Annual Financial Report - 47 of 60

The risk	Our response
Deferred tax assets Refer to the summary of critical accounting policies on pages 72 to 76, the Group Audit Committee Report on pages 348 to 352 and the disclosures of deferred taxation in Note 9 on the Financial Statements.
The recognition of deferred tax assets relies on significant application of judgement by the directors in respect of assessing the probability and sufficiency of future taxable profits, future reversals of existing taxable temporary differences and ongoing tax planning strategies. Due to the size of the Group's deferred tax assets and the associated uncertainty surrounding recoverability, this is considered a key audit risk. The deferred tax assets giving rise to the greatest risks are those in the US, Brazil, UK and Mexico. In 2013 we have considered each of these significant assets and our focus has included changes in tax legislation and practice in Mexico and, within the UK tax group, the ability of the parent company to generate sufficient future income to offset current year tax losses.	Our audit procedures included the assessment of controls over the recognition and measurement of deferred tax assets and the assessment of assumptions used in projecting the Group's future taxable profits in relevant jurisdictions. Assumptions tested included the Group's commitment to continue to invest sufficient capital in the US and evaluation of the expected impact of tax planning strategies that support the recoverability of deferred tax assets. We compared key inputs used by the Group to forecast future profits to externally available data, e.g. economic forecasts, and the Group's own historical data. We used our own tax specialists to assess critically future tax planning strategies. Where tax treatment may be uncertain, we have assessed the appropriateness of the Group's approach, which is often supported by external legal or tax advice, using our tax specialists and considered possible alternative scenarios. Additionally, we assessed whether the Group's disclosures of the application of judgement in estimating recognised and unrecognised deferred tax asset balances appropriately reflect the Group's deferred tax position. This risk also affected our parent company audit.
Goodwill impairment Refer to the summary of critical accounting policies on pages 72 to 76, the Group Audit Committee Report on pages 348 to 352 and the disclosures of goodwill in Note 22 on the Financial Statements.
Goodwill impairment testing of cash generating units ('CGU's) utilises estimates of value-in-use from estimated future cash flows. Due to the uncertainty of forecasting and discounting future cash flows and the significance of the Group's recognised goodwill, this is deemed a significant risk. Uncertainty is typically highest for those CGUs where headroom between value-in-use and carrying value is limited and where the value-in-use is most sensitive to estimates of future cash flows. In 2013, we continued to focus on businesses which are subject to structural reform or repositioning, particularly GPB businesses in Europe.	Our audit procedures included the assessment of controls over the recognition and measurement of goodwill impairment and assumptions used. Assumptions tested include the cash flow projections based on the plans approved by the Board and the discount rates used to discount them as part of the value-in-use models applied. We assessed the reasonableness of cash flow projections and compared other key inputs to externally available industry, economic and financial data and the Group's own historical data and considered the sensitivity of significant CGUs to changes in value-in-use. With the assistance of our own specialists, we critically assessed the assumptions and methodologies used to forecast value-in-use for those CGUs where significant goodwill was found to be sensitive to changes in those assumptions. Additionally we considered whether the Group's disclosures of the application of judgement in estimating CGU cash flows and the sensitivity of the results of those estimates in Note 22 on the financial statements adequately reflect the risks associated with goodwill impairment. On an overall basis, we also compared aggregate values in use determined by the Group to external market valuations.

 

The risk	Our response
Interests in associates Refer to the summary of critical accounting policies on pages 72 to 76, the Group Audit Committee Report on pages 348 to 352 and the disclosures of interests in associates in Note 21 on the Financial Statements.
The majority of HSBC's interests in associates relate to its 19.03% interest in Bank of Communications Co., Limited ('BoCom'), which is listed on the Hong Kong and Shanghai stock exchanges. Under the equity method of accounting for associates, these interests are initially stated at cost, and are adjusted thereafter for the post-acquisition change in HSBC's share of the net assets of the associate less any impairment provisions. In 2013, we focused on the possible impairment of BoCom indicated by the fact that its market value has been below its carrying amount for sustained periods of time in 2013, and the subsequent estimate of its recoverable amount based on its value-in-use (which was sensitive to the projected future cash flows and discount rates).	Our audit procedures included an assessment of the methodology to calculate the value-in-use and the assumptions used in this calculation. We assessed the reasonableness of cash flow projections in the short to medium term and considered the appropriateness of long-term growth rates used to extrapolate these cash flows. We compared key inputs in the value-in-use model such as revenue growth rates, cost-to-income ratio and discount rate to externally available industry, economic and financial data, to consensus market forecasts and to BoCom's recent experience. We met with management of BoCom to understand their views on business performance and trends as part of our assessment of HSBC's future cash flow projections. We also compared the results of the value-in-use calculations to market available price/earnings multiples for BoCom and other listed banks in mainland China and assessed the Group's analysis of the difference between the market value and the value-in-use of its interest in BoCom. This assessment included consideration of the valuation methodologies and assumptions used by other market participants. Additionally, we considered whether the Group's disclosures of the application of judgement in estimating the recoverable amount and the sensitivity of the results of those estimates in Note 21 on the financial statements adequately reflect the risks associated with impairment of interests in associates.

