THE REGISTRAR OF THE HONG KONG INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS v. WONG TAK MAN STEPHEN AND ANOTHER

Press Summary (English)

Press Summary (Chinese)

FACV No. 10 of 2017

IN THE COURT OF FINAL APPEAL OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

FINAL APPEAL NO.10 OF 2017 (CIVIL)

(ON APPEAL FROM CACV NO. 233 OF 2015)

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JUDGMENT

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Mr Justice Ribeiro, Acting CJ:

1.  This appeal raises questions concerning the meaning and proper application of accounting standards relating to the treatment of an asset classified as an available-for-sale financial asset and the duties of auditors in respect thereof for the purposes of professional disciplinary proceedings.

A.  The audit and the disciplinary proceedings

A.1  Background to the audit

2.  The audit was of the financial statements for the year ended 30 June 2009 of Heng Tai Consumables Group Limited (“Heng Tai”), a company listed on the Hong Kong Stock Exchange.  The auditors were the 2^nd appellant firm (“RSM”) with the 1^st appellant acting as the engagement partner. 

3.  The relevant financial asset was a parcel of 71,060,000 shares in China Zenith Chemical Group Limited (“CZ”), a company also listed on the Hong Kong Stock Exchange.  Heng Tai first acquired shares in CZ in early 2004 and, in the following three years, increased its shareholding which it regarded as a long-term investment and part of its business expansion plan.  Prior to Heng Tai’s disposal of 400 million shares in CZ in late 2007, Heng Tai accounted for its investment in CZ as in an associate.  After such disposal, the remaining CZ shares held by Heng Tai were accounted for as an available-for-sale financial asset (“AFSFA”) shown as an investment in its balance sheet.

4.  Standards for the accounting treatment of such financial assets[1] are contained in Hong Kong Accounting Standard 39 (“HKAS 39”)[2] which, in the version containing amendments as at May 2009, will require close examination.   For present purposes, it suffices to note that HKAS 39 requires such assets to be measured at fair value[3] and requires gains and losses of such assets to be recognised directly in equity through the statement of changes in equity, until the asset is derecognised.[4]  However, if the fair value of such financial assets should decline to an extent that provides objective evidence that impairment loss has been incurred, the standard requires the cumulative loss to be removed from equity and recognised in profit or loss even though the financial asset has not been derecognised.[5]  Impairment losses recognised in profit or loss cannot be reversed through profit or loss.[6]

5.  The HKAS 39 scheme for the treatment of AFSFAs was reflected in the Notes to Heng Tai’s financial statements setting out the Company’s Significant Accounting Policies.[7]

6.  When the 71,060,000 shares (representing a 1.9% interest in CZ) were reclassified as an AFSFA in Heng Tai’s balance sheet, they were recorded as costing $37,690,100 and thus at $0.53 per share.  Their quoted market price then proceeded to fall.  In the year ended 30 June 2008, based on a closing bid price of $0.465 per share, the statement of changes in equity noted an unrealised fair value loss of $4,647,200, the balance sheet fair value of the CZ shares being stated as $33,042,900.

7.  In the year ended 30 June 2009, a further unrealised fair value loss of $18,120,300 on a closing bid price of $0.21 per share was noted, bringing the cumulative AFSFA loss to $22,767,500 recognised directly as a deficit in an investment revaluation reserve, with the balance sheet fair value of the shares stated as $14,922,600.

A.2   The audit

8.  The cumulative loss of $22,767,500, as the auditors noted, was a decline that was “not small as compared to the investment cost of $37,690,100”.  It represented more than 60% of such cost.  The consolidated profit of the Group for the year (without reduction for the accumulated AFSFA loss) was $110,030,000.  RSM accordingly conducted an impairment review.

9.  After discussions, RSM agreed with Heng Tai’s management that it was not appropriate to transfer the accumulated fair value loss from equity to profit or loss, in the light of (i) their interpretation of HKAS 39 (to which I shall return[8]); (ii) the decline in fair value being due to the impact of the global financial crisis in 2008 and 2009, felt by many listed companies; (iii) the apparently sound financial condition of CZ[9] so that its share price was expected gradually to move upward; (iv) CZ’s net asset value at 30 June 2009 exceeding the cost of the shares; (v) the view that prices of CZ shares were quoted in a thin market and might not reflect their true fair value; and (vi) since CZ had not declared any dividend since 2006, the fact that no adverse impact on the estimated future cash flows was anticipated. 

10.  In the audit working papers, it was noted that in August 2009, when given the opportunity of purchasing additional CZ shares at $0.11 per share, Heng Tai purchased two parcels of 35,530,000 shares and 18,663,713 shares respectively.  These post-balance sheet events were taken as evidence of management’s confidence in a likely upward movement of the CZ share price.

11.  RSM issued an unqualified audit report dated 28 October 2009.

A.3   The disciplinary proceedings

12.  Following receipt of a complaint, the Financial Reporting Council (“FRC”) directed[10] the Audit Investigation Board (“AIB”) to conduct an investigation into a possible auditing irregularity involving non-recognition of impairment losses on the AFSFA in Heng Tai’s 2009 financial statements. 

13.  The AIB produced a detailed Investigation Report dated 19 October 2012 in which its main findings were stated as follows:

“The AIB noted that paragraph 58 of HKAS 39 requires an entity to assess at each balance sheet date whether there is any objective evidence that a financial asset ... is impaired. If any such evidence exists, the entity is required to follow paragraph 67 of HKAS 39 to determine the amount of impairment losses for a financial asset classified as available-for-sale. Paragraph 61 of HKAS 39 specifies that a significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is objective evidence of impairment.

At 30 June 2009, the Company’s AFS Financial Assets, with an original cost of $37.7 million, were carried at the fair value of $14.9 million based on the quoted market price at that date.  The AIB considers the cumulative decline in the fair value of the AFS Financial Assets of $22.8 million which represented over 60% of the original cost, was significant, and therefore considers it an objective evidence of impairment.  Following the requirement in paragraph 67 of HKAS 39, the cumulative decline in the fair value of $22.8 million should have been removed from equity, ie, investment revaluation reserve, and recognized in profit or loss in the 2009 Financial Statements.”

14.  The AIB concluded:

“As the non-recognition of impairment losses represented approximately 21% of the consolidated profit of the Group for the year ended 30 June 2009, the AIB considers that RSM should have expressed a modified opinion on the 2009 Financial Statements in this respect. The AIB, therefore, considers that there is non-compliance with paragraphs 11 and 13 of HKSA 700.”[11]

15.  The FRC adopted the Investigation Report and referred the complaint to the Hong Kong Institute of Certified Public Accountants (“the Institute”), conveying the AIB’s opinion that there had been non-compliance with HKSA 700.11 and HKSA 700.13.

