HONG KONG IPO GUIDE 2013
companies, joint ventures, key management personnel and/or major shareholders. Over the past decade, the definition of related party has been broadened to include key management personnel. The purpose of disclosing related party transactions is to ensure a company’s financial statements draw potential investors’ attention to the possibility that the company’s financial position and profits or losses may have been affected by the existence of related parties and by transactions and outstanding balances with such parties. A related party relationship could have an effect on the profits or losses and financial position of an entity. Related parties may also enter into transactions that unrelated parties would not. For example, an entity that sells goods to its parent at cost might not sell on those terms to another customer. Also, transactions between related parties may not be set at the same amounts as between unrelated parties. Therefore, the existence of related party transactions may affect how potential investors assess a company’s operations and the Prospectus should set out the risks and opportunities that these related party transactions create. The related party disclosure requirements can present a particular problem for Mainland Chinese companies seeking to list on the HKEx. Many of these enterprises have experienced tremendous growth in business operations during the past decade and usually the structure of the organizations have not kept pace with the growth. Experience has shown us that the senior managers of these companies generally do not understand related party transactions as defined by HKFRS and Hong Kong's listing rules. Mainland Chinese companies may not have kept complete records of related party transactions and may not have adequate internal controls for such transactions. Also, major related party transactions originating at the subsidiary level may not have been adequately reported back to the head office. It is also common for Chinese companies to have no separation of the business/cash flows between the owners’ fund and the monies generated by the operations. Certain cash in and out through the owners’ bank accounts may not be properly identified and recorded. The Reporting Accountants are required to obtain an understanding of the nature and business rationale of a company's related party relationships and transactions sufficient to identify, assess and respond to the risks of material misstatement resulting from them. It is sometimes difficult to identify related party relationships and transactions if these are not identified or disclosed by management. In some circumstances, particularly in the absence of proper records, the Reporting Accountants may need to rely on the management's representation of these related party transactions. The Reporting Accountants may need to use the following procedures to identify related party transactions: • requesting from management personnel a list of related parties and any transactions the company has completed with those parties during the trade record period; • reviewing the Board minutes for authorization of transactions; • understanding and evaluating investment transactions; for example, the purchase or sale
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