveness and efficiency of operations

and compliance with applicable laws and regulations

Five components under HKSA are:

Control environment;

Risk assessment process;

Information system;

Control activities; and

Monitoring of controls. Source: HKSA and Textbook 1

49 49 49



Controls over inventories

Inventory records

Physical controls

Periodic stocktaking

Inventory management

– holding costs and ordering costs

– JIT – Just-in-time

50 50 50



Quantum assessment of losses of inventories

Supporting insurance claims

Attached article of “Quantum Assessment of Losses of

Inventories by Forensic Accountants”, concurrently

published by Actuarial Society of Hong Kong, Chartered

Institute of Building, HKICPA and Institute of Chartered

Accountants in England & Wales in 2013-14

51 51 51



Quantum assessment of losses of inventories

Physical stocktake

Roll-forward Direct

Perpetual inventory system

Observable financials

Observable correlations Indirect

Calculation to assess the unknown value (i.e. value of lost inventories)

52 52 52



Controls over fixed asset

Fixed assets register

A register recording capital expenditure

Date

Description

Serial / make number

Amount

Location

53 53 53



COSTS

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54 54 54 54



Capital Expenditure

Long-term benefits to the entity

Long-term costs to the entity (asset life cycle)

55 55

55 55



Revenue Expenditure

Fixed costs – remaining at the same amount

regardless of how much or how little work is done

Variable costs – varying in proportion to the changes in

volume or activity

Direct costs - traceable to an object to which the costs

are to be determined

Indirect costs - not traceable to a department, a

product, an activity or a customer

Source: Textbook 1

56 56 56



F

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THANK YOU ……

for your attention and sharing

57



We hope that you have obtained an overview of the

following topics and how they might relate to your work as

surveyors in Hong Kong.

Financial statements

Financial reporting framework

Accounting ratios

Audit reports

Business valuation

Budgets

Internal controls

Costs

58

Further References

59

60

Benny K B Kwok

Tel : (852) 2111 1867 / (852) 3157 6297

Email: [email protected] / [email protected]

Fax : (852) 3690 2757

Web : www.Forensic.HK

For enquiries about the HKIS sponsored book:

Email: [email protected]

Business Terms & Phrases for Surveyors, Engineers & Facilities Managers in Hong Kong

Sr Benny K B Kwok FCA CPA(Practising) MHKIS MRICS MCIOB

Sponsored by The HKIS

journalism business hong kong institute of surveyors benny k b kwok forensic expert

forensic accounta

nt cpa cpa book arts creative arts media publish book marketing marketer pr agency

hong kong hk www.journ

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Various terms and phrases emerge every day in business. Some people may not check every unfamiliar item, but the stakes can be high. Misinterpretation of key words, particularly in written correspondence, causes embarrassments and costs money. Business Terms & Phrases for Surveyors, Engineers & Facilities Managers in Hong Kong provides a convenient and standalone coverage of terms and phrases commonly used in business. Although information is widely available in the public domain, they do not necessarily give consistent (or even correct) meanings and messages. It can be tricky for those less well trained in business to understand the differences and to establish the rights and wrongs. This pocket-size book fills in the gap by presenting a source of practical references of key business terms and phrases, primarily for postgraduate students and professionals in their early careers, with more than 1,000 carefully selected entries reflecting the popularity of their usage in Hong Kong’s business environment. Benny K B Kwok is a renowned forensic accountant and expert in litigation support, dispute analysis and fraud investigation, and is the author of three internationally acclaimed titles: Forensic Accountancy 1st & 2nd Editions (LexisNexis), Financial Analysis in Hong Kong 1st & 2nd Editions (The Chinese University Press) and Accounting Irregularities in Financial Statements (Gower Publishing). Mr Kwok has acted as a single joint expert in civil proceedings and an expert witness in arbitration hearings, disciplinary proceedings as well as civil and criminal trials, at the District Court and the High Court, in respect of accounting, commercial and financial matters. Over the last two decades, Mr Kwok served on the Solicitors’ Disciplinary Tribunal, the Obscene Articles Tribunal and the Board of Review, and was the Examiner of the CPA Qualification Programme of the Hong Kong Institute of Certified Public Accountants for 7 years. Mr Kwok has recently been appointed as a Visiting Fellow with School of Professional Education & Executive Development of The Hong Kong Polytechnic University (PolyU SPEED) for his teaching and research interests in forensics, auditing, surveying and business law.