16.  The Institute’s Council then referred the complaint to its Disciplinary Committee (“the Committee”) pursuant to section 34(1)(a)(vi) of the Professional Accountants Ordinance (“PAO”),[12] charging the present appellants with having “failed or neglected to observe, maintain or otherwise apply a professional standard, namely HKAS 39”.

17.  After a hearing on 1 June 2015, the Committee found the complaint substantiated but also held that there were “strong mitigating factors” causing it to take “a very lenient approach”, fixing the penalty at $10,000 for each respondent, plus costs.  It also directed that no publicity should be given to the sanction imposed without the consent of the respondents.

A.4   The Court of Appeal’s decision and the present appeal

18.  The appellants lodged an appeal to the Court of Appeal[13] against the Committee’s ruling that they had breached section 34(1)(a)(vi).  The present respondent, the Institute’s Registrar, lodged a cross-appeal against the Committee’s order prohibiting publicising of the sanction.  Giving its reasons on 30 August 2016,[14] the Court of Appeal dismissed both the appeal and the cross-appeal.  The appellants’ application to the Court of Appeal for leave to appeal to this Court was also dismissed.[15]

19.  By its Determination dated 27 April 2017, the Appeal Committee[16] granted leave to appeal on the following questions of law, namely:

(1) Do auditors who, without more, wrongly interpret or apply a professional standard in discharging their function as auditors thereby commit a breach of s.34(1)(a)(vi) of the Professional Accountants Ordinance, Cap.50 (“PAO”)?

(2) Does s.34(1)(a)(vi) of the PAO import a standard of reasonableness or other similar considerations which are relevant to assessing whether an auditor has “failed or neglected to observe, maintain or otherwise apply a professional standard” within the meaning of such provision?

(3) On the true construction of Hong Kong Accounting Standard 39, must an impairment adjustment be made once there has been a significant or prolonged decline in the fair value of an available-for-sale asset?

20.  Question 3 is logically the first question since a negative answer would remove the basis of the disciplinary finding against the appellants, and since Questions 1 and 2 only arise if the answer to Question 3 is in the affirmative.  I shall therefore consider Question 3 first.  However, before doing so, a preliminary matter should be dealt with.

B.  Preliminary matter – the complaint before the Committee

21.  Mr Johnny Mok SC[17] sought to argue that the complaint faced by the appellants was defective in that “it was wrong to transpose the alleged non-compliance of HKSA 700 (which was the professional standard relied upon by AIB) into a breach of HKAS 39”.   Mr Mark Strachan SC[18] rightly objects on the ground that leave to appeal was never granted for this point to be argued.

22.  In any event, the argument can be simply disposed of.  It is, as the Committee held, merely a criticism as to the form of the complaint.  True it is that the complaint alleged that the appellants had “failed or neglected to observe, maintain or otherwise apply a professional standard, namely HKAS 39” which was, on its face, inapt since HKAS 39 is an accounting standard which applies to the audited entity rather than the auditors.  But as the appellants undoubtedly appreciated from numerous communications with, and the findings of, the AIB, the substance of the complaint against them was that they had failed to comply with standards which required them as auditors to form an opinion “as to whether the financial statements give a true and fair view or are presented fairly, in all material respects, in accordance with the applicable financial reporting framework” which “involves evaluating whether the financial statements have been prepared and presented in accordance with the specific requirements of the applicable financial reporting framework for particular classes of transactions, account balances and disclosures”.[19]

23.  In the present case, the applicable reporting framework consisted of the paragraphs of HKAS 39 regarding the specific requirements governing the accounting treatment of AFSFAs.  The appellants were required, as auditors, to evaluate whether Heng Tai’s treatment of the AFSFA comprising the CZ shares had been prepared and presented in accordance with those standards.  The complaint might have been more accurately drawn if it had run along the lines that the appellants had “failed or neglected to observe, maintain or otherwise apply a professional standard, namely HKSA 700, in that they failed properly to evaluate Heng Tai’s compliance with HKAS 39 in respect of an AFSFA, before issuing an unmodified audit opinion”.  However, no one was in any doubt that such was the substance of the complaint being investigated by the AIB and the Committee.  As the Court of Appeal held,[20] the Committee was right to reject the “wrong charge” argument, adopting a “substance over form” approach, since the form of the charge gave rise to no procedural or other unfairness.

C.  Question 3: On the true construction of HKAS 39, must an impairment adjustment be made once there has been a significant or prolonged decline in the fair value of an available-for-sale asset?

24.  The PAO defines “professional standards” to include “standards of accounting, auditing and assurance practices, issue or specified ... under section 18A”.[21] Section 18A(1) provides the statutory basis for requiring standards issued by the Institute’s Council to be adhered to by certified public accountants:

“The Council may, in relation to the practice of accountancy,

issue or specify any—

(a) ...

(b) standards of accounting, auditing and assurance practices,

required to be observed, maintained or otherwise applied by any certified public accountant.”

25.  PAO sections 34 and 35 provide for disciplinary proceedings and sanctions against a certified public accountant who “failed or neglected to observe, maintain or otherwise apply a professional standard”,[22] this being the provision presently invoked by the Institute in respect of the appellants’ failure properly to evaluate Heng Tai’s accounting treatment of the AFSFA.

26.  Evaluation of an entity’s accounting treatment of an AFSFA must be premised on the auditors’ understanding of the applicable standard.  The present discussion concerns the correctness or otherwise of the appellants’ understanding of whether an impairment loss had to be recognised, an issue turning on the true construction of the relevant paragraphs of HKAS 39.

C.1   Financial assets measured by their fair value

27.  The stated objective of HKAS 39 is relevantly “to establish principles for recognising and measuring financial assets”.[23]  Where a financial asset is designated as an AFSFA, it is measured at its fair value both initially[24] and after its initial recognition.[25]

28.  “Fair value” is defined as “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”[26] and it is important for present purposes to note that the standard specifies that “[the] best evidence of fair value is quoted prices in an active market.”[27]  Application Guidance (AG71) issued in December 2007 explains that:

“A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis. Fair value is defined in terms of a price agreed by a willing buyer and a willing seller in an arm’s length transaction. The objective of determining fair value for a financial instrument that is traded in an active market is to arrive at the price at which a transaction would occur at the balance sheet date in that instrument (ie without modifying or repackaging the instrument) in the most advantageous active market to which the entity has immediate access...”[28]

It reiterated that:

“The existence of published price quotations in an active market is the best evidence of fair value and when they exist they are used to measure the financial asset or financial liability.”[29]

29.  This is how fair value is measured in respect of equity instruments such as Heng Tai’s parcel of CZ shares.  I might interject that at the disciplinary hearing and before the Court of Appeal, the appellants had sought to argue that the quoted prices of CZ’s shares were not an appropriate measure of the fair value of Heng Tai’s investment because they were too thinly traded for the prices to be a reliable indication of value. That argument was rejected by the Committee which found that the quoted price of CZ shares “remained relatively stable within the band of approximately $0.15 and $0.25 per share” and since there had been continued trading in such shares in the material period.[30] This was upheld by the Court of Appeal[31] and the argument against the reliability of  quoted prices is not pursued before this Court.

