China is a country known to everybody breathing on this Mother Earth. Apart from other companies and multinationals, which spend millions and billions of dollars on their branding, China has developed its name as a brand itself. This year has marked up a large step forward for the continuous integration of world capital and trade markets, with China in the process of adopting a considerable number of the accounting standards laid out by the International Accounting Standards Board (IASB). The local Chinese GAAP (generally accepted accounting principles), known as the Chinese Accounting Standards (CAS) was largely replaced by the International Financial Reporting Standards (IFRS), to bring China more in line with the rest of the world.
The new procedures which have become law in the beginning of 2007, on January 1, have remained the fruit of a lot of protracted debate and discussion, involving the Chinese Ministry of Finance, different members of the International Accounting Standards Board and representatives of some Chinese audit and consultancy firms. Deloitte Touché Tohmatsu, the renowned firm for professional accounting services, has been serving the provision of consultancy services to the Chinese Ministry of Finance since 1993, advising on how best implement a new methodology of accounting, and how it would best suit the Chinese accounting system.
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These consultations finally bore fruit on February 15th of 2006, when the Chinese Finance Ministry announced that they were to usher in a new era of Chinese accounting by introducing Accounting Standards for Business Enterprises, or ASBEs.
The ASBEs cover almost all of the major topics one can find in the International Financial Reporting Standards literature, albeit with some notable exceptions, and have been applicable to all listed Chinese companies since the beginning of the year. In the future, it is expected and highly assured that other firms are likely to be mandated to conform to the reformed standards in the Chinese MoF's plans. Unlisted companies are being advised strongly to adopt to the new measures, or at least carry out preparations in some part to make their finances appear more transparent to international investment.
Ever since 1949 with the establishment of People's Republic of China until the opening-up and economic reform introduced in 1978, China was substantially ruled by Mao Tse-Tung's regime. The Soviet accounting model provided important guidelines for the Maoist regime (Hilmy 1999).
As a typical phenomenon at the time, the battleground of accounting research was not vested in academic or practical considerations, but in politics. The political reality was Mao's philosophy that strong central leadership and nationally upheld principles are prerequisite for building a powerful socialist country (Mao 1993). Under the premises, the dominant political ideology under Maoism was characterized by class struggle primacy, public ownership and central planning.
The class struggle primacy which has orientated by the Marxist notion of struggle of class had generated distinct debates on accounting between China and the West. While the early 20th century Anglo-American accounting theorists proposed great interests towards the relationships between accounting and economics (e.g. see Hatfield 1922; Paton 1927; Gilman1929; Carton 1939), early Chinese accounting practitioners had been debating whether 'foreign' accounting methods should be adopted based on the consideration that whether accounting is based upon class or culture. In 1951, a famous academic scholar Huang, Shou-ding (1951) published an article named "How to develop an accounting theoretical basis for the new China". In the first issue of the journal "New Accounting", Huang claims that "â€¦different socio-economic systems brought different accounting modesâ€¦Capitalism has its accounting theory suitable to its own capitalist system â€¦the new PRC adopts a socio-economic system distinct to the Capitalism which requires a different accounting theoretical basis â€¦". Under the political climate at the time, this claim was re-interpreted into debates such as "different classes should have different accounting systems", "accounting belongs to class" and "accounting is class-based". Some academics argued that accounting theory in capitalism and practice suit and protect the capitalist economic system. Some academics argue that accounting functions as a means of accelerating class exploitation (Xin and Huang 1951).
Practitioners had a belief that socialist accounting should have been based upon Marxist political economy and began to ask questions. Among those questions were: "Whose interest does accounting cycle serve? Who actually controls accounting?" (Ezzamel et al. 2007, p. 677) The justified and legitimized view was that the main purpose of accounting information is to meet the needs of proletariats rather than those stake holders such as managers or investors (Grady 1965; Paton and Littleton 1970).
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The principle of conservatism has been brought into the debates through a further political lens (Brunswik, 1952). Capitalists' interests were believed to be protected because "if high profits are desired to be generated, assets have to be valued high whereas if a reduced profit is desired, assets are valued low" (Xin and Huang 1951, pp. 13-14). Conservatism was also claimed to have masked the exploitation of surplus values and to speed up capital accumulation (Yan 1951). Similar viewpoints overwhelm many other counter viewpoints because of the dominance of the political atmosphere. (Lloyd)
The IFRS and its Features
International Financial Reporting Standards (IFRS) are Standards, Interpretations and the Framework adopted by the International Accounting Standards Board (IASB) (Pixley).