July/August 2016

Pages : ~250

ISBN : 978-988-77351-0-6

Price : HK$150 HK$120 Special price for HKIS members or probationers (valid until 31 Dec 2016 & inclusive of local delivery)

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sep16v1

W hen a disaster strikes and rescue and relief operations are underway, one should

start counting the losses. Most companies nowadays have business continuity plans, including insurance coverage and recovery measures, to help offset losses and damage to assets comprising buildings, structures, plants, equipment, fixtures, fittings and inventories.

Forensic accountants often address the quantum of various tangibles and intangi-bles for businesses and litigators, including losses of inventories. This issue can be addressed through several approaches.

Direct approach

Physical inventory countThe methodologies in assessing lost inventories depend on the scope and cover-age of the particular insurance policy, but quantum assessment generally starts with a direct approach by carrying out a physical inventory count (i.e. a stock take) on the date at which the assessment is required.

The assessment date may be the date at which the disaster struck or the date imme-diately following it. The physical inventory count refers to inspections of the existence, quantity and condition of inventories by tracing individual items from the claimants’ records to the physical inventories and vice versa, so as to confirm the completeness and accuracy of those records.

Inventories may comprise raw materi-als, semi-finished products or finished products. Raw materials and finished prod-ucts are readily identifiable, while counting semi-finished products requires the ability to measure the percentage of completion.

If it is not practicable to identify the semi-finished products with either the

Quantum assessment of lossesof inventories by forensic CPAsInsurance generally compensates claimants against losses of business profits and damages to assets. Benny K.B. Kwok discusses forensic accounting approaches to estimating the losses of inventories

components, which have gone into them, or the finished products, which will emerge from them, forensic accountants should evaluate the reliability and accuracy of the costing system in measuring the percentage of completion.

In addition, the extent of damages and obsolescence and any third party’s inventories should be identified during the physical inven-tory count.

However, a physical inventory count by itself does not necessarily prove the owner-ship and valuation. The items counted should be vouched to the corresponding suppliers’ invoices and delivery documents, and if ap-plicable also to the subsequent sales records as a crosscheck for the valuation reflecting any damages or obsolescence.

Perpetual inventory systemSome claimants maintain perpetual inven-tory systems, comprising records of inventory movements and periodic physical inventory counts, to provide an indication of the inven-tories costs throughout the year. Still, forensic accountants have to evaluate the system before relying on it for the quantum assess-ment of lost inventories. However, not too many claimants have such perpetual inventory systems in place.

Roll-forward A physical inventory count at the assessment date is not always practicable due to the total extinguishment of inventories, while a perpetual inventory system, even if in place, might not operate effectively.

Accordingly, alternative procedures, such as relying on a physical inventory count on another date close to the assessment date should be conducted.

Such a physical inventory count is set as a baseline for rolling forward to the assessment date, which means an inspection of relevant invoices and delivery documents tracing items

of inventories and reconciling their movements between the two dates.

Forensic accountants should also examine the sequence of the delivery documents (for both issues and receipts of inventories) in order to confirm the integrity and completeness of the inventory movements.

If the roll-forward is carried out over an extended period of time, say longer than a year, the forensic accountants should stay alert to a higher margin for errors.

Indirect approach

When inventories and their records are destroyed, the forensic accountants might adopt an indirect approach to assess lost inventories by examining the available contemporaneous documents and the relationships between inventories and other relevant observable data.

Opening inventories plus purchases are those available for sales during a particular period. Costs of sales equate to opening invento-ries plus purchases minus closing inventories.

Closing inventories are what remain unsold at the period end, which could represent the lost inventories at the assessment sate. Gross profits represent the amount of sales in excess of costs of sales, such that:

Gross profits = Sales – Costs of salesCosts of sales = Sales – Gross profits

Gross profits = Sales – (Opening inventories + Purchases – Closing inventories)

Sales – Gross profits = (Opening inventories + Purchases – Closing inventories)

Closing inventories = Opening inventories + Purchases – (Sales – Gross profits)

Forensic accounting

46 May 2014

As illustrated above, there are three or four variables in the equations representing the amount of closing inventories, i.e. the quantum of lost inventories at the assessment date.