C.2.  Measuring gains and losses

30.  HKAS 39.55 materially provides:

“A gain or loss arising from a change in the fair value of a financial asset ... shall be recognised, as follows. ...

(b) A gain or loss on an available-for-sale financial asset shall be recognised directly in equity, through the statement of changes in equity..., except for impairment losses (see paragraphs 67-70) ... until the financial asset is derecognised, at which time the cumulative gain or loss previously recognised in equity shall be recognised in profit or loss. ... Dividends on an available-for-sale equity instrument are recognised in profit or loss when the entity’s right to receive payment is established ...”

31.  The standard therefore recognises that there may be gains or losses in the fair value of an AFSFA and provides that such gains and losses should be recorded directly in equity, ie, in the balance sheet, “except for impairment losses”.  This leads us to HKAS 39.58 which obliges the audited entity to assess whether that exception applies:

“An entity shall assess at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets is impaired. If any such evidence exists, the entity shall apply ... paragraph 67 (for available-for-sale financial assets) to determine the amount of any impairment loss.”

32.  HKAS 39.67 provides as follows:

“When a decline in the fair value of an available-for-sale financial asset has been recognised directly in equity and there is objective evidence that the asset is impaired (see paragraph 59), the cumulative loss that had been recognised directly in equity shall be removed from equity and recognised in profit or loss even though the financial asset has not been derecognised.”

33.  HKAS 39.68 quantifies the cumulative loss to be so removed from equity:

“The amount of the cumulative loss that is removed from equity and recognised in profit or loss under paragraph 67 shall be the difference between the acquisition cost (net of any principal repayment and amortisation) and current fair value, less any impairment loss on that financial asset previously recognised in profit or loss.”

34.  If such an impairment loss concerns an AFSFA which consists of an investment in an equity instrument, that loss is treated as realised since HKAS 39.69 provides:

“Impairment losses recognised in profit or loss for an investment in an equity instrument classified as available for sale shall not be reversed through profit or loss.”

C.3   When is there objective evidence of an impairment loss?

35.  The crucial issue that divides the parties in the present case is whether the auditors should have concluded that Heng Tai ought to have recognised that objective evidence of an impairment loss existed in relation to the CZ shares, triggering HKAS 39.67.  The resolution of that issue depends on the true construction of HKAS 39.59 and HKAS 39.61 in the context of the abovementioned provisions.

36.  HKAS 39.59 provides as follows:

“A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. It may not be possible to identify a single, discrete event that caused the impairment. Rather the combined effect of several events may have caused the impairment. Losses expected as a result of future events, no matter how likely, are not recognised. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the holder of the asset about the following loss events:

(a) significant financial difficulty of the issuer or obligor;

(b) a breach of contract, such as a default or delinquency in interest or principal payments;

(c) the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider;

(d) it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

(e) the disappearance of an active market for that financial asset because of financial difficulties; or

(f) observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including:

(i) adverse changes in the payment status of borrowers in the group (e.g. an increased number of delayed payments or an increased number of credit card borrowers who have reached their credit limit and are paying the minimum monthly amount); or

(ii) national or local economic conditions that correlate with defaults on the assets in the group (e.g. an increase in the unemployment rate in the geographical area of the borrowers, a decrease in property prices for mortgages in the relevant area, a decrease in oil prices for loan assets to oil producers, or adverse changes in industry conditions that affect the borrowers in the group).”

37.  It may be noted that HKAS 39.59 has the following features:

(a) It applies to financial assets generally and not (as we shall see in the case of HKAS 39.61) to any particular classes of financial assets.

(b) It provides that objective evidence of impairment exists if (i) a loss event is identified which (ii) has an impact on future cash flows of the financial asset that can be reliably estimated. 

(c) It adopts an “incurred loss” approach and rejects recognition of “losses expected as a result of future events, no matter how likely”.

(d) It gives examples of loss events, all of which impact upon estimated future cash flows of the financial asset.  Thus, sub-paragraphs (a) to (f) refer to cases where the issuer of the financial asset develops serious financial difficulties, calling into question the ability of the financial asset to generate income for the holder and thus adversely affecting the holder’s estimated future cash flows from that asset.

38.  It is important to bear in mind that while HKAS 39.59 focusses on specific loss events adversely affecting cash flows, what constitutes objective evidence of impairment loss is not the impact on cash flows per se, but a decline in the fair value of the AFSFA, fair value being the basis for measuring gain and loss in respect of financial assets throughout HKAS 39.  The effect of a loss event with an adverse effect on cash flows generated by the financial asset is that the fair value of the asset decreases since the amount which a knowledgeable, willing party would be willing to pay for such an impaired asset in an arm’s length transaction must inevitably be discounted. 

39.  There may obviously be objective evidence of impairment – evidence of a decline in the AFSFA’s fair value – which does not depend on an adverse impact on cash flow.  HKAS 39.61 identifies two categories of such objective evidence.  It provides as follows:

“In addition to the types of events in paragraph 59, objective evidence of impairment for an investment in an equity instrument includes information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates, and indicates that the cost of the investment in the equity instrument may not be recovered. A significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is also objective evidence of impairment.”

40.  The following features of HKAS 39.61 may be noted:

(a) It refers to objective evidence of impairment which is additional to the objective evidence provided by “the types of events in [HKAS 39.59]”, that is, loss events which impact on cash flows.

(b) Unlike HKAS 39.59 which covers financial assets generally, HKAS 39.61 deals specifically with investments in equity instruments.

(c) It does not mention cash flows and does not base impairment loss on adverse impacts on cash flows.  Instead it focusses on the asset’s decline in value below its investment cost. 

(d) It identifies two situations as providing objective evidence of such impairment loss, the first involving information about significant adverse changes in the technological, market, economic or legal environment in which the issuer of the equity instrument operates, which information indicates that the cost of the investment in the equity instrument may not be recovered.

(e) The second involves a significant or prolonged decline in the fair value of the investment in an equity instrument below its cost.  Since, as we have seen, HKAS 39 states that the best evidence of fair value is quoted prices in an active market, this equates with a significant or prolonged decline in the quoted price of an AFSFA consisting of listed shares.

