Accounting Policy Changes and Retrospective Adjustments in IPO Financials

The SFC and HKEX published a joint statement in December 2024 (SFC/HKEX Joint Statement, 13 December 2024) specifically flagging retrospective accounting policy changes as a recurring deficiency in IPO prospectuses filed between 2022 and 2024. The statement noted that 23% of the 186 prospectuses reviewed during that period contained material retrospective adjustments that were either inadequately disclosed or lacked a clear basis under Hong Kong Financial Reporting Standards (HKFRS). For CFOs and company secretaries preparing a listing application on the Main Board or GEM, this statistic carries immediate operational weight: the HKEX Listing Division now routinely issues additional queries under Listing Rules 9.10(1) and 9.11(23a) when retrospective adjustments exceed 5% of any line item in the audited track record period. The window for correcting such disclosures closes before the A1 filing, not after. A retrospective adjustment that is poorly documented — or worse, applied inconsistently — can trigger a re-filing of the entire track record period under HKFRS, adding 4 to 8 weeks to the listing timetable and incurring incremental sponsor, auditor, and legal fees in the range of HKD 1.5 million to HKD 3.0 million per restatement, based on data from the HKEX’s own Listing Committee review papers (HKEX Listing Decision LD127-2024). This article examines the regulatory framework governing retrospective adjustments in IPO financials, the specific scenarios that trigger HKEX scrutiny, and the practical steps listing applicants must take to avoid timetable disruption.

The Regulatory Framework Under HKFRS and the Listing Rules

HKFRS, which is substantively converged with IFRS as adopted by the International Accounting Standards Board, provides the mandatory accounting framework for all Hong Kong-incorporated issuers and foreign issuers that elect to prepare financial statements under HKFRS for listing purposes. Listing Rule 4.04 requires that the accountants’ report in a prospectus comply with HKFRS as issued by the Hong Kong Institute of Certified Public Accountants (HKICPA). Retrospective adjustments are governed primarily by HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, which distinguishes between a change in accounting policy (retrospective application) and a correction of a prior period error (retrospective restatement). The distinction is not merely academic: a change in policy requires justification that the new policy provides more reliable and relevant information, while a correction of an error requires disclosure that the previously issued financial statements contained a material misstatement.

HKAS 8 and the Hierarchy of Accounting Policies

HKAS 8 paragraph 14 establishes a hierarchy for selecting and applying accounting policies: first, any specific HKFRS standard or interpretation that directly addresses the transaction; second, in the absence of a specific standard, management must use its judgement in developing and applying a policy that results in information that is relevant and reliable. In an IPO context, the sponsor’s financial due diligence team must document this hierarchy for every material accounting policy applied during the track record period. The HKEX’s Listing Decision LD127-2024 specifically cited two cases where applicants attempted to retrospectively change their revenue recognition policy from a point-in-time model to an over-time model under HKFRS 15 without demonstrating that the new policy was required by the standard or that the old policy was an error. In both cases, the Exchange required the applicants to revert to the original policy and disclose the attempted change as a sensitivity analysis in the prospectus risk factors section, not as a retrospective adjustment in the financial statements.

The SFC’s Focus on Consistency and Comparability

The SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Chapter 571 of the Laws of Hong Kong) requires sponsors to exercise due diligence in verifying that financial information in the prospectus is not misleading. Paragraph 17.6 of the Code, as amended in 2022, explicitly requires sponsors to assess whether retrospective adjustments impair the comparability of financial information across the track record period. The SFC’s enforcement division has taken disciplinary action against two sponsors in 2023 and 2024 for failing to identify that retrospective adjustments to depreciation methods — from straight-line to reducing balance — had been applied inconsistently across different asset classes within the same group. The resulting fines totalled HKD 18 million, and both sponsors were required to undertake independent reviews of their financial due diligence procedures.

Scenarios That Trigger Retrospective Adjustments in IPO Financials

Retrospective adjustments in IPO financials arise from three principal sources: changes in accounting policies mandated by new or amended HKFRS standards, voluntary changes in accounting policies that management believes will improve the relevance and reliability of financial information, and corrections of material prior-period errors identified during the IPO due diligence process. Each category carries distinct disclosure requirements and different levels of regulatory scrutiny.

Mandatory Changes from New HKFRS Standards

When the HKICPA issues a new or amended HKFRS standard that takes effect during or after the track record period, the issuer must apply the standard retrospectively unless the standard itself provides specific transitional provisions. HKFRS 17 Insurance Contracts, effective for annual periods beginning on or after 1 January 2023, is the most significant recent example. Issuers in the insurance sector that filed IPO applications in 2024 were required to restate their 2021 and 2022 comparatives under HKFRS 17, even if those periods were originally prepared under HKFRS 4. The HKEX’s guidance note GL112-24 (February 2024) clarified that the Exchange expects the accountants’ report to include a reconciliation from the previously reported figures under HKFRS 4 to the restated figures under HKFRS 17, with a separate note explaining the transition adjustments. Failure to provide this reconciliation in the draft prospectus resulted in the Exchange issuing a “deficiency letter” under Listing Rule 9.10(1) for three of the five insurance IPO applications filed in the first half of 2024, adding an average of 5.2 weeks to the vetting process.