As long as the available contemporaneous documents can substantiate the value of those variables, the lost inventories can be quantified by simple algebra. However, if the value of a variable is unknown, the forensic accountants should form estimates based on the relevant observable data and the assumption of a constant degree of correlation. In other words, based on the constant correlation among the variables, the forensic accountants can project the unknown variable(s) based on the observable amount(s) of the remaining variable(s).

In carrying out such a projection, three accounting ratios are particularly relevant; gross profit margin, inventory turnover and inventory turnover days.

Dividing gross profits by sales results in the gross profit margin, which reflects the percentage of gross profit in every dollar of sales and often stays relatively stable unless there are material changes to the nature of business and its operation.

The formula is set out below:

In addition, inventory turnover and inventory turnover days are two meaningful accounting ratios that can facilitate the interpretation of how efficient inventories are being sold and subsequently replenished. Dividing the costs of sales by the average or closing inventories gives the inventory turnover with the relevant formula as follows:

Inventoryturnoverdays

= x

Closing inventories = Opening inventories + Purchases – Costs of sales

in a given period and is generally important for claimants because profitability in most businesses largely depends on how efficient its inventories are being sold and subsequently replenished.

Average inventories generally refer to the sum of opening and closing inventories divided by two.

Either closing inventories or average inven-tories may be used as the denominator as long as the comparison remains consistent. Gener-ally, the higher the inventory turnover, the better the profits would be, because a higher inventory turnover means inventories are being bought, sold and replenished faster.

A low inventory turnover might indicate sluggish sales and obsolete inventories. How-ever, an excessively high inventory turnover, which differs from the industry norms, may suggest losses due to shortages and poor customer service.

A more intuitive way to view inventory turnover is to express it in days showing the average number of days required to sell the products and is represented by:

Gross profit margin = Gross profits

Sales

Inventory turnover = Costs of sales

Closing inventories or Average inventories

Costs of sales

Closing inventories or Average inventories 365 days

As an illustration, if the claimants have lost the records of sales and purchases for two years immediately before the assessment date – known as the gap period – forensic accoun-tants can seek to reconstruct the records based on the receipts and withdrawals stated in the claimants’ bank statements.

However, even if the inventories at the beginning of the gap period are known, having reconstructed the records of sales and purchas-es during the gap period is still not adequate in the assessment of closing inventories.

Accounting ratios can facilitate the assess-ment. By applying the gross profit margin and inventory turnover ratio (as calculated in accordance with the accounts and financial statements before the gap period) to the reconstructed records of sales and purchases for the gap period, forensic accountants can estimate the gross profits and ultimately the lost inventories.

By and large, the quantum of lost invento-

ries at a given point in time depends on at least nine factors: • Nature of business;• Nature of operations;• Nature, type and condition of inventories;• Demand for inventories;• Supply of inventories;• Cost structure;• Storage condition of inventories; • Financial position of business; and• Expectation of future business.

By adopting the indirect approach of quan-tum assessment of lost inventories, forensic accountants assumed that each of the above nine factors are materially unchanged during the relevant time (i.e. the gap period and the period before the gap period, which form the basis for the projection in data reconstruction). If any of these assumptions is not reflective of the case circumstances, the quantum assess-ment is subject to adjustments.

Summary

In summary, the direct approach of forensic accountants in quantum assessment of lost inventories comprises:• Conducting a physical inventory count

on the assessment date together with the vouching to supporting documents and records;

• Relying on the claimants’ perpetual inven-tory system together with an evaluation of the system; and

• Conducting a physical inventory count on the alternative date together with the roll-forward procedures.

Failing that, the forensic accountants, by using the indirect approach, may form the assessment by projecting the established corre-lation between sales, purchases, costs of sales and inventories onto the observable variables during the gap period.

Benny K.B. Kwok is a CPA (Practising) and forensic accountant in Hong Kong.

Or:

Inventory turnover indicates how many times the inventories are being turned over

A PLUS

May 2014 47

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