Dawning of a new era

The accounting reform, which was first launched in China in the 1980s in response to Government’s open policy, has gone through several phases. Having far-reaching implications for China’s accounting development, the reform embraces a wide range of areas, including financial reporting, the accounting profession and education. In respect of financial reporting, regulations were revised or newly promulgated and accounting standards were developed.

The adoption of the first accounting standard in 1992 by the Ministry of Finance (MoF) signified a move towards the Anglo-American approach of regulating financial reporting. Starting in the early 2000s, the development of accounting standards in China has accelerated, with a total of 16 accounting standards being adopted by 2005. While an increasing number of state-owned enterprises seek listing in overseas capital markets (including Hong Kong), the harmonisation of China’s accounting practice with international practice has become a priority agenda in regulating financial reporting by the MoF. In 2006, the MoF made a significant move to bringing its accounting and auditing standards into line with international rules by issuing a set of 39 accounting standards, some being revisions of existing standards while others were newly developed, mostly modelled on IFRS. An exposure draft of an Application Guideline for these standards was also developed and issued recently for public consultation. These standards are to be implemented on 1 January 2007 in the sectors of listed companies, and adoption by other sectors is being encouraged. While the existing 16 accounting standards will continue to be applicable to non-listed companies, the MoF plans a phased implementation: non-listed large state-owned enterprises will adopt the new standards in the next phase, followed by a full implementation by all enterprises.

Features of new accounting standards

The newly promulgated accounting standards embraces all IFRS issued before 31 December 2005, except IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, and IAS 29, Financial Reporting in Hyperinflationary Economies (see the box for a list of the accounting standards concerned). The presentation of financial statements has converged to that specified in International Accounting Standard (IAS) 1, Presentation of Financial Statements. In addition, the new standards reflect a greater use of fair value in measuring transactions. Examples are impairment loss recognition, which requires a write-down of assets to their recoverable amounts; held-for-trading investment to be measured at fair value through profit and loss; and investment properties to be reported at fair value. Meanwhile, the application of these standards will entail more professional judgement.

While China’s new accounting standards seem to correspond to IFRS in terms of topics covered, the extent of convergence is yet to be analysed, as often the devil is in the detail. Some accounting issues dealt with in IFRS are not addressed in China’s accounting standards, and some treatments specified in China’s accounting standards are different from those in IFRS. For instance, the defined benefit post-employment benefit scheme, which is the key issue addressed in IAS 19, Employee Benefits, is not covered in the corresponding China’s accounting standard because of the limited adoption of such a scheme in China. On transfer from inventories or owner-occupied property to investment property, the excess of carrying amounts of the property over its fair value shall be recognised as loss, whereas the excess of its fair value over its carrying amount is recognised in equity, but IFRS requires both to be dealt with in profit and loss. Also, some issues in the new standards are yet to be clarified, such as: the treatment for share-based payment transactions with cash alternatives; the requirement for comparative financial statements for business combination under common control; and the determination of profit and loss for transactions between a company and its minority shareholders. A detailed analysis of the difference between China’s new accounting standards and the corresponding IFRS is not feasible until the Application Guideline is formally released.

Regulatory framework of financial reporting

The adoption of accounting standards has prompted changes in the regulatory framework for regulating financial reporting. At the top level, the Accounting Law of the People’s Republic of China (the Accounting Law) enacted by the National People’s Congress serves as a “mother law”, which addresses issues relating to the authority of regulating national financial reporting, the scope of accounting, accounting supervision, accounting organisation and personnel in enterprises, and the legal responsibility of enterprises and accounting personnel. At the next level, the Financial Reporting Rules for Business Enterprises (Rules), issued by the State Council, further elaborate on the provisions in the Accounting Law. It requires the management in charge of an enterprise to be responsible for the truthfulness and completeness of financial reports. No organisations or individuals have the authority to instruct enterprises to provide financial reports which conceal material information or contain false information. The legal liabilities for breaching this rule are stipulated.

At the third level of the framework are the accounting standards, including the Basic Accounting Standard, and specific operational accounting standards. The Basic Accounting Standard serves a similar purpose as IASB’s Framework for the Preparation and Presentation of Financial Statements, while operational accounting standards address specific accounting issues. Concurrently, accounting systems for all business enterprises and for specific sectors, i.e. financial institutions and small enterprises promulgated by the MoF, are adopted.

For limited companies, financial reporting is further regulated by the Company Law, promulgated by the National People’s Congress of PRC, which contains provisions relating to financial and accounting affairs. The China Securities Regulatory Commission (CSRC), charged with administering the securities markets, has also issued regulations governing the disclosure of financial information by listed companies.

Characterised by a hierarchy of regulatory bodies and the concurrent applicability of existing and new standards, as well as accounting systems for different sectors, China’s regulatory framework of financial reporting is more complex as compared with other jurisdictions which adopt or converge with IFRS.

Conclusion

The adoption of new accounting standards in China will no doubt enhance the comparability of financial statements across industries and help foreign investors to analyse the financial statements of Chinese enterprises. Enterprises that need to prepare two sets of financial statements currently – one for domestic use based on existing standards and the other for overseas listing requirements based on IFRS – are expected to experience a reduction in reporting costs when the new standards are adopted. Given that fair value is used in the measurement of assets and liabilities, the balance sheets will reflect a true and fair representation of an enterprise’s financial position. Meanwhile, distributable profits will increase as a number of items, such as government subsidies, gain on debt restructuring and gain on the exchange of non-monetary assets – which are currently recorded in equity – will be reported in profit and loss. This, however, may lead to a volatility in reported profits and may make it more difficult to assess an entity’s operating performance.

While aiming to accelerate convergence with IFRS, the adoption of new accounting standards gives rise to an ever increasing challenge to the accounting profession in China. A massive training project has been announced recently by the MoF to train in a very short period of time the accounting personnel in listed companies and accounting firms, as well as academics. Meanwhile, developing proper mechanisms for compiling fair value information, and having accounting systems in place to meet the new reporting requirements, are also a challenge to the Government as well as enterprises in the adoption of the new accounting standards.

Sonia Khao is ACCA Hong Kong’s head of technical services.