According to the provisions set out in the Hong Kong Companies Ordinance, companies that are incorporated in Hong Kong must maintain proper books of accounts and must also satisfy statutory audit requirements on an annual basis. The Hong Kong Institute of Certified Public Accountants (HKICPA) is responsible for regulating the accountancy profession in Hong Kong.

Since January 2005, Hong Kong has adopted a Financial Reporting Standards (FRS) framework that has been modelled on International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB).

Hong Kong Accounting Standards

Accounting standards are a set of rules that govern the treatment of financial transactions, by specifying certain fundamental principles, defining the meanings of terms and demanding minimum levels of disclosure.

Accounting standards in Hong Kong are known as Hong Kong Financial Reporting Standards(HKFRS)and set out recognition, measurement, presentation and disclosure requirements dealing with transactions and events that are important in general purpose financial statements. It is the application of HKFRS that gives us a “true and fair view” of financial statements.

The HKICPA has also issued a Financial Reporting Standard (SME-FRS) for certain qualifying SMEs. By 30 April 2010, the Institute intends to issue the Hong Kong Financial Reporting Standard for Private Entities (HKFRS for Private Entities)for Hong Kong companies that do not have public accountability. The HKFRS for Private Entities will eliminate some accounting treatments permitted under full HKFRSs, remove topics and disclosure requirements that are not generally relevant to private entities, and simplify requirements for recognition and measurement.

Scope of HKFRS

• The term Hong Kong Financial Reporting Standards includes all Hong Kong Financial Reporting Standards, Hong Kong Accounting Standards (HKAS), and Interpretations issued by the Hong Kong Institute of Certified Public Accountants (HKICPA).
• According to the HKICPA, HKFRS are designed to apply to general purpose financial statements and other financial reporting of all profit-oriented entities.
• Profit-oriented entities include those that are engaged in commercial, industrial, financial and similar activities. They include mutual insurance companies and other mutual cooperative entities that provide dividends or other economic benefits directly and proportionately to their owners, members or participants.
• HKFRS are not designed to apply to non-profit activities in the private sector, public sector or government.
• HKFRS apply to all general purpose financial statements that are directed towards the common information needs of a wide range of users such as shareholders, creditors, employees and the public at large. The objective of financial statements is to provide information about the financial position, performance, and cash flows of an entity that is useful in making economic decisions.
• A complete set of financial statements includes:
  • A balance sheet;
  • An income statement;
  • A statement showing either all changes in equity or changes in equity other than those arising from capital transactions with owners and distributions to owners;
  • A cash flow statement; and
  • Accounting policies and explanatory notes.

Accrual basis of accounting

One of the main principles of Hong Kong accounting standards is that an entity prepares its financial statements, except for cash flow information, using the accrual basis of accounting. Under the accrual basis of accounting, the effects of transactions and other events are recognized when they occur and are reported in financial statements of the periods to which they relate. Financial statements prepared on the accrual basis of accounting inform users not only of past transactions involving the payment and receipt of cash, but also of obligations to pay cash in the future and of resources that represent cash to be received in the future.

Standards of HKFRS

The HKFRS consists of 41 distinct accounting standards, 9 financial reporting standards and several interpretations. Each standard relates to a specific topic such as presentation of financial statements, inventories, statement of cash flows, income taxes etc. Some examples of the standards set out in the HKICPA’s HKFRS Handbook include:

HKAS 1: Presentation of financial statements

Hong Kong Accounting Standard 1 Presentation of Financial Statements (HKAS 1) specifies the overall requirements for presentation of financial statements, guidelines for their structure and minimum requirements for their content.
According to HKAS 1:

• When preparing financial statements of an entity, the management shall make an assessment of the entity s ability to continue as a going concern, unless the management intends to liquidate the entity or cease trading. When an entity does not prepare financial statements on a going concern basis, it shall disclose this fact, together with the basis on which it prepared the financial statements and the reason why the entity is not regarded as a going concern.
• An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting.
• An entity shall not offset assets and liabilities or income and expenses, unless required or permitted by a HKFRS.
• An entity shall present a complete set of financial statements (including comparative information) at least once in a year.

HKAS 2: Inventories

Hong Kong Accounting Standard 2 Inventories (HKAS 2) specifies the accounting treatment for inventories. One of the main issues in accounting for inventories is the amount of cost to be recognized as an asset and carried forward until the related revenues are recognized. HKAS 2 offers guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realizable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.
According to HKAS 2:

• Inventories shall be measured at the lower of cost and net realizable value.
• The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
• The cost of inventories shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formula.

HKAS 18: Revenue

Hong Kong Accounting Standard 18 Revenue (HKAS 18) sets out the accounting treatment that is accorded to revenue arising from certain types of transactions and events. The primary issue in accounting for revenue is determining when to recognise revenue.
According to HKAS 18:

• Revenue shall be measured at the fair value of the consideration received or receivable.
• Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied:
  • The entity transfers to the buyer the significant risks and rewards of ownership of the goods;
  • The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
  • The amount of revenue can be measured reliably;
  • It is probable that the economic benefits associated with the transaction will flow to the entity; and
  • The costs incurred or to be incurred in respect of the transaction can be measured reliably.

For a complete set of HKFRS, please refer to the HKICPA’s HKFRS Handbook.

Financial Reporting Standards for SMEs (SME-FRS)

The SME-FRS set out the recognition, measurement, presentation and disclosure requirements for an entity that prepares and presents the financial statements in accordance with the SME-Financial Reporting Framework. The following entities qualify for preparing financial statements under the SME-FRS:

• For companies that are incorporated in Hong Kong:
  • Companies that satisfy the criteria under section 141D of the Companies Ordinance.
• For overseas companies:
  • Companies that have no public accountability;
  • Companies that meet any two of the following criteria:
    • The annual revenue of the company is below HK$50 million;
    • The total assets of the company are below HK$50 million;
    • The company has a maximum of 50 employees.
  • Companies whose owners agree to prepare the financial statements in accordance with the SME-FRS.

The SME-FRS are simplified accounting principles based on the HKFRS. Certain topics of the HKFRS have been omitted in the SME-FRS, as they are not relevant to typical SMEs. The SME-FRS consists of 17 accounting standards that cover topics such as presentation of financial statements, accounting policies, leases, etc. Topics such as interim financial reporting, segment reporting, employee benefits, statement of cash flows, etc. have been omitted in the SME-FRS. For a complete set of SME-FRS, please refer to the HKICPA’s SME-FRS.