C.4   The answer to Question 3

41.  The foregoing analysis leads to the conclusion that the answer to Question 3 is in the affirmative with the addition of the following italicised words: On the true construction of HKAS 39, an impairment adjustment must be made in respect of an AFSFA consisting of an equity instrument once there has been a significant or prolonged decline in its fair value. 

42.  This is because, in its second sentence, HKAS 39.61 identifies as a head of objective evidence of impairment, a significant or prolonged decline in the fair value of an equity instrument below its cost. This is a category of objective evidence of impairment which is additional to, and independent of, the categories of objective evidence comprising loss events which impact upon cash flows, set out in HKAS 39.59.  It is also independent of the head of objective evidence described in the first sentence of HKAS 39.61.

43.  This interpretation of HKAS 39.61 was adopted by the AIB:

“Paragraph 61 of HKAS 39 specifies that a significant or prolonged decline in the fair value of an investment in an equity instrument below its costs is also objective evidence of impairment ... Given this explicit statement, it is not appropriate to consider a significant decline in the fair value is [sic] only an indication of possible impairment or ‘an example of the Loss Event constituting objective evidence of impairment’,”[32]

44.  It was also the approach of the Committee.  It found HKAS 39.61 “very clear” and “that for listed/quoted equity instruments such as shares quoted in an active stock market ... a significant or prolonged decline in the quoted share price of a listed company will no doubt be the most objective evidence of impairment.”[33] Since the cumulative decline in the fair value of the CZ shares of $22.8 million which represented over 60% of the original cost, was significant, no other evidence was needed to trigger HKAS 39.67.

45.  This was upheld by the Court of Appeal[34] which cited in support relevant paragraphs from the “Basis for Conclusions” issued by the International Accounting Standards Board (“IASB”) to which I shall return.[35]  Cheung JA referred in particular to BC 106 which states:

“The Board[36] agreed that for marketable investments in equity instruments any impairment trigger other than a decline in fair value below cost is likely to be arbitrary to some extent. ...”

His Lordship commented:

“It is precisely because of the risk of arbitrariness referred to in BC 106 that paragraph 61 expressly recognizes a significant or prolonged decline in the fair value of the equity instrument below its cost as objective evidence of impairment.”[37]

C.5   The auditors’ approach

46.  The auditors’ understanding of the applicable standard is revealed by this statement in their working papers:

“Our analysis

As per HKAS 39, a financial asset is impaired, if and only if:

(a) Objective evidence of impairment resulted from loss event, eg prolonged or significant decline in the fair value of CZ, significant financial difficulty of CZ, significant changes with adverse effect in technological, market, economic or legal environment so that the costs of investment in CZ may not be recovered; and

(b) the loss event impacted on the estimated future cash flows from CZ.” 

47.  The words I have italicised come from HKAS 39.61 while those that are not italicised come from HKAS 39.59.  The auditors therefore elided the two paragraphs and failed to recognise that (i) those paragraphs deal respectively with different types of financial asset, HKAS 39.61 dealing specifically with equity instruments (with which we are concerned); (ii) that the two paragraphs refer to different heads of objective evidence of impairment; (iii) that while the objective evidence referred to in HKAS 39.59 involves loss events which have an adverse impact on future cash flows, HKAS 39.61 (in its second sentence) looks for objective evidence of a significant decline in the asset’s fair value below its investment cost. 

48.  Having indiscriminately mixed the two provisions together, the auditors erroneously treated an adverse impact on cash flows as an essential requirement for finding objective evidence of impairment in every case.  They failed to appreciate that no such requirement attaches to either of the heads of objective evidence specified in HKAS 39.61.

49.  The auditors noted that there had been a $22,767,500 decline in the AFSFA’s fair value that was “not small as compared to the investment cost of $37,690,100”, representing as it did, more than 60% of such cost.  However, they failed to recognise that such a decline was “significant” and sufficient to trigger HKAS 39.61.  Instead, they proceeded to consider irrelevant matters which did not detract from the plainly established objective evidence of impairment but which were relied on as somehow justifying the non-triggering of HKAS 39.61.  Those matters included (i) the fact that the quoted share prices of many listed companies had also been adversely affected by the global financial crisis; (ii) the fact that CZ had recurring profits and a net asset value exceeding Heng Tai’s investment cost; (iii) the disclosure in Heng Tai’s financial statements that the directors had considered but excluded impairment of the Company’s listed AFSFA investment;[38] and (iv) management’s expectation that the share price would rise, as evidenced by the post-balance sheet acquisition of additional CZ shares.

C.6   The appellants’ argument set out in their Written Case

50.  The appellants’ Written Case seeks to defend the auditors’ interpretation of the relevant paragraphs of HKAS 39.  The central proposition it states is that:

“... impairment adjustment is not to be made unless and until impairment loss has occurred and the loss event has an impact on the estimated future cash flows of the financial asset that can be reliably estimated.”[39]

51.  Thus, it argues that HKAS 39.59 “imposes the two conditions and provides that the financial asset is impaired only if both conditions are satisfied”.[40]

52.  Accordingly, like the auditors, the appellants’ Written Case elides HKAS 39.61 with HKAS 39.59.  It contends that “HKAS 39.61 is not a stand alone provision” and that it provides:

“... two additional types of loss event (being one of the conditions set out in HKAS 39.59) applicable to equity instruments. One of these ‘loss events’ is ‘significant or prolonged decline in the fair value of an investment in an equity instrument below its cost’.”[41]

53.  The Written Case seeks to support this construction of the standard by arguing that:

“Such interpretation is supported by the opening phrase of HKAS 39.61 ‘[i]n addition to the types of events in paragraph 59’ [emphasis added]. The word ‘events’ clearly refers to ‘loss events’.”[42]

54.  The argument therefore treats HKAS 39.61 as merely adding two “loss events” to the list found in HKAS 39.59 and proceeds to attach to them the requirement that they must have an adverse impact on future cash flows.

55.  That construction cannot be accepted.  HKAS 39.61 states:

“In addition to the types of events in paragraph 59, objective evidence of impairment for an investment in an equity instrument includes information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates, and indicates that the cost of the investment in the equity instrument may not be recovered. A significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is also objective evidence of impairment.”

56.  Looking at the first sentence: its subject is the phrase “objective evidence of impairment for an investment in an equity instrument”; its verb is “includes”; and its object is the phrase describing “information” about the relevant significant changes.  The first sentence of HKAS 39.61 therefore sets out a category of objective evidence relating to equity instruments.  The introductory words “In addition to the types of events in paragraph 59” indicate that this head of objective evidence of impairment is additional to the heads of objective evidence comprising the “types of events in paragraph 59”.

