Audit Response

Audit Response in China: Procedures and Compliance Guidelines

1. Overview

Audit response refers to the formal process through which entities in China address inquiries, findings, and requests for information from external auditors during the statutory financial statement audit. This process is a critical component of corporate governance and financial management, ensuring the accuracy, completeness, and compliance of financial disclosures. In China, this practice is governed primarily by the Company Law, the Accounting Law, and the Chinese Auditing Standards issued by the Ministry of Finance (MOF) and the Chinese Institute of Certified Public Accountants (CICPA). A robust audit response mechanism is essential for maintaining investor confidence, meeting regulatory obligations of bodies like the China Securities Regulatory Commission (CSRC), and upholding the integrity of financial markets.

2. Applicable Objects & Scenarios

• Applicable Objects:

  • All companies limited by shares and limited liability companies.
  • Listed companies on Shanghai, Shenzhen, and Beijing Stock Exchanges (subject to stricter requirements).
  • State-Owned Enterprises (SOEs) and large financial institutions.
  • Other entities required by law to undergo an annual statutory audit (e.g., certain foreign-invested enterprises, public interest entities).
  • The Board of Directors, Audit Committee, and financial management team are typically responsible for overseeing and coordinating the response.

• Key Scenarios:

  • Annual Financial Statement Audit: The primary scenario, occurring after the fiscal year-end.
  • IPO or Securities Issuance: During due diligence for initial public offerings or bond issuances.
  • Regulatory Investigations: In response to specific inquiries from the CSRC, State Administration of Foreign Exchange (SAFE), or tax authorities.
  • Special Audits: For mergers & acquisitions, restructuring, or litigation support.
  • Internal Control Audits: For listed companies, responding to auditors' evaluations of internal control over financial reporting.

3. Core Conclusions

• Mandatory Cooperation: Management has a legal and contractual obligation to provide full cooperation and access to all necessary information, records, and personnel for the audit.
• Timeliness is Critical: Delays in responding to auditor requests can lead to audit delays, qualified opinions, or regulatory scrutiny.
• Accuracy and Completeness: Responses and provided documentation must be accurate, complete, and not misleading. The entity's leadership is ultimately responsible for the financial statements.
• Formal Communication Channel: All significant audit findings (e.g., uncorrected misstatements, scope limitations, fraud) will be formally communicated in writing, requiring a formal written response from management or those charged with governance.
• Professional Skepticism: Auditors are required to exercise professional skepticism. Responses should be substantiated with evidence, not just assertions.

4. Procedures & Steps

Step 1: Preparation

• Designate a Team: Form an audit response team led by the CFO or Financial Controller, involving accounting, treasury, legal, and operational staff.
• Understand Auditor's Plan: Review the auditor's planned audit scope, timeline, and preliminary request list (PBC - Prepared By Client list).
• Internal Review: Conduct a pre-audit internal review of accounts, reconciliations, and supporting documents for major transactions.
• Compile Documents: Gather prior-year audit reports, board minutes, significant contracts, and new accounting policy documents.

Step 2: Application & Submission

• This step involves the ongoing process of responding to auditor requests, not a single application.
• Formal Kick-off Meeting: Hold a meeting with auditors to confirm timelines, key contacts, and communication protocols.
• Systematic Response: Assign each PBC item to a responsible person. Establish an internal review process before submission to auditors.
• Maintain Log: Keep a detailed log of all information requests, responses provided, and pending items to ensure nothing is overlooked.
• Management Representation Letter: Prepare to provide this signed letter at the audit's conclusion, affirming management's responsibility for the financial statements and the completeness of information provided.

Step 3: Review & Confirmation

• Address Audit Findings: Review all audit adjustments proposed by the auditors (journal entries). Discuss and agree on corrections.
• Draft Financial Statements: Prepare draft financial statements incorporating agreed-upon audit adjustments.
• Review Audit Reports: Carefully review the drafts of the auditor's report (including the opinion) and the management letter (which details internal control observations).
• Formal Response to Management Letter: Prepare a formal, written response to the management letter, outlining corrective actions planned or taken.
• Final Sign-off: The Board of Directors or Audit Committee reviews and approves the final audited financial statements before they are issued.

5. Frequently Asked Questions (FAQ)

Q1: What is the most common reason for audit delays? A1: The most common reason is the untimely or incomplete provision of information requested by the auditors, such as missing bank confirmations, unsigned contracts, or unresolved account reconciliations.

Q2: Are we obligated to provide all information the auditor asks for? A2: Yes, within the scope of the audit engagement and relevant auditing standards. Failure to provide necessary information is a scope limitation and may result in a qualified opinion or disclaimer of opinion on the financial statements.

Q3: What should we do if we disagree with an audit finding or proposed adjustment? A3: Engage in a professional, evidence-based discussion with the audit partner. Provide additional documentation or alternative interpretations of accounting standards. If unresolved, the matter may need to be escalated to the Audit Committee.

Q4: What is the "Management Representation Letter," and is it mandatory? A4: It is a mandatory written statement from management provided to the auditors at the conclusion of the audit. It confirms management's responsibilities and the validity of significant oral and written representations made during the audit.

Q5: How should we handle suspected fraud or illegal acts identified during the audit? A5: You have a legal obligation to investigate. The audit committee should be informed immediately. The auditors also have obligations to communicate such findings to those charged with governance and, in some cases, to regulatory authorities.

Q6: What are the consequences of providing false information to auditors? A6: This constitutes a severe violation and may lead to legal liability under the Securities Law and Criminal Law, including fines for the company and potential imprisonment for responsible individuals. The auditor will withdraw from the engagement.

6. Risks & Compliance

• Disclaimer: This article provides general guidance and does not constitute legal or professional advice. Entities must consult with their professional auditors and legal counsel for situation-specific advice.
• Key Risks:
  • Audit Risk: Delays or poor-quality responses increase the risk of a modified audit opinion, which can damage reputation and creditworthiness.
  • Regulatory Risk: Inadequate cooperation or misleading information can trigger investigations and penalties from the CSRC, MOF, or other regulators.
  • Legal Risk: Directors and officers may bear personal liability for misrepresentations in financial statements.
• Compliance Focus:
  • Always act in good faith and with transparency.
  • Ensure all communications are documented.
  • Uphold the principles of the Chinese Code of Corporate Governance (for listed companies).

7. References & Sources

• Ministry of Finance of the People's Republic of China (MOF): The authority for accounting and auditing standards. http://www.mof.gov.cn/
• Chinese Institute of Certified Public Accountants (CICPA): Issues Chinese Auditing Standards and regulates the profession. http://www.cicpa.org.cn/
• China Securities Regulatory Commission (CSRC): Regulations for information disclosure of listed companies. http://www.csrc.gov.cn/
• Company Law of the People's Republic of China: Stipulates the requirement for financial reporting and audit.
• Accounting Law of the People's Republic of China: Establishes the fundamental legal framework for accounting practices.

8. Related Topics

• Annual Financial Report Preparation (China)
• Internal Controls over Financial Reporting (ICFR) in China
• Corporate Governance for Listed Companies in China
• CSRC Information Disclosure Guidelines
• Chinese Accounting Standards for Business Enterprises (CAS)