Consolidated financial statements
Pursuant to section 379(2), a holding company must prepare consolidated financial statements that comply with sections 380, 381 and 383.
If the company is a holding company at the end of the financial year, consolidated financial statements must be prepared instead unless the company is
(a) a wholly owned subsidiary; or
(b) a partially owned subsidiary where -
(i) at least 6 months before the end of the financial year, the directors notify the members in writing of the directors’ intention not to prepare consolidated statements for the financial year, and the notification does not relate to any other financial year; and
(ii) all members agree in writing before the end of the financial year that consolidated financial statements will not be prepared for the financial year and the agreement does not relate to any other financial year.
HKFRS 10 Consolidated Financial Statements
Paragraph 4(a) of HKFRS 10 Consolidated Financial Statements also sets out exemption criteria in respect of which entities are exempt from preparing consolidated financial statements. The criteria set out in paragraphs 4(a)(i)-(iii) of HKFRS 10 are typically met by any intermediate holding company which satisfies s379(3) of the CO. However, the criteria set out in paragraph 4(a)(iv) of HKFRS 10, which are that the company’s ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with HKFRSs or IFRSs, may, or may not, be met depending on the situation of the company’s parent entity.
For example, the criteria in HKFRS 10.4(a)(iv) would not be met in the following situations:
(a) the company is a wholly owned subsidiary of a private Hong Kong incorporated company which is not required to file its financial statements on public record; or
(b) the company is a wholly owned subsidiary of a US parent which issues US GAAP financial statements but does not issue IFRS financial statements.
Section 379 of the CO is explicit on which companies should prepare company level financial statements and which should prepare consolidated financial statements and these requirements take precedence over s380. That is, s379 determines which type of financial statements need to be prepared (company level or consolidated), and s380 then contains the “general requirements for financial statements” being the requirements for the contents of those financial statements (company level or consolidated) as are required to be prepared under s379.
On this basis, the “accounting standards applicable to the financial statements” referred to in s380(4)(b) are those relevant to the type of financial statements (company level or consolidated) required by s379. This is supported by the definition of “accounting standards applicable to the financial statements” set out in s380(8)(b):
“a reference to accounting standards applicable to any financial statements is a reference to accounting standards as are, in accordance with their terms, relevant to the company’s circumstances and to the financial statements”
In the case of a holding company preparing company level financial statements to satisfy section 379(1), the statement of compliance included in the financial statements in accordance with section 4 of Schedule 4 to the CO and paragraph 16 of HKAS 1 Presentation of Financial Statements should clearly state that the financial statements comply with the accounting standards applicable to the company level financial statements only. For the avoidance of doubt, it is also advisable for the statement of compliance to explain why the company is not required to prepare consolidated financial statements.
Consequences of the directors of a partially owned subsidiary of another body corporate missing the “six months before the year-end” deadline
If the directors miss the “six months before the year-end” deadline, then they must comply with the full requirements for that financial year i.e. they must prepare consolidated financial statements or seek legal advice on the consequences of failing to comply with the relevant statutory requirements. Failure to meet the six months deadline cannot be excused by the members as this is a statutory requirement.
Failing to meet this deadline in one financial year does not preclude the directors from taking steps to meet it in good time for the next financial year. However, it should be noted that the notification that is required under section 379(3)(b) in order to claim exemption from the preparation of consolidated financial statements can only apply to one financial year. Therefore, every year a fresh notification no later than 6 months before the end of the year is required if the directors are seeking to take advantage of section 379(3)(b).
Consequences of failing to prepare consolidated financial statements under s379
It should be noted that if the company fails to prepare consolidated financial statements when required to do so under s379 and/or the financial statements that it prepares fail to comply with sections 380, 381(if applicable) or 383, then each director may be held to have committed an offence. Specifically:
- s379(4) states that a director has committed an offence and is liable to a fine of $300,000 if the director fails to take all reasonable steps to secure compliance with these sections; and
- s379(5) states a director has committed an offence and is liable to a fine of $300,000 and imprisonment for 12 months if the director wilfully fails to take all reasonable steps to secure compliance with these sections.
Subject to permitted exclusions, the consolidated financial statements must include all the subsidiary undertakings of the company (section 381).