57.  The second sentence of HKAS 39.61 identifies a further head (“also”) of objective evidence of impairment constituted by a significant or prolonged decline in the fair value of an investment in an equity instrument below its cost.

58.  Paragraph 61 is thus concerned with setting out categories of objective evidence which are additional to the objective evidence constituted by “the types of events in paragraph 59”, consisting of loss events with adverse impacts on future cash flows of the financial asset.  The words “the types of events in paragraph 59” in the opening phrase of HKAS 39.61 are not a reference to “loss events” – the word “loss” is not used.  In the context of the words which follow, the words “the types of events in paragraph 59” are a reference to the types of events which constitute objective evidence of impairment under HKAS 39.59.  They do not operate to convert the two additional heads of objective evidence of impairment in HKAS 39.61 into merely additional “loss events” to be tacked onto HKAS 39.59.

C.6a Basis for conclusions (as at December 2007)

59.  The conclusion that HKAS 39.61, particularly in its second sentence, sets out an independent or “stand-alone” head of objective evidence of impairment sufficient to trigger HKAS 39.67, is supported by published guidance.

60.  Noting that HKAS 39 is based on IAS 39 issued by the IASB, the Institute’s Council stated that it “agreed with the IASB’s basis for conclusions on IAS 39” and that “there are no significant differences between HKAS 39 and IAS 39”.[43] It therefore reproduced the IASB’s “basis for conclusions” for reference.

61.  In paragraph BC96, comments received by the IASB disagreeing with use of quoted prices for measuring the fair value of an instrument quoted in an active market were noted.  In response, the IASB justified using quoted prices as follows:

“BC97. However, the Board confirmed that a quoted price is the appropriate measure of fair value for an instrument quoted in an active market, notably because (a) in an active market, the quoted price is the best evidence of fair value, given that fair value is defined in terms of a price agreed by a knowledgeable, willing buyer and a knowledgeable, willing seller; (b) it results in consistent measurement across entities; and (c) fair value as defined in the Standard does not depend on entity-specific factors. ...”

62.  Guidance was also relevantly given in respect of impairment and uncollectibility of financial assets as follows.

“BC105. Under IAS 39, investments in equity instruments that are classified as available for sale ... are subject to an impairment assessment. The original IAS 39 did not include guidance about impairment indicators that are specific to investments in equity instruments. Questions were raised about when in practice such investments become impaired.

BC106. The Board agreed that for marketable investments in equity instruments any impairment trigger other than a decline in fair value below cost is likely to be arbitrary to some extent. If markets are reasonably efficient, today's market price is the best estimate of the discounted value of the future market price. However, the Board also concluded that it is important to provide guidance to address the questions raised in practice.

BC107.  The revised IAS 39 includes impairment triggers that the Board concluded were reasonable in the case of investments in equity instruments (paragraph 61). They apply in addition to those specified in paragraph 59, which focus on the assessment of impairment in debt instruments.”

63.  BC105 therefore indicates that the intention in IAS 39, reproduced in HKAS 39, is to provide “impairment indicators that are specific to investments in equity instruments”.  BC106 explains that for investments in marketable equity instruments, any impairment trigger other than a decline in fair value below cost is excluded because of likely arbitrariness.  It is thus approaching such a decline as a “stand-alone” impairment trigger.  BC107 makes it clear that the impairment triggers being discussed are those set out in paragraph 61, which the IASB concluded “were reasonable in the case of investments in equity instruments” contrasting them with the impairment triggers in paragraph 59 “which focus on the assessment of impairment in debt instruments”.

C.6b July 2009 Newsletter of the International Financial Reporting Interpretations Committee (“IFRIC”)

64.  It is the policy of the Institute’s Council to develop financial reporting standards to achieve convergence with IFRSs issued by the IASB.[44] Thus, as previously noted, HKAS 39 is based on IAS 39.  Guidance provided in the captioned newsletter (cited by the AIB in its Investigation Report) on IAS 39.61 is therefore relevant:

“(ii) Paragraph 67 of IAS 39 requires an entity to recognise an impairment loss on available-for-sale equity instruments if there is objective evidence of impairment. Paragraph 61 of IAS 39 states: ‘A significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is also objective evidence of impairment.’ [emphasis added] Consequently, the IFRIC concluded that when such a decline exists, recognition of an impairment loss is required”.

65.  The IFRIC therefore regarded the second sentence of IAS 39.61 as a “stand-alone” impairment trigger.  This is reinforced by the subsequent paragraphs in the Newsletter which stated:

“(iii) The fact that the decline in the value of an investment is in line with the overall level of decline in the relevant market does not mean that an entity can conclude the investment is not impaired.

(iv) The existence of a significant or prolonged decline cannot be overcome by forecasts of an expected recovery of market values, regardless of their expected timing. Consequently, the IFRIC concluded that an anticipated market recovery is not relevant to the assessment of ‘significant or prolonged’.”

66.  This was a rejection of the relevance of two of the matters relied on by the auditors in the present case as justifying the non-triggering of HKAS 39.67.

C.7   The appellants’ argument as modified by Counsel

67.  At the outset of the hearing, Mr Mok SC indicated that he had modified his views regarding the central proposition in the Written Case[45] that an impairment adjustment “is not to be made unless and until impairment loss has occurred and the loss event has an impact on the estimated future cash flows of the financial asset that can be reliably estimated”.  Asked to clarify his position in writing, Counsel provided “2^nd Supplemental Submissions” stating as follows:

§1  The 2^nd condition of HKAS 39.59 refers to the effect of the loss event, namely, the value of the investment is impaired in the sense that it is expected that the estimated future cash flows back to the entity have been impacted upon – i.e. they would not be collected as originally agreed or expected.

§2  The future cash flow can take the form of return of the principal on a debt instrument, but it may also take the form of the proceeds of sale of an equity instrument.  In the latter case, if it is expected that the proceeds of a future sale of the instrument would fall below the cost of investment, such expected impact would constitute an impairment loss.

§3  Such impairment loss in the case of equity instruments may be caused by one of the loss events set out in HKAS 39.59 (a)-(f), e.g. “significant financial difficulty of the issuer of the equity instrument”, or “the disappearance of an active market for that financial asset because of financial difficulties”.

§4   HKAS 39.61 provides further examples of loss events in relation to an equity instrument.  The 1^st sentence is concerned with loss events in the form of “significant changes with an adverse effect that have taken place in the technological, market, economic, or legal environment in which the issuer operates”, but such loss events by themselves do not constitute impairment loss.