Many of the standards integral part of IFRSs are known by their older name of International Accounting Standards (IAS). IASs were issued in the years between 1973 and 2001 by the globally recognized Board of the International Accounting Standards Committee (IASC). On 1st April 2001, the new IASB took over the responsibility from the IASC for setting International Accounting Standards. During its very first meeting the new Board adopted all the existing IAS and SICs. The IASB has, however, continued to develop standards calling the new standards IFRS. IFRSs are considered all around the world as a "principles based" set of standards in which they establish broad rules as well as dictating specific and precise treatments. International Financial Reporting Standards comprise of:
International Financial Reporting Standards (IFRS) - standards which have been issued after 2001
International Accounting Standards (IAS) - standards which were issued before 2001
Interpretations originated from the International Financial Reporting Interpretations Committee (IFRIC) - standards issued after 2001
Standing Interpretations Committee (SIC) -interpretations issued before 2001
A Framework for the Preparation and Presentation of Financial Statements came into existance which describes the principles underlying IFRS (Panosa 2004).
In making the judgment described above, the IFRC refers to, and considers the applicability of the following sources in a top-down order:
(a) The requirements and guidance in Standards and Interpretations which deal with similar and related issues; and
(b) The standard definitions, recognition criterion and measurement concepts for assets, liabilities, income and expenses in the IFRC Framework.
The Need for and Benefits of New Accounting Standards
To say it simply, changes needed to be made. For China there is a need to maintain its development as a big player in the foreign investment market. Similarly it needs to continually update its business and accounting practices, which have often been considered out of synchronization with the rest of the world. Accounting practices have remained as an area which had been criticized widely, with standards falling somewhat short of those set out by the IASB, giving foreign investors an investment headache when looking to perform due diligence work and other important procedures on domestic Chinese firms.( IASB: "IASB Work")
Furthermore, now that China has already made considerable approach towards being a fully-fledged market economy, some methodologies in accounting that had been applicable to the previous system of a centrally planned economy, had gone obsolete. An accounting method designed to measure how well production targets are met in a planned economy would surely be largely at odds with what was required in a free market. (Lloyd)
Modern accounting intensely needs to be able to analyze the financial health of a company in such a way so that it correctly allocates funds and other resources to its various departments. The Chinese system on the other hand, used to be, initially, simply a statement of compilation of the assets owned by a particular company, with no measurement of liquidity, performance or profit and loss. Moreover, there was no written record of the debts of a company, giving managers an extremely difficult task of running a firm profitably, as they were unable to determine from where the firm was losing money (Panosa 2004),
Financiers and investors all around the world have so long called for harmonization of accounting standards around the world so that companies can be compared on a common level playing field. Whilst this was unlikely to be achieved entirely in the short-term, the accountancy reforms have marked a noteworthy step towards unity in practice, and will assist investors in being more confident about their decisions. In turn this is likely to "enable a broader base of investors to consider investment in more Chinese companies," says Yvonne Kam of PricewaterhouseCoopers, further cementing China's reputation as an attractive place to do business (Pixley).
The New Standards and Potential Pros & Cons
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Instead of phasing in gradually over time as it has been the case with many other countries' adoptions of standardized procedures, China has chosen to adopt the main standards essentially in one go. Quite how this will pan out is difficult to tell and may be a question which only time can answer to. However, this initial shift in accounting standards is unlikely to be the end of the Chinese accounting reforms and so changes are expected to be ongoing on a continual basis. Sir David Tweedie, Chairman of the IASB, writing in a Deloitte Report of 2006, remarks that "convergence is a process" and that the goal of fully uniform accounting standards between other countries and especially the Chinese firms and those applying IFRS is attainable "in light of the progress that has been made," though no mention is made of any additional convergence procedures (Lloyd).
To be taken as a whole the majority of the changes are in line with IFRS but the differences that do exist are representatives of China's unique position in the global economy. This unique standing is characterized by a prohibition of reversing an asset impairment decision; financial statements which incorporate certain government grants; and related party disclosures between particular state-owned enterprises. Prior to these reforms Chinese Accounting Procedures had a single basic standard and sixteen precise standards, most of which were implemented fairly recently, between 1996 and 2001. This needs to be increased considerably to conform to IFRS standards. Indeed, twenty two additional specific standards have been added to the Chinese Accounting Standards, more than double the original number, with the initial sixteen also experiencing some modifications (IASB: "IASB Work").
Some potential impacts of the new revolution in the convergence process are as follows:
â€¢Â Â Â Firms which are undergoing transition to the new system are finding it difficult to present a true picture of the impact of the change, at least in the short term. This has arisen the opportunities to provide misleading information to stakeholders in the form of incorrect financial reporting, damaging share values. It is imperative for persistent market confidence that firms should be able to communicate their true performance to shareholders.
