Making sustainable business risk judgments is complex systems engineering, and even PwC has failed to meet public expectations of top international auditors
Text | Zheng Hui Chen Jiayao
Edit | Wang Bo
China Evergrande (3333. HK, hereinafter referred to as "Evergrande") debt crisis is spreading more and more widely.
On October 15, PwC, one of the big four accounting firms that provided financial audit services for Evergrande, was questioned.
On the same day, the Hong Kong Financial Reporting Bureau issued an announcement, holding that in the 2020 annual report and the 2021 interim report, Evergrande did not clearly state whether there was significant uncertainty in the continuing operation. As an annual report auditor, PwC only issued an unqualified opinion in the audit opinion of the 2020 annual report, and did not mention the significant uncertainty of going concern.
To this end, the Hong Kong Financial Reporting Council will launch an investigation.
The Hong Kong Financial Reporting Council (FRC) is the regulator of auditors (accounting firms) of listed entities and has the power to inspect, investigate and accredit overseas auditors of listed entities and to discipline the auditors of listed entities.
Caijing called the bureau twice to inquire about the progress of the investigation and possible sanctions, and both sides said they would not comment on the cases under investigation. Regarding whether the results of the investigation will be made public, the other party also did not give a clear answer.
Under normal circumstances, if PwC believes that there are significant uncertainties in Evergrande's going concern, it should issue an "unqualified opinion with emphasis on the matter paragraph" in the audit report, which is more likely to attract the attention of investors and play a role in warning of risks than a clean "standard unqualified opinion".
"Finance" learned that there have been documents within Puhua that in 2020, China Evergrande has a high debt scale and debt ratio, and after the three red line policies for housing enterprise financing are proposed, China Evergrande may face the pressure of reducing debt and unsustainable operation. The audit team consulted with the risk management department on the relevant risks.
But that was all, PwC ultimately did not issue a clear risk warning in Evergrande's audit report.
Since the second half of the year, Evergrande's liquidity crisis has gradually emerged. Employees, home buyers, suppliers and investors have flocked to Evergrande's Shenzhen headquarters to defend their rights, and many domestic and foreign rating agencies have downgraded evergrande's credit rating.
As one of the world's top four audit firms, why did PwC not specify the relevant risks in its 2020 annual report? Will PwC be severely punished for this?
Puhua's silence
In fact, in the 2020 financial report, Evergrande's debt crisis appeared.
According to the 2020 annual report, Evergrande has nearly 2 trillion yuan of total liabilities on its books, and the net debt ratio is as high as 159.3%. Its interest-bearing debt balance ranked first among housing enterprises, reaching 716.5 billion yuan.
At the end of 2020, Evergrande's available monetary funds are 158.7 billion yuan, and the interest-bearing debts due within one year are 335.5 billion yuan, and the monetary funds are far from enough to cover short-term liabilities.
In September 2020, the regulator set up three red lines of "the net debt ratio is not more than 100%, the cash short-term debt ratio is not less than 1, and the asset-liability ratio excluding contract liabilities is not more than 70%" to restrict the financing activities of housing enterprises. Among the top five real estate enterprises, Evergrande is the only red-file enterprise with three lines in full step.
The above-mentioned internal PwC documents show that it has noticed changes in the market financing environment and Evergrande's own excessive leverage, but ultimately chose to remain silent.
According to public information, the project partner who issued the 2020 audit report for Evergrande is Yang Chuhao, a partner of PwC Guangdong. Caijing called PwC China South to ask why it did not warn in time, and its senior marketing consultant said that the company was inconvenient to respond.
Evergrande has been working with PwC for 12 years, and since Evergrande was listed in Hong Kong in 2009, PwC has been its royal auditor.
A former PwC senior auditor argued that it would not be reasonable if the public could see from Evergrande's statements that going concern was risky, but PwC did not give a hint on the comments page. However, he also mentioned that judging the major uncertainty of continuing operations is not only to look at the statements to draw conclusions, but also to see what work Puhua has done and why it has made a decision not to warn of risks.
A number of auditors from the Four Major And Mainland auditors told Caijing that during the audit process, the management of the enterprise will generally explain to the auditor the company's future business plan, profit forecast, liabilities and repayment arrangements, etc., and the auditors will evaluate this and some important financial data and special events. One of the auditors said that most clients do not have the problem of going concern, and that an audit of going concern is usually a process.
However, there is also a big four audit manager who believes that the quality control of the big four accounting firms is very strict, even if PwC does not prompt the risk of Evergrande's continuous operation in the audit report, it must have also made a record of reviewing the risk points internally, which cannot be a blind spot.
The final audit report did not mention the risk of Evergrande's continuing operation, which may be that PwC believes that the risk does not exist after professional judgment and does not require special disclosure.
In fact, whether a company has the risk of going concerned involves forecasting the future and needs to consider many factors. "In general, the problem of going concern is only found in enterprises that are clearly on the verge of bankruptcy, which is difficult to accurately judge, and our audit is not a panacea." The above-mentioned former PwC Senior Auditor spoke.
It's hard to decide
How exactly does a company have "significant uncertainty about going concern"?
Caijing reviewed the China Certified Public Accountants Auditing Standard No. 1324 - Going Concern and the Application Guide and found that although the auditing standards listed a number of indications for reference, they did not give clear criteria.