§5   The parallel in HKAS 39.61 to the 2^nd condition in HKAS 39.59 is that there must be an indication “that the cost of the investment in the equity instrument may not be recovered”.

§6   The 2^nd sentence in HKAS 39.61 likewise describes a loss event, which is parallel to the 1^st condition in HKAS 39.59.  The 2^nd condition in HKAS 39.59 is applicable if it is expected that the estimated cash flows back the entity would be impacted upon in a future sale of the equity instrument in the sense that the proceeds would fall below the cost of investment, i.e. the same condition as set out in the 1^st sentence of HKAS 39.61.

68.  This represents an attempt to conjure up a second condition to the objective evidence of impairment identified in the second sentence of HKAS 39.61.  The reasoning appears to run along the following lines:

(a) HKAS 39.59 sets out heads of objective evidence of impairment which have two elements: loss events plus an impact on cash flows [§§1 and 3].

(b) “Cash flow” should be given a broad meaning to embrace the proceeds of a future sale of the equity instrument, and if such proceeds are less than the investment cost, this should be regarded as an adverse impact on cash flows constituting impairment loss [§2].

(c) The head of objective evidence contained in the first sentence of HKAS 39.61 has a “parallel” structure involving a “loss event” constituted by significant adverse changes in the issuer’s environment, plus a risk of non-recovery of the investment cost [§§4 and 5].

(d) The second sentence should be construed as having a “parallel” structure: The “significant or prolonged decline” is the first condition and an adverse impact on cash flows is the second. The latter condition should be interpreted to mean a projection that the proceeds on a future sale of the equity instrument would fall below the cost of investment [§6]. 

69.  This argument cannot be accepted.  There is no warrant for introducing a gloss on the concept of “cash flow”.  HKAS 39.59 straightforwardly requires objective evidence of a loss event which has an impact on the estimated future cash flows of the financial asset, which assumes the continued existence of the financial asset and an assessment of the income it is likely to generate.  There is no reason to strain the notion of “cash flow” to include possible losses on a future sale of the asset when no such sale is presently contemplated (which is why the asset is not derecognized and remains accounted for in the balance sheet). 

70.  Secondly, there is no basis for suggesting that because the heads of objective evidence in HKAS 39.59 and in the first sentence of HKAS 39.61 may be seen as having two elements – a loss event plus a second condition – the head of objective evidence identified in the second sentence of HKAS 39.61 ought likewise to have a second condition attributed to it by some form of “parallel” reasoning, when no words importing any such condition exist in the second sentence.

71.  Thirdly, even if one were to go along with the contrived reasoning to arrive at §6 quoted above, it is hard to see how the new formulation could possibly work.  The proposition appears to be that, in addition to objective evidence of a significant or prolonged decline in the AFSFA’s fair value below investment cost, a second condition must be satisfied before HKAS 39.67 is triggered, namely, that:

“... it is expected that the estimated cash flows back to the entity would be impacted upon in a future sale of the equity instrument in the sense that the proceeds would fall below the cost of investment ...”

72.  A future sale when?  How is the date for the sale to be selected?  How is one to ascertain what the quoted price and hence what the sale proceeds will be at that future time so as to ascertain whether such proceeds fall below the investment cost?  This involves a departure from the incurred loss model adopted in the applicable standard.  As HKAS 39.59 specifies: “Losses expected as a result of future events, no matter how likely, are not recognised.”  Moreover, the modified formulation invites subjective speculation and lacks observable data capable of providing reasonable assurance based on objective evidence.

73.  In contrast, if one accepts, as do the AIB, the Disciplinary Committee, the IASB, the IFRIC and the Court of Appeal, that the second sentence of HKAS 39.61 is an independent and self-contained standard for assessing impairment loss, the entity and the auditors are, at the balance sheet date, able to rely on objective evidence of a significant or prolonged decline in the fair value of an equity instrument by examining the record of quoted prices and trading volumes.  It would be a matter of judgment to decide whether the decline is “significant”.  But that would be based on objective evidence.

74.  The suggestion in §6 of the reformulation that the proposed gloss on the second sentence of HKAS 39.61 introduces a condition which is “the same condition as set out in the 1^st sentence of HKAS 39.61” is plainly incorrect.  The first sentence of HKAS 39.61 involves examining observable facts including “information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates”, providing objective evidence for an indication that “the cost of the investment in the equity instrument may not be recovered”.  This is very different from the speculative suggestion in §6 of the re-formulation.

75.  For the foregoing reasons, I do not accept the appellants’ interpretation of the applicable standard and would uphold the construction adopted by the Disciplinary Committee and the Court of Appeal.

D.  Question 1: Do auditors who, without more, wrongly interpret or apply a professional standard in discharging their function as auditors thereby commit a breach of PAO s.34(1)(a)(vi)?

Question 2: Does s.34(1)(a)(vi) import a standard of reasonableness or other similar considerations which are relevant to assessing whether an auditor has “failed or neglected to observe, maintain or otherwise apply a professional standard” within the meaning of such provision?

76.  Since the answer to Question 3 is “Yes”, Questions 1 and 2 fall to be considered.  They may be taken together as they both concern the true construction of section 34(1)(a)(vi).  The essential issue is whether, given that there was a failure to apply an applicable standard, section 34(1)(a)(vi) should be construed as incorporating a standard of reasonableness capable of excusing the auditors notwithstanding their default in observing the standard.

77.  As we have seen,[46] PAO section 18A authorises the Institute’s Council to issue accounting and auditing standards which certified public accountants are required to observe, maintain or otherwise apply.

78.  PAO section 34(1)(a) sets out categories of complaints against a certified public accountant which, if made to the Registrar of the Institute’s Council, must be referred to the Institute’s Council which may in turn refer the complaint to its Disciplinary Panels.  The categories of complaint are of three types.  The first[47] covers complaints involving cases where the certified public accountant has been convicted of certain criminal offences or been punished under the FRC Ordinance and the third[48] involves breaches involving corporate practices. 

79.  The present complaint falls within the second category[49] which involves infringements of professional standards or duties.  The relevant provisions are as follows:

“A complaint that –

(a) a certified public accountant – ...

(iv) has been negligent in the conduct of his profession;

(v) without reasonable excuse, failed or neglected to comply with any direction issued under section 32F(2) and with which he was required by the Practice Review Committee to comply;

(vi) failed or neglected to observe, maintain or otherwise apply a professional standard;

(vii) without reasonable excuse, failed or neglected to comply with any requirement made under section 42D in relation to him by an Investigation Committee;

(viii) has been guilty of professional misconduct;

(ix) refused or neglected to comply with the provisions of any bylaw or rule made or any direction lawfully given by the Council;

(x) was guilty of dishonourable conduct; ...

shall be made to the Registrar who shall submit the complaint to the Council which may, in its discretion but subject to section 32D(7),[50] refer the complaint to the Disciplinary Panels.”