Voluntary Changes and the “More Reliable and Relevant” Threshold

Voluntary changes in accounting policy are the most common source of retrospective adjustments in IPO financials, and also the most scrutinised by the Listing Division. HKAS 8 paragraph 14(b) requires that a voluntary change must result in the financial statements providing more reliable and more relevant information about the effects of transactions. In practice, the Exchange interprets this threshold strictly. The Listing Committee’s review of IPO applications filed in 2023 found that 14 of the 22 cases where voluntary retrospective adjustments were made involved a change in the method of measuring inventory cost — from weighted average to FIFO — or a change in the depreciation method for property, plant, and equipment. In 10 of those 14 cases, the Exchange required the applicant to provide additional evidence that the new policy was not merely more convenient or more tax-efficient, but genuinely more representative of the underlying economic substance. The evidence required included board minutes documenting the rationale, a comparison of the financial impact under both policies for the entire track record period, and an independent audit opinion on the appropriateness of the change.

Correction of Material Prior-Period Errors

The IPO due diligence process often uncovers errors in financial statements that were previously audited for statutory purposes. HKAS 8 paragraph 42 requires that material prior-period errors be corrected retrospectively by restating the comparative amounts for the prior period(s) presented. The key distinction from a change in accounting policy is that an error correction must be disclosed as such, with a clear explanation of why the previously issued financial statements were incorrect. The SFC’s Guidance Note on Financial Due Diligence for IPO Sponsors (June 2023) emphasises that sponsors must not characterise a material error correction as a “change in accounting estimate” to avoid the stigma of a restatement. In one enforcement case from 2023, the SFC found that a sponsor had allowed an issuer to classify a HKD 42 million revenue recognition error as a change in estimate, thereby avoiding a retrospective restatement. The sponsor was fined HKD 8 million and the issuer’s listing application was withdrawn.

Practical Steps for CFOs and Company Secretaries

The preparation of IPO financials that withstand HKEX scrutiny requires a structured approach to identifying, documenting, and disclosing retrospective adjustments. The following steps are derived from the Exchange’s published guidance and from observations of successful A1 filings in 2024.

Pre-Filing Audit and Documentation

Before the A1 filing, the reporting accountant must complete a detailed audit of the track record period, typically three financial years for a Main Board applicant under Listing Rule 4.04(1) and two financial years for a GEM applicant under GEM Rule 7.03(1). During this audit, the sponsor and auditor should jointly prepare a “retrospective adjustment memorandum” that identifies every material adjustment made to the statutory financial statements. The memorandum should cite the specific HKFRS standard and paragraph that requires or permits the adjustment, quantify the impact on each line item in the statement of profit or loss and other comprehensive income and the statement of financial position, and explain the treatment of comparatives. This memorandum becomes a key document in the sponsor’s due diligence file and is routinely requested by the HKEX under Listing Rule 9.11(23a) during the vetting process.

Disclosure in the Accountants’ Report and Prospectus

The accountants’ report must include a note that clearly describes the nature of each retrospective adjustment, the reason for the adjustment, and the amount of the adjustment for each period presented. HKAS 8 paragraph 29 requires that when a voluntary change in accounting policy has a material effect on the current period or any prior period presented, the entity shall disclose the amount of the adjustment for each financial statement line item affected. The prospectus should also include a separate risk factor, typically under “Risks Relating to the Financial Position of the Group,” that explains the impact of the retrospective adjustment on the comparability of financial information. The HKEX’s Guide for Listing Applicants (October 2024) recommends that the risk factor quantify the percentage change in net profit or net assets attributable to the adjustment for each year in the track record period.

Managing the Exchange’s Vetting Queries

When the Exchange issues a query under Listing Rule 9.10(1) regarding a retrospective adjustment, the response must be submitted within the timeframe specified in the query letter, typically 15 business days for an initial query. The response should include a detailed technical memorandum from the reporting accountant, a confirmation from the sponsor that the adjustment complies with HKFRS, and, where applicable, a comparison of the financial results under the old and new policies for the entire track record period. The Listing Division’s practice note PN-2024-03 (March 2024) indicates that the Exchange will not accept a response that merely repeats the disclosure in the prospectus. The response must demonstrate that the adjustment was not made to improve the financial ratios or to meet a specific listing eligibility requirement under Listing Rules Chapter 8.

Conclusion: Three Actionable Takeaways for the Listing Applicant

First, the sponsor and reporting accountant must prepare a retrospective adjustment memorandum during the audit of the track record period, not after the A1 filing, to avoid the Exchange issuing a deficiency letter that adds 4 to 8 weeks to the vetting timetable. Second, any voluntary change in accounting policy must be supported by a documented board resolution and an independent audit opinion that the new policy provides more reliable and more relevant information, as required by HKAS 8 paragraph 14(b), and the sponsor must be prepared to defend this rationale against the Exchange’s standard queries under Listing Rule 9.10(1). Third, the prospectus must include a quantified risk factor explaining the percentage impact of each material retrospective adjustment on net profit and net assets for each year in the track record period, and the accountants’ report must contain a reconciliation note that meets the disclosure requirements of HKAS 8 paragraphs 28 and 29.