 

Our application of materiality and an overview of the scope of our audit

The materiality for the Group financial statements as a whole was set at US$1,195m. This has been determined with reference to a benchmark of Group profit before taxation, adjusted to exclude fair value movements on long-term debt attributable to credit spread ('own credit spread') which we believe to be one of the principal considerations for members of the company in assessing financial performance. Materiality represents 5.3% of Group profit before tax and 5.0% after adjustment to exclude own credit spread.

We agreed with the Group Audit Committee to report to it all corrected and uncorrected misstatements we identified through our audit with a value in excess of US$60m, in addition to other audit misstatements below that threshold that we believe warranted reporting on qualitative grounds.

Audits for Group reporting purposes were performed by local audit teams at the key management reporting units and entities (together 'components') in all five regions:

·     Europe (7 components)

·     Asia Pacific (8 components)

·     North America (4 components)

·     Middle East and North Africa (1 component)

·     Latin America (3 components)

These audits covered 86% of total Group operating income; 84% of total profits and losses that made up Group profit before tax; and 90% of total Group assets. The segment disclosures in Note 12 set out the individual significance of each region.

The audits undertaken for Group reporting purposes at the key reporting components were generally performed in accordance with the materiality levels used for local audits, which were set individually. Materiality used at the components ranged from US$35m to US$1,173m.

Detailed audit instructions were sent to the auditors of all the key reporting components. These instructions covered the significant audit areas that should be covered by these audits (which included the relevant risks of material misstatement detailed above) and set out the information required to be reported back to the Group audit team. The Group audit team visited locations in all of the regions listed above and teams from components in each region attended a Group audit planning meeting.

The Group audit team also held regular telephone meetings with the regional and local auditors at all the regional locations and the majority of those other locations that were not physically visited. In addition, regional audit teams visited locations of key components within their regions.

 

Our separate opinion in relation to IFRSs as issued by the International Accounting Standards Board (IASB) is unmodified

As explained in Note 1(a) on the Group financial statements, in addition to complying with its legal obligation to apply IFRSs as adopted by the EU, the Group has also applied IFRSs as issued by the IASB.

In our opinion, the Group financial statements comply with IFRSs as issued by the IASB.

Our opinion on other matters prescribed by the Companies Act 2006 is unmodified

In our opinion:

§ the part of the Directors' Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and

§ the information given in the Strategic Report and Directors' Report for the financial year for which the financial statements are prepared is consistent with the financial statements.

We have nothing to report in respect of matters on which we are required to report by exception

Under ISAs (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading.

In particular, we are required to report to you if:

§ we have identified material inconsistencies between the knowledge we acquired during our audit and the directors' statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group's performance, business model and strategy; or

§ the Corporate Governance section of the Annual Report and Accounts describing the work of the Group Audit Committee does not appropriately address matters communicated by us to the Group Audit Committee.

Under the Companies Act 2006 we are required to report to you if, in our opinion:

§ adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or

§ the parent company financial statements and the part of the Directors' Remuneration Report to be audited are not in agreement with the accounting records and returns; or

§ certain disclosures of directors' remuneration specified by law are not made; or

§ we have not received all the information and explanations we require for our audit.

Under the Listing Rules we are required to review:

§ the directors' statement, set out on page 367, in relation to going concern; and

§ the part of the Corporate Governance Statement relating to the company's compliance with the nine provisions of the UK Corporate Governance Code (2010) specified for our review.

We have nothing to report in respect of the above responsibilities.

Scope of report and responsibilities

As explained more fully in the Directors' Responsibilities Statement set out on pages 408 and 409, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view.

A description of the scope of an audit of financial statements is provided on the Financial Reporting Council's website at www.frc.org.uk/auditscopeukprivate.

This report is made solely to the company's members, as a body and subject to important explanations and disclaimers regarding our responsibilities, published on our website at http://www.kpmg.com/uk/auditscopeukco2013b, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions.

 

Guy Bainbridge (Senior Statutory Auditor)

for and on behalf of KPMG Audit Plc, Statutory Auditor

Chartered Accountants

15 Canada Square

London

E14 5GL

24 February 2014