80.  The complaint against the appellants under section 34(1)(a)(vi) was that they had “failed or neglected to observe, maintain or otherwise apply a professional standard, namely HKAS 39” but, as noted above[51] the substance of that complaint was that the appellants had failed or neglected to observe, maintain or otherwise apply the auditing standard HKSA 700, in that they failed properly to evaluate Heng Tai management’s compliance with HKAS 39 in respect of an AFSFA, before issuing an unmodified audit opinion.

D.1   The language of section 34(1)(a)(vi)

81.  On its face, section 34(1)(a)(vi) does not provide for any form of reasonable excuse as a justification for failing or neglecting to apply a relevant standard.  The legislature could of course have provided for such an excuse, as it did by use of the words “without reasonable excuse” in paragraphs (v) and (vii).   But it does not do so.

82.  Taking section 34(1)(a)(vi) in the context of the other paragraphs in section 34(1)(a), it is apparent that a range of complaints of varying seriousness and requiring proof of different constituent elements are specified.  Thus, complaints in the first category (eg, involving conviction for a criminal offence, especially an offence involving dishonesty) would obviously be at the serious end of the spectrum.  A range also exists within the second category of complaints.  Thus, a complaint under paragraph (iv) requires negligence to be established.  Different constituents have to be proved to establish professional misconduct under paragraph (viii) or dishonourable conduct under paragraph (x).  With paragraphs (v) and (vii), the certified public accountant has to be shown to have failed or neglected to comply with specific directions or requirements, such failure being excusable on reasonable grounds.  Reasonable excuse is, however, not mentioned in paragraph (ix) which involves refusing or neglecting to comply with the Council’s lawful bylaws, rules or directions.

83.  It is natural to read section 34(1)(a)(vi) as specifying a ground of complaint at the least serious end of the spectrum, not aimed at punishment, but aimed simply at enforcing the application of published standards in the interests of uniform and predictable professional practice without implying any fault, moral blame or misconduct.  Such a complaint would merit commensurately minor sanctions.[52] Indeed, that appears to have been the approach adopted by the Committee in the present case in deciding on “very lenient” treatment of the appellants after having found the complaint substantiated.

84.  Professional standards operating in that manner are not uncommon.  Mr Strachan SC cited several examples in the case-law where failures to comply with applicable standards without fault on the individual’s part were upheld as infringements of those standards. 

85.  Thus, for instance, in Sadler v General Medical Council,[53] a Privy Council case involving a doctor who, through no fault of his own, failed to complete a required period of retraining to demonstrate an acceptable standard of professional performance, Lord Walker of Gestingthorpe stated:

“[Their Lordships] ... are prepared to accept that the appellant did all he could to achieve effective retraining, and that the very unfortunate delay in starting the retraining is not his fault. But (whether in legal language or in everyday speech) failure does not always imply fault, and their Lordships are satisfied that in this context it should not be taken as implying fault. The purpose of all the provisions is to protect the public from sub-standard medical care, not to punish practitioners for blameworthy acts or omissions. The appellant was most unfortunate in the long delay in the commencement, and the abrupt termination of his retraining. But the fact is that he had not complied with the statement of requirements.”

D.2   Reasonable excuse via HKSA 700

86.  As noted above,[54] the substance of the complaint against the appellants is that they failed or neglected to observe, maintain or otherwise apply the auditing standard HKSA 700 in that they failed properly to evaluate Heng Tai’s non-compliance with HKAS 39 in respect of an AFSFA, before issuing an unmodified audit opinion.  Mr Mok SC submits that HKSA 700 requires no more than reasonable best endeavours by an auditor, so that its incorporation as a necessary element of section 34(1)(a)(vi) complaint provides a basis for holding that the complaint was not established.

D.3   The relevant provisions of HKSA 700[55]

87.  HKSA 700.5 provides that

“... the objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.”

88.  The aim is to produce an audit opinion which states:

“... whether the financial statements ‘give a true and fair view’ or ‘are presented fairly, in all material respects,’ in accordance with the applicable financial reporting framework.”[56]

89.  HKSA 700.10 elaborates on the applicable framework, pointing out that:

“... the financial reporting framework provides a context for the auditor’s evaluation of the fair presentation of the financial statements, including whether the financial statements have been prepared and presented in accordance with the specific requirements of the applicable financial reporting framework for particular classes of transactions, account balances and disclosures.”

In the present case, the applicable financial reporting framework consists of the relevant paragraphs of HKAS 39. 

90.  HKSA 700.11 and HKSA 700.12 stress that the focus of the auditing exercise is on the audit evidence and requires such evidence to be capable of providing reasonable assurance that the financial statements are free from material mis-statement:

HKSA 700.11

“The auditor should evaluate the conclusions drawn from the audit evidence obtained as the basis for forming an opinion on the financial statements.”

HKSA 700.12

“When forming an opinion on the financial statements, the auditor evaluates whether, based on the audit evidence obtained, there is reasonable assurance about whether the financial statements taken as a whole are free from material misstatement. This involves concluding whether sufficient appropriate audit evidence has been obtained to reduce to an acceptably low level the risks of material misstatement of the financial statements and evaluating the effects of uncorrected misstatements identified.”

91.  HKSA 700.13 addresses the process of evaluation in arriving at the audit opinion:

HKSA 700.13

“Forming an opinion as to whether the financial statements give a true and fair view or are presented fairly, in all material respects, in accordance with the applicable financial reporting framework involves evaluating whether the financial statements have been prepared and presented in accordance with the specific requirements of the applicable financial reporting framework for particular classes of transactions, account balances and disclosures. This evaluation includes considering whether, in the context of the applicable financial reporting framework:

(a) The accounting policies selected and applied are consistent with the financial reporting framework and are appropriate in the circumstances;

(b) The accounting estimates made by management are reasonable in the circumstances;

(c) The information presented in the financial statements, including accounting policies, is relevant, reliable, comparable and understandable; and

(d) The financial statements provide sufficient disclosures to enable users to understand the effect of material transactions and events on the information conveyed in the financial statement, for example, in the case of financial statements prepared in accordance with Hong Kong Financial Reporting Standards (HKFRSs), the entity’s financial position, financial performance and cash flows.”

92.  Mr Mok SC relied on HKSA 700.12 for his submission that a standard of reasonableness was introduced since the auditor was only expected to achieve “reasonable assurance”, stressing that auditors are not guarantors of the accuracy of the financial statements. 

