Evergrande and its auditor are under investigation

Hong Kong’s peak financial audit regulator, the Financial Reporting Council, has announced it is investing going concern reporting of China Evergrande Group (HKG: 3333).

The reporting in question relates to Evergrande’s 2020 annual accounts and 2021 interim accounts.

The regulator is also probing the audit of accounts carried out by PricewaterhouseCoopers (PwC) on the 2020 annual accounts.

In financial reporting, “going concern” refers to the assumption that an entity is able to service it debt and continue operations without needing to liquidate or wind up operations.

Going concern is assumed unless otherwise indicated. So companies must disclose any material uncertainties.

If the auditor of a company’s accounts has doubts as to the entity’s ability to continue as a going concern it must outline those doubts in the audit report.

The investigation has been launched after the regulator received a complaint from a member of the public on these matters in relation to the 2020 annual accounts and 2020 audit.

What the Financial Reporting Council is investigating

In its 2020 annual accounts, China Evergrande referred to financing activities conducted to properly manage the Group’s liquidity risk and capital structure, along with alternative plans to mitigate potential cash flow impacts if there are significant adverse changes in the economic environment.

However, as at 31 December 2020, China Evergrande reported the following:

  • Cash and cash equivalents of RMB159 billion that did not cover its current liabilities of RMB1,507 billion.
  • Further borrowings of RMB167 billion maturing in 2022.
  • Made no explicit statement in the 2020 annual accounts as to whether material going concern uncertainties existed before or after the effects of implementing the mitigating plans.

In its 2020 audit, PwC expressed an unmodified audit opinion in its auditor’s report on the 2020 annual
accounts but made no reference to going concern material uncertainties.

In 2021 interim accounts, China Evergrande:

  • Disclosed that the company was negotiating with suppliers and construction workers on some contracts for which work was suspended due to overdue property development accounts payable.
  • Identified other mitigating measures it would adopt to address liquidity issues.
  • Made an equivocal statement to the effect that if the mitigating measures are effectively implemented the going concern basis is appropriate in the 2021 interim accounts but if they cannot be implemented effectively it would be inappropriate to prepare the 2021 Interim Accounts on the going concern basis.

However, China Evergrande made no explicit statements in the 2021 interim accounts as to whether material going concern uncertainties existed, the directors judged it appropriate to adopt the going concern basis and, if so, whether that judgment was significant.

The Council says it’s investigation will focus on two specific areas:

  1. Enquire into whether China Evergrande’s going concern assessments for the 2020 Annual Accounts and the 2021 Interim Accounts, and the disclosures in those financial statements relating to going concern uncertainties and the adoption of the going concern basis of accounting, complied with the applicable financial reporting standards.
  2. Investigate whether PwC’s audit work on China Evergrande’s going concern assessment in the 2020 Audit and its auditor’s report complied with applicable auditing standards.

The Financial Reporting Council has the power to impose fines of up 10 HK$10 million for auditing misconduct.

Evergrande’s latest blow

Following more missed coupon payments attached to offshore bonds, Evergrande has been dealt a new blow.

Over the past fortnight there had been rumours circulating that Chinese state-owned Yuexiu Property (HKG: 0123) was primed to purchase the China Evergrande Centre in Hong Kong’s Wan Chai district for up to US$1.8 billion.

The China Evergrande Centre is the current headquarters of the China Evergrande Group.

However, according to Reuters sources the deal has fallen through over concerns about Evergrande’s financial situation.

Evergrande has around $669 million in coupon payments outstanding in the remainder of this year alone, with $7.4 billion worth of bonds maturing next year.

The fallen property giant has managed to offload numerous asset over the past few months, with the proceeds appearing to be used predominately to service onshore debt owed to Chinese enterprises.

Related: The Chinese property giant more geared than Evergrande

Evergrande auditor
Source: Bloomberg