Where the company falls within the reporting exemption for the financial year, one or more subsidiary undertakings may be excluded from consolidation when:
(a) their exclusion measured on an aggregate basis is not material to the group as a whole; or
(b) their inclusion would involve expense and delay out of proportion to the value to members of the company. (section 381(2) & section 19.2 of SME-FRF & SME-FRS (Revised 2014))
Accordingly, if all of the subsidiary undertakings are excluded in accordance with the applicable accounting standards, the holding company’s financial statements will be its own company level financial statements.
Section 19.3 of SME-FRF & SME-FRS (Revised 2015) states that a parent may only exclude a subsidiary from consolidation on the grounds of expense and delay out of proportion to the value to members of the company if the members of the company have been informed in writing about, and do not object to, this exclusion. In order to satisfy this condition:
(a) the notification to the members of the company must:
(i) state which financial year that the notification relates to (and the notification must not relate to more than one financial year);
(ii) specify the subsidiary or subsidiaries proposed to be excluded; and
(iii) state the directors’ reasons for believing that the inclusion of the subsidiary or subsidiaries in the consolidated financial statements may involve expense and delay out of proportion to the value to the shareholders;
(b) in the case of an entity which needs to obtain shareholder approval in order to qualify for the reporting exemption, the notification to the members of the company proposing to exclude one or more subsidiaries from consolidation must be included as part of the notice to obtain the necessary shareholder approvals required to qualify for the reporting exemption and must be subject to the same approval and objection processes as apply to that approval;
(c) in all other cases the notification must be sent to the members before the date of approval of the financial statements and must allow the members of the company a period of no less than one month to raise objections, unless all the members of the company confirm that such a period is not necessary; and
(d) within the time frame allowed in accordance with (b) or (c) no member has indicated to the company that they disagree with the directors’ assertion that the inclusion of the subsidiary or subsidiaries would involve expense and delay out of proportion to the value to members of the company.
Under paragraph 19.16(g) the parent needs to provide additional extensive disclosures in financial statements on any excluded subsidiaries.
Where the company does not fall within the reporting exemption for the financial year, one or more subsidiary undertakings may be excluded from consolidation when their exclusion measured on an aggregate basis is not material to the group as a whole (section 381(3))
If all of the company’s subsidiaries are collectively immaterial in accordance with section 381(3) then the company is not required to comply with section 379(2) (preparation of consolidated financial statements). In order for this to be the case when the holding company has more than one subsidiary, then the company’s subsidiaries must be immaterial when taken together in accordance with section 381(3)(b). It is not sufficient for each subsidiary to be individually judged to be immaterial.
Company-level or Consolidated financial statements
The requirement to prepare either company-level or consolidated financial statements is set out in section 379 of the CO.
If a holding company is required to prepare consolidated financial statements then it is not required to prepare company-level financial statements; and
If a holding company is a wholly owned subsidiary of another body corporate (or a partially-owned subsidiary and its shareholders do not object to the preparation of company-level financial statements) then the company is not required to prepare consolidated financial statements.
A wholly owned subsidiary of another body corporate may prepare annual consolidated financial statements so long as the annual consolidated financial statements comply with sections 380 and 383 and in every respect with the requirements applicable to annual consolidated financial statements, in which event no company-level financial statements are required to be prepared by it.
However, if the annual consolidated financial statements do not comply in every respect with the requirements applicable to annual consolidated financial statements, then the wholly owned subsidiary should prepare company-level financial statements for the purposes of compliance with section 379(1) and should regard any additional consolidated financial statements or consolidated financial information which it chooses to prepare in respect of the full financial year as “non statutory accounts” within the meaning of section 436. Further guidance on “non statutory accounts” can be found in Accounting Bulletin 6 issued by the HKICPA.
Signing of company level statement of financial position in consolidated financial statements
Section 387 of the CO states that the directors must sign a statement of financial position that “forms part of any financial statements”. As Schedule 4 to the CO requires the company level statement of financial position of the holding company to be included in the notes to its consolidated financial statements, it follows that this is a statement of financial position that falls under the scope of section 387. It must therefore be approved by the directors and signed on their behalf by 2 directors, or in the case of a company having only one director, by that director, despite the fact that the directors have already approved the entire set of consolidated financial statements (which includes notes to the consolidated financial statements) by signing on the consolidated statement of financial position.