A former PwC assistant auditor told Caijing that in an audit project in which he participated, the company's current assets on the books were less than the current liabilities, and the person in charge of the audit refused to issue an unqualified opinion if he did not get the bank credit or extended the period and could not prove the sustainable operation of the enterprise in the next year.
However, another audit manager believes that the basis for judgment is not single, and there are many factors to consider. Generally, it will first look at whether the company's current assets can cover the current liabilities, and if the current liabilities are too much, it is necessary to further consider whether the company has a corresponding financing plan or other sources of funds to bear the current liabilities.
Caijing used Wind to inquire about the audit reports issued by the A-share market last year with "unqualified opinions with emphasis on the matter paragraph" and prompting "material uncertainties related to going concerns", a total of 62 companies.
The reasons for the risks that these companies are prompted for are also a combination of factors, including but not limited to: insufficient current assets to cover current liabilities, long-term losses or significant losses in the current year, negative cash flows from operating activities, large interest-bearing debts that are difficult to repay, poor debt indicators, debt defaults or material adverse litigation.
It is worth noting that 44 of the 62 companies that have been warned of the risk of going concern are companies that have been issued ST risk warnings. That said, these 44 companies have been classified by the stock exchange as having anomalies in financial or other aspects, which can be an important reference for auditors.
Among the remaining companies that have not been ST, including Huaxia Happiness (600340. SH) and 000620.SZ), but these two companies had debt defaults before the release of their 2020 annual reports.
From the perspective of financial data, although Evergrande's short-term debt repayment is under pressure at the end of 2020, its current assets can cover current liabilities, and before the annual report is released, Evergrande has not had a clear debt default event in the financial market.
In fact, it is difficult for an auditor to directly determine whether there are significant uncertainties in the continuing operation of the enterprise based on simple book financial data.
Caijing refers to the 2020 Kerry full-caliber sales rankings, selects 50 top listed real estate companies, and queries their financial data, auditors and opinions. The current assets of these 50 companies can cover their current liabilities.
Further screening for companies whose cash does not cover short-term interest-bearing debt (see Table 1). It can be seen that among these companies, although the debt repayment level and net debt ratio are not performing well, only Xinli Holdings has currently defaulted on debt.
The 2020 annual reports of Blu-ray Development, Modern Real Estate and Fantasia all show that cash can cover short-term interest-bearing liabilities, and the net debt ratio of Blu-ray and Fantasia has not exceeded the red line value of 100%. But all three companies have defaulted on their debts this year.
From this point of view, companies with relatively better financial indicators defaulted a year ago, while companies with poorer indicators did not default.
One auditor pointed out that even if some companies have defaulted on their debts, they can only be regarded as "signs" first. "Suppose that after the debtors' meeting is held, there is a direct debt-to-equity swap, and nothing will happen." He said.
Although it is important to judge whether the enterprise has the risk of going concerned, the complexity of the actual situation often makes this judgment difficult to be absolute and lacks uniform standards.
Liability is unclear
What liability will PwC bear if there are no significant uncertainties related to going concern in the 2020 Annual Report? Many audit practitioners interviewed by Caijing did not give clear answers.
In fact, the provisions of the auditing standards are also vague.
Article VII of the Auditing Standard 1324 states that if there are future events or circumstances that may cause the audited entity to cease to operate, the potential impact of the inherent limitations of the audit on the ability of the certified public accountant to detect material misstatements will increase. CPAs cannot make predictions about these future events or circumstances. Accordingly, the fact that the CPA did not mention in the audit report material uncertainties related to the audited entity's ability to continue as a going concern cannot be considered a guarantee of the audited entity's ability to continue as a going concern.
That is to say, if future events lead to uncertainty in the company's going concern, then the failure of the auditor to give relevant notices is also forgivable. Descriptions that leave room for interpretation leave room for the auditor.
Whether PwC's audit work was adequate and whether the decision not to warn was reasonable remains to be further investigated.
Caijing sent a letter to the Chinese Institute of Certified Public Accountants to inquire about PwC's issues and responsibilities in this matter, but did not receive a formal reply. However, the relevant staff said that the Hong Kong Financial Reporting Bureau only questioned, the matter is still in the early stages, if you want to formally investigate, the process is expected to be relatively long, therefore, it is not convenient to answer the relevant questions at present.
Evergrande's main business is Chinese mainland, and most of the audit work should also be completed by the mainland. Whether the Hong Kong Financial Reporting Council could investigate the working papers of the Mainland Institute, the above-mentioned staff member said that it was not clear what the specific powers of the Hong Kong Financial Reporting Council were. If a mainland listed company has a problem and needs to investigate the mainland firm, it should go through the Ministry of Finance, the Securities Regulatory Commission and other institutions.
The Financial Reporting Council of Hong Kong provided Caijing with a disciplinary policy that shows that in general, the Financial Reporting Council must disclose it to the public unless the sanction is a non-public reprimand, or the disclosure will affect the criminal legal process or harm the public interest.
A former KPMG senior auditor said the regulator needed to do something to respond to public concerns. He speculated that the final conclusion of the investigation should find some small flaws, but the problem was not big.
The audit is faced with objective conditions and its own ability, and gives a "reasonable guarantee" rather than an "absolute guarantee". Audits also need to take into account real-world factors to sustain customers. But even so, the public still expects, and needs to break through various obstacles and give the most objective and accurate audit opinions, especially for heavyweight companies like Evergrande.
The author is a researcher and journalist at Caijing