Enforcement issues of accounting principles in China

Introduction

In the 21st century, globalisation is deemed inevitable in the development of the world economy. As commercial language, accounting information is internationally accepted so that control over accounting issues and the prevention of accounting fraud are critical to economic development (China Accounting Standards Committee, 2007). In this context, financial reporting quality is regarded as an endogenous function of market demands and political influences that are specific to each country (Chen Cheng, 2007).

The participation of Chinese companies in the world economy has grown during recent decades at a pace that surpasses all other economies significantly. Nevertheless, areas such as accounting and auditing remain a concern. China fully understands that a sound financial reporting system plays a key role in the process of economic development (Financial Reporting in Mainland China, 2007). In saying so, it is important to mention that it is not the standards itself that seem problematic but rather the enforcement of standards.

Based on a report written in 2003, this analysis will present aspects that can be a concern with regard to enforcement of accounting standards. After describing each point, an update to what extent it has been resolved will be given. Finally, this report will highlight new enforcement issues that have arisen since 2003 before concluding with an outlook concerning China’s future in the field of accounting.

Factors influencing enforcement of accounting standards

The enforcement of accounting and auditing standards in China in 2003 can only be described as weak and detection of falsified reports is considered exceptional (Opper, 2003). Formal harmonization processes have not been accompanied by a harmonization of accounting practices and false information in financial statements is regarded as one of the central deficiencies of business in China.

Enforcement of accounting standards can be achieved by various means. In her article, Opper (2003) mentions the following points:

- Regulatory bodies and legal framework

The Ministry of Finance (MoF) and finance departments of provinces supervise the enforcement of accounting in China and as such are responsible for the accuracy of accounting work, with the exception of listed companies which are supervised by the China Securities Regulatory Commission (CSRC).

Being guided by the MoF, the Chinese Institute of Certified Public Accountants (CICPA) monitors and controls enforcement issues. The problematic fact is that this organisation is not independent from two perspectives (Opper, 2003). One problem arises due to financial support from the government for CICPA and a second stems from council members being appointed by the government instead of being elected. As a consequence, public service experience outweighs accounting knowledge. Scarce financial resources and staff shortages further weaken the efficiency of CICPA.

Finally, China’s Accounting Law specifies fines for non−compliance, however two major shortcomings in this field minimise the efficiency of these fines: firstly, setting an upper limit to fines equals decreasing relative costs with possible gains achieved through successful accounting fraud (Opper, 2003). Additionally, the fact that the Law does not promote incentives to avoid wrongdoings in general is also counter−productive. Intentional malfeasance is punishable, however unintentional violations of the Law are not subject to legal sanctions, opening the door for opportunistic behaviour.

According to research, the organizational structure of supervision has not changed since 2003, i.e. the MoF continues to be responsible for promulgating accounting and auditing rules (Corporate Governance in China, 2006). In contrast to Opper’s article, these rules are now in accordance with international standards, as will be highlighted in more detail below. Further to this change, the Chinese government appears willing to show to Western societies that adherence to accounting standards is taken seriously. This is the summary of recent initiatives by the government, for example sending CPAs overseas for training or recognising the Association of Chartered Certified Accountants as training body (Country Survey China, 2007). Also, Chen Cheng (2007) describe the institutional oversight system today as an effective instrument in creating an accounting framework, with enforcing bodies monitoring the accounting process with the aim of ensuring legal action when malfeasances are detected, contradicting Opper’s findings in 2003.

With regard to personnel issues, it is problematic that Chinese accounting students are not exposed to international accounting standards. Furthermore, comments by large accounting firms such as Deloitte and BDO indicate that the problem of staff shortages persists: “If we had even more people, and all the firms are saying this, you would see even more growth” (Country Survey China, 2007, p. 12). Getting experienced staff is particularly difficult, however this is slightly offset by Chinese accounting professionals returning to China from overseas where they have developed skills and expertise.

Shortcomings in the fields of fines have not been dealt with as the system outlined by Opper (2003) is described in China’s Accounting Law of 1999. Since then, no further amendments have taken place so that fines are still a rather weak tool in preventing accounting fraud.

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