93.  However, “reasonable assurance” in the context of HKSA 700.12 does not have any bearing on the issue being discussed.  As explained in HKSA 200.17:[57]

“Reasonable assurance is a concept relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are no material misstatements in the financial statements taken as a whole. Reasonable assurance relates to the whole audit process.”

94.  It is in that context that HKSA 200.18 states:

“An auditor cannot obtain absolute assurance because there are inherent limitations in an audit that affect an auditor’s ability to detect material misstatements ...”

95.  Thus, HKSA 700.12 specifies “reasonable assurance” as the standard of reliability required of the audit evidence to provide a proper foundation for the audit opinion.  No evidential issue arises in the present case.  The audit evidence enabling the auditors to evaluate Heng Tai’s failure to trigger HKAS 39.67 was objective evidence of a significant or prolonged decline in the fair value of the CZ shares below the investment cost. The Committee and the Court of Appeal held that there was reliable and  pertinent evidence available, consisting of the quoted prices and trading volumes of the shares over the year ended 30 June 2009, enabling the cumulative loss to be compared with the known acquisition cost.  The difficulty, as noted above, was that the auditors misinterpreted HKAS 39.61 and so failed to give effect to that standard.  It had nothing to do with the accumulation of evidence necessary to form their unqualified audit opinion.

D.4   A reasonable misinterpretation of HKAS 39.61?

96.  Mr Mok SC submitted on behalf of the appellants that in so far as the appellants had misinterpreted the applicable standard, it was a reasonable error to make, given that the relevant provisions were very unclear and difficult to construe.  Mr Mok SC sought to find support for this approach in the Preface to Hong Kong Financial Reporting Standards[58] which, in §§21 and 22 state as follows:

“21. Council ... expects members of the HKICPA[59] who assume responsibilities in respect of financial statements to observe HKFRSs.”[60]

“22. Where this responsibility is evidenced by the association of members’ names with such financial statements in the capacity of directors or other officers, the onus will be on them to ensure that the existence and purpose of HKFRSs are fully understood by non-member fellow directors and other officers. Members of the HKICPA should also use their best endeavours to ensure that HKFRSs are observed and that departures found to be necessary are adequately disclosed and explained in the financial statements.”

97.  I am unable to see how these paragraphs assist the appellants’ argument.  In the first place, paragraph 22 deals with the responsibility of members acting, not in the capacity of auditors, but as directors or other officers of a company.  It requires them to ensure that their fellow corporate officers fully understand the applicable standard.  Thus, far from giving members an excuse for reasonably failing to comprehend a standard, paragraph 22 presupposes that members have a proper understanding which enables them to give their fellow officers advice about the standard. The reference to “best endeavours” is made in the context of requiring members who are officers do their best to ensure “that the HKFRSs are observed and that departures found to be necessary are adequately disclosed and explained in the financial statements”.  This again assumes that the member has a proper understanding of the applicable standard to be able to exercise such best endeavours in relation to the preparation of the financial statements.

98.  Paragraph 23 of the Preface which follows does deal with members who act as auditors.  It provides that they “should be in a position to justify departures, to the extent that their concurrence with the departures is stated or implied.”  This is germane to the present case where the appellants concurred with the departure by Heng Tai from the requirements of HKAS 39.61.  Far from excusing them for not understanding the relevant standard, the Preface requires them to be in a position to justify such concurrence.

99.  I therefore can see no basis for reading into section 34(1)(a)(vi) some standard of reasonableness capable of exonerating the appellants. 

100.  Nor do I accept that the relevant accounting standards were ambiguous or unclear, as the appellants sought to submit.  The AIB had no difficulty in applying HKAS 39.61, calling it an “explicit statement” and treating it as a self-contained standard.  This view was evidently shared by the FRC and the Institute which adopted the AIB Report and referred the matter to the Disciplinary Committee which found that standard “very clear”.  It is also a view shared by the IASB which considered the paragraph 61 impairment triggers reasonable and opined that any impairment trigger other than a decline in fair value below cost was likely to be arbitrary.   

101.  In my view, as the foregoing analysis shows, when properly construed in the context of other relevant paragraphs of HKAS 39, the meaning of HKAS 39.61 is straightforward and clear.  As the authorities show, the meaning of a provision may emerge as unambiguous and clear at the end of what may appear to be a difficult process of construction.  As Lord Wilberforce pointed out:

“... ambiguity in this context is not to be equated with difficulty of construction, even difficulty to a point where judicial opinion as to meaning has differed. This is, I venture to think, elementary law.”[61]

102.  And in Scammel v Ouston,[62] Lord Wright stated:

“[The Court] will not be deterred by mere difficulties of interpretation. Difficulty is not synonymous with ambiguity so long as any definite meaning can be extracted.”

103.  In the Written Case, the appellants also sought to argue that an exculpatory standard of reasonableness is introduced first, by construing section 34(1)(a)(vi) as taking effect in a manner reflecting auditors’ common law duties for the purposes of tortious liability in negligence;[63] and secondly, by construing it as a provision subject to a presumption of mens rea and thus importing an intermediate form of liability allowing for a defence of reasonable belief.[64]  These submissions were (correctly) not pursued at the hearing and require no further discussion.

D.5   Conclusion as to Questions 1 and 2

104.  For the foregoing reasons, my answers to Questions 1 and 2 are respectively “Yes” and “No”.

E.  Disposal of the appeal

105.  The auditors failed properly to evaluate Heng Tai’s failure to trigger HKAS 39.67 before issuing their unmodified audit opinion and thus failed or neglected to observe, maintain or otherwise apply the professional standards set out in HKSA 700.  The Disciplinary Committee was entitled to find the complaint established while recognising that it merited only a token sanction.  And the Court of Appeal was right to uphold the Disciplinary Committee’s ruling. 

106.  I would accordingly dismiss this appeal and make an order nisi that the appellants pay the respondent’s costs with liberty to the parties to lodge written submissions on costs within 21 days of the handing down of this judgment, the order nisi to stand as an order absolute without further direction in default of such written submissions.

Mr Justice Tang PJ:

107.  I agree with the judgment of Mr Justice Ribeiro Acting CJ.

Mr Justice Fok PJ:

108.  I agree with the judgment of Mr Justice Ribeiro Acting CJ.

Mr Justice Bokhary NPJ:

109.  I agree with the judgment of Mr Justice Ribeiro Acting CJ.

Mr Justice Gummow NPJ:

110.  I agree with the judgment of Mr Justice Ribeiro Acting CJ.

Mr Justice Ribeiro, Acting CJ:

111.  The Court unanimously dismisses the appeal and makes the orders referred to in paragraph 106 of this judgment.