â€¢Â Â Â A new accounting system would also lead to a new taxation system, which will then need to be regulated and established by the appropriate local tax authorities. This could mean assessing a firm's tax liability may be subject to whatever tax amendments, if any, are brought in.
â€¢Â More consistent and regulated financial reporting could lead to higher volatility in results for firms, a situation which would need to be explained to any parties with a stake in the firm. This could also be coupled with several difficulties in acquiring finance with loan agreements becoming tighter (Pixley).
Some remaining differences with IFRS:
â€¢Â Â Â Certain specific standards in the CAS do allow only a cost model to compute the value of fixed and intangible assets. On the other hand the IFRS allowing a revaluation model.
â€¢Â Â Â IFRS provides an option to class as expenses all borrowing costs while ASBE maintains, under certain circumstances, that borrowing costs should be capitalized.
â€¢Â Â Â Biological assets must be measured using a cost model under ASBE, rather than with a fair value model in the IFRS, unless evidence exists to warrant the use of fair value.
â€¢Â Â Â The new ASBE prohibits reversing impairment losses but IFRS allows it under some circumstances, preventing only goodwill impairment.
â€¢Â Â Â When presenting a financial report, ASBE still restricts some aspects of the statement that would be allowed under IFRS. Expenses, for instance, are analyzed in different ways depending on the particular aspect of the statement. They are analyzed by function for income statement, and the direct method for cash flow statements (Lloyd).
But it must also be noted that various gaps still exist. A substantial problem remains in form of the sheer volume of financial information that is in requirement by firms in order to comply with the new regulations. Embedding an almost totally new accounting system into an economy can prove to be a very complicated task. Addison Everett of PwC has claimed that, from his long experience, integration of new standards into old ones can prove to be highly difficult: "clients who adopted IFRS for the first timeâ€¦did not fully contemplate the amount of financial information, most of which had not been collected in the past that is needed." This increase in information requirements needs to be converged with increases in training and knowledge of the new systems by those drawing up financial statements. Development of such expertise is neither an easy nor a particularly rapid procedure. It will require huge up shifts not just from the accountant's side, but everyone in the financial market from investors to bankers, and also a firms' non-financial workers such as human resources and management.( IASB: "IASB Work").
These discourses have remained in discussion in forms of regulations speeches, and articles by prominent regulators, politicians, academics and practitioners who disseminate political ideology into the domain of accounting. The distinct appraisals of accounting from different ideological lens, (e.g. the nature of capital exploitation under Mao and a technology under Deng), truly reflects how easily accounting could be de-legitimized and molded. This notion that accounting is neutral is highly contestable when connected to the context of constitution. There is no doubt that those factors which have been presumed to constitute accounting could reflect accurate and precise images of a concrete reality; instead of producing truth effects in a politically driven way. (Ezzamel et al 2007, p. 697) demonstrates that "ideological transition opens up a space that facilitates greater debates of regimes of truth."(Panosa 2004)
The importance and acceptance of IFRS has increased significantly over the past few years. Convergence with this international benchmark is now deemed as a high priority. However, given the specific circumstances and history of individual countries like China, various differences currently exist between Chinese national standards and IFRS. For instance, Chinese firm's recently-published comparison of IAS and US GAAP identified over 80 differences. The MOF clearly supports and synchronizes with international accounting harmonization and has been working to achieve convergence of CAS with IFRS by giving due consideration to IFRS in the process of drafting each CAS. The MOF closely follows IFRS, in line while having due regard to national laws, and the practical issues associated with effective implementation by Chinese enterprises. While it is actively carrying on convergence with IFRS, the MOF necessarily has had to ensure that accounting standards are being appropriately addressed in the country and the national circumstances that exist during this transitional period in the economy.
Specific circumstances that currently exist include a very significant portion of the economy that is dominated by state owned or public enterprises. Even though the enterprises are restructured into joint stock enterprises and have branched out from the government structure, functional or regional government the remaining stakeholders still do exert significant influences over the enterprises and their trading partners and transactions. Related party transactions are said to be pervasive. Many transfers of assets are driven by the government rather than motivated by pure business objectives.
Free markets have not sufficiently developed in many areas of the world. Financial statements are multi-functional, serving not only the needs of the investors but also other stakeholders such as and including the State for supervisory and management purposes. Enterprises and professional intermediaries, firms and corporations such as auditors and values are at still under development. During this transitional period, accounting standards must be realistically implemented by the preparers and auditors of financial statements. Deloitte Touché Tohmatsu has newly published a comparison of IFRS and PRC GAAP and it is expected that this will serve to promote a more comprehensive understanding of Chinese GAAP by foreign investors of financial information prepared under PRC GAAP. This comparison is available in electronic form at the following website at ww.iasplus.com (by selecting China from the "Countries" link).