Annual Financial Report - 44 of 54

 

The risk	Our response
Deferred tax assets Refer to the critical accounting estimates and judgements and disclosures of deferred taxation in Note 8 on the Financial Statements and the Group Audit Committee Report on pages 277 to 279.
The recognition of deferred tax assets relies on the 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 recognised deferred tax assets (US$7.4bn) and the associated uncertainty surrounding recoverability, this is considered a key audit risk. In 2014, we have continued to focus on the most significant deferred tax assets which arise in the US, Brazil and Mexico. We paid particular attention to the tax planning strategy in the US, which continues to rely on the capital support of the parent company, and to management's forecasts of future profitability in Brazil that support the deferred tax asset.	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. We also challenged the Group's assumptions and commitment to continue to invest sufficient capital in the US by evaluating the expected tax planning strategies that will be employed and the availability of capital that collectively support the realisation of the recognised deferred tax assets. We compared key inputs used by the Group to forecast future profits to externally available data such as economic forecasts and the Group's own historical data and performance and assessed the sensitivity of the outcomes to reasonably possible changes in assumptions. We also used our own tax specialists to critically assess the appropriateness of the future tax planning strategies. 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.
The risk	Our response
Goodwill impairment Refer to the critical accounting estimates and judgements and disclosures of goodwill in Note 21 on the Financial Statements and the Group Audit Committee Report on pages 277 to 279.
Goodwill impairment testing of cash generating units ('CGUs') relies on estimates of value-in-use based on estimated future cash flows. Due to the uncertainty of forecasting and discounting future cash flows and the significance of the Group's recognised goodwill (US$19.2bn), 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 2014, we focused on CGUs that were most sensitive and reliant on future cash flow projections and, as a result of recent historical performance, were expected to have reduced headroom, particularly GPB businesses in Europe.	Our audit procedures included the assessment of controls over the Group's process for the recognition and measurement of goodwill impairment, including the assumptions used. We also tested the key assumptions forming the Group's value-in-use calculation, including the cash flow projections and discount rates. We assessed the reasonableness of cash flow projections and compared key inputs, such as the discount rates and growth rates, to externally available industry, economic and financial data and the Group's own historical data and performance. 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. On an overall basis, we also evaluated the aggregate values-in-use determined by the Group to its external market capitalisation. 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 adequately reflect the risks associated with goodwill impairment.

 

The risk	Our response
Interests in associates Refer to the critical accounting estimates and judgements and disclosures of interests in associates in Note 20 on the Financial Statements and the Group Audit Committee Report on pages 277 to 279.
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. BoCom's market value has been below its carrying amount for a sustained period, and therefore its current carrying amount (US$14.6bn) continues to rely on the Group's significant judgement in determining BoCom's recoverable amount based on its value-in-use. The projected future cash flows and discount rates used by the Group in determining BoCom's value-in-use are subject to estimation uncertainty and sensitivity. Therefore, we consider this a key audit risk.		Our audit procedures included the assessment of the Group's methodology and calculation of BoCom's value-in-use. We evaluated the reasonableness of cash flow projections against BoCom's most recent financial performance and considered the appropriateness of key inputs such as long-term growth rates used to extrapolate these cash flows, the discount rate, the risk-weighted assets to total assets ratio and the loan impairment charge to gross loans ratio and compared these to available industry, economic and financial data, and to consensus market forecasts. We met with BoCom's management to understand current business performance and expectations and whether they were properly reflected in the Group's own assumptions. 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 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$930m, determined with reference to a benchmark of Group profit before tax, normalised 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 5.0% of Group profit before tax and 5.1% after adjustment to exclude own credit spread.

We report to the Group Audit Committee any corrected or uncorrected identified misstatements exceeding US$45m, in addition to other identified misstatements that warranted reporting on qualitative grounds.

Our approach to scoping components was: for some regions, we instructed the regional audit team to conduct and report to us on a full scope regional audit and specified certain components within those regions that should be subject to a full scope audit overseen by the relevant regional audit team; within other regions, we directly instructed component audit teams to conduct and report to us full scope audits. Accordingly, we instructed or specified full scope audits at 23 components across all five regions as follows:

·   Europe (7 components)

·   Asia (8 components)

·   Middle East and North Africa (1 component)

·   North America (4 components)

·   Latin America (3 components)

These audits covered 82% of total Group operating income; 78% of total profits and losses that made up Group profit before tax; and 88% of total Group assets. The segment disclosures in Note 11 set out the individual significance of each region.

We approved materiality for those full scope audits that we directly instructed, ranging from US$50m to US$750m having regard to the mix of size and risk profile of the Group across the components.

The Group audit team visited locations in Europe, Asia, North America and Latin America 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 audit teams and other component auditors. In addition, regional audit teams visited locations of key componentswithin their regions.

Our separate opinion in relation to IFRSs as issued by the International Accounting Standards Board 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 International Standards on Auditing (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 pages 290 and 291, in relation to going concern; and

·   the part of the Corporate Governance Statement relating to the company's compliance with the ten provisions of the 2012 UK Corporate Governance Code 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 page 328, 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 http://www.frc.org.uk/auditscopeukprivate.

This report is made solely to the company's members, as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at http://www.kpmg.com/uk/auditscopeukco2014b, 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                                                                                                                                            23 February 2015