Accounting Reform in China

1. Accounting Reform in China Howard Davies

2. Objectives • To explain why China’s accounting practices have been in need of reform • to identify the main components of China’s developing accounting and regulatory framework • to examine some of the differences which remain between Western and Chinese accounting practices

3. THE SYSTEM BEFORE REFORM • Under central planning the function of accounting was to ensure that the State Plan was met • Accounting standards did not exist • Three kinds of system existed simultaneously: • Systems developed by the Ministry of Finance alone • e.g. the Industrial Accounting System used in manufacturing • Systems developed by the MoF with other Ministries • e.g. The MoF and the Ministry of Commerce developed a system for enterprises in commerce • Systems devised at provincial level by the supervising authorities of an industry, supervised by the MoF

4. REFORM HAS BROUGHT SIGNIFICANT CHANGES • Many enterprises “outside the plan” • Wider variety of enterprise forms • Different forms using different accounting techniques • New enterprises cut across industrial and geographic boundaries • Which system to use? • How to measure performance? • How to compare performance? • How to identify bankrupt enterprises? • How to value a firm for listing or foreign investors? • What kind of macro-economic action needed?

5. FOREIGN INVESTORS AND TRADING PARTNERS NEED MORE INFORMATION • To evaluate the position of their own enterprises • To understand the position of Chinese enterprises • for purchase • for credit-worthiness • for developing longer-term relationships

6. A NEW REGULATORY FRAMEWORK TO BE PRODUCED • To improve the quality of information • To standardise practice • To harmonise with international practice

7. BASIC ELEMENTS OF THE SYSTEM • Standards are set by the central government, not by the profession • The Accounting Society of China plays a consultative role • In November 1992 the new fundamental accounting standard was introduced, effective from July 1 1993 • The Enterprise Accounting System (EAS) • The fundamental standard, applicable to all enterprises in the PRC • EAS sets the basic definitions and principles of accounting in the PRC

8. Four Basic Assumptions • Accounting entity • Going concern • Accounting period • Unit of Measurement

9. Assets Liabilities Owners’ equity Revenues Expenses Profits Six Elements

10. Qualitative Characteristics Objectivity Relevance Comparability Consistency Timeliness Understandability Accounting Principles Matching principle Accrual principle Prudence Historical cost Capital/Revenue expenditure distinction Materiality Twelve General Principles

11. GENERAL FINANCIAL PRINCIPLES FOR ENTERPRISES (GFPE) • The financial practices of firms with different ownership forms to be standardized • State enterprises separated from the state so that funds treated as loans or contributions to capital. Income taxation separated from profit distribution • Income tax no longer seen as return on the State’s investment • NEED FOR MORE DETAIL MET BY INDUSTRY-BASED SYSTEMS BASED ON THE EAS AND GFPE

12. Unification of the regulatory authorities for accounting Centralised setting of Principles and Assumptions A New Accounting Equation Assets = Liabilites and Owner’s Equity Abolition of Fund Accounting Adoption of international format balance sheet, income statement, cash flow statement, consolidated statement Owner’s capital to be maintained Less arbitrary allocation of overheads LIFO Inventory Evaluation allowed Bad Debts may be anticipated - prudence More flexible rules on depreciation Double-entry book-keeping Features of the New System

13. A Quantum Leap for China, BUT • A major shortage of accountants • Costly to convert past information • 6,000 hours for Shanghai Vacuum • Still major differences from international practice • depreciation, bad debt provision and exchange rates used set by State and not realistic • welfare provisions taken from profit, not treated as expenses • loss of value for inventory not appropriately measured • should be lowest of market value or cost, but cost is used

14. Much Depends on Auditing, BUT • No audit for most collective and private firms • Only 25% of SOEs audited anually • (Joint stock and FIEs are annually audited) • 10 Auditing standards issued but practice varies widely • very short • no 3rd party verification • auditors not present for inventory count • MoF has conflict of interest - auditors are engaged by MoF, report to it but get information from it

15. OVERALL? • Significant progress but a long way to go • Plan for 100,000 accountants by 2000 • International firms allowed to provide services, in collaboration with locals

16. WHAT ARE THE BARRIERS TO ACCOUNTING REFORM? • Ideology no longer a barrier • Resources are a problem • ARE CULTURAL BARRIERS A PROBLEM? • Chow, Chau and Gray (1995) • Combining Hofstede’s Societal Values and Gray’s Accounting Values

17. Societal Values and Accounting Values • Hofstede’s Societal Values • Power Distance • Uncertainty Avoidance • Collectivism • Masculinity • Long-term orientation • Gray’s Accounting Values • Statutory control • Uniformity • Conservatism • Secrecy

18. What Predictions?

19. What Predictions?

20. The Conclusion?(Chow, Chou and Gray) • China is setting up an accounting system based on US/UK practice • self-regulation • individual judgments • accounting standards not regulations • transparency and open-ness • But the cultural environment encourages • statutory control • uniformity • conservatism • secrecy