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IFRS Adoption: The China Experience

By Richard Meyer — September 3, 2008

he United States isn’t the only economic superpower finally lurching into the global accounting age. On the other side of the world, China is doing much the same.

Like many nations, China is adopting International Financial Reporting Standards with considerable enthusiasm—and like many nations, is doing so by issuing its own national interpretation of IFRS, rather than using the “pure” standards published by the International Accounting Standards Board in Brussels.

For the most part, the differences between IFRS and China’s home-grown standards—the Accounting Standards for Business Enterprises, issued by the Ministry of Finance in February 2006—are less than dramatic. Shortly after the arrival of ASBE two years ago, Deloitte issued a document outlining the differences between it and IFRS, which ran all of 50 pages.

Most of those 50 pages are filled with run-of-the-mill details: a few technical differences in accounting for stock options, some quibbles about how to expense the costs for securing construction contracts, and other minor departures from IFRS.

But ASBE veers away from IFRS significantly in at least one area: disclosure of related parties. IFRS generally requires related-party transactions to be disclosed. In China, however, so many companies are state-owned—and therefore related—that disclosing them all would leave the footnotes to a financial statement hundreds of pages long.

As a result, under Chinese accounting rules, state control does not necessarily trigger related-party disclosures.


Taylor
“They are not a market economy in the same sense as the Western economies are, so they have made slight alterations,” says Stephen Taylor, a partner at Deloitte. “Chinese accounting standards say that you are not related just because you are a state-controlled entity; you have to have influence … Just because you are a state-controlled entity, it doesn’t mean another state-controlled entity can necessarily influence you.”

Taylor is quick to note that this provision makes some sense. The state is so pervasive in China, he says, that it’s tough to buy plane tickets or purchase office supplies without dealing with the government. If you too are a state-controlled entity—and if you’re a Chinese business of any size or import, there’s a fair chance that you are—you might end up churning out reams of paperwork to disclose something not all that useful.

IASB Efforts

Indeed, China’s stance about state-owned entities has struck so many as a fair point that the International Accounting Standards Board is considering revising its own standards for related-party transactions to bring them closer to China’s line of thinking. The organization issued an exposure draft in February 2007 that broached reducing the disclosure requirements for entities that are related only because they are state owned, and IASB plans to decide on the matter by the end of the year.

“What convergence means is that China will not just move toward international standards. In some circumstances that might mean the IASB moving closer to the [China] alternative,” says Taylor.

According to IASB, the proposed change sprung from routine discussions with the Chinese rather than any concerted lobbying from Chinese authorities. IASB also believes that a change in the standard will not hinder reform in China by obscuring or protecting state involvement in the economy. Rather, IASB spokesmen say, it will promote better accounting practices in China and may actually help investors and non-Chinese regulators get a better sense of what’s going on.

“We had a genuine concern that if you disclose so many parties as related parties, you’ll get hundreds of pages of disclosure and the real related parties will be masked,” says Alain Teixeira, director of technical activities at IASB.

ASBE NO IFRS
Although the ASBEs are substantially in line with IFRSs, there are still some differences between the ASBEs and IFRSs. Some of the key differences are:

  • ASBE 4 and ASBE 6 only allow the cost model for measurement of fixed assets and intangible assets, while IAS 16 allows a revaluation model.
  • Under the ASBEs, land use rights are normally classified as intangible assets and not as operating leases. Where the land use rights meet the criteria to be accounted for as an investment property, the accounting is not restricted to the fair value model as in IAS 40. The cost model may be used.
  • For jointly controlled entities, ASBE 2 only allows the equity method of accounting. IAS 31 also allows proportionate consolidation.
  • ASBE 8 prohibits the reversal of all impairment losses where IAS 36 only prohibits the reversal of the impairment of goodwill.
  • Borrowing costs meeting the capitalization criteria should be capitalized. However, IAS 23 gives an option to expense all borrowing costs.
  • State-controlled entities are not regarded as related parties simply because they are state-controlled. There is no exemption for state-controlled entities under IAS 24.
  • Biological assets shall be measured using the cost model unless there is evidence of a reliable fair value under ASBE 5. This is in direct contrast to IAS 41 which requires fair value to be used unless it is clearly unreliable.
  • Unlike IFRS 3, ASBE 20 includes and addresses within its scope business combinations involving entities under common control. However, ASBE 20 does not cover reverse acquisitions.
  • For presentation purposes, the ASBEs restrict certain options available under IFRSs, for example, expenses shall be analysed by function for income statement presentation purposes, the direct method is required for cash flow statements and only the gross presentation is allowed for government grants related to assets.

Source

Comparing IFRS With Chinese Standards.

The more complex challenge for IASB will be to specify exactly what related-party transactions should be disclosed. The Board plans to discuss the matter in September and may ask for more comments after that.


Conway
“It is a big issue,” says Andrew Conway, deputy CEO of the National Institute of Accountants in Australia. “Related-party transactions are disclosed for a reason, disclosed because the market needs to know that there are potential conflicts. How this plays out will be interesting to watch.”

According to Conway, the key to IFRS is its brand and credibility; the standards will only be as good as the market perceives them to be. If IFRS incorporates too many compromises for individual nations and those compromises make it difficult to understand a company’s accounting or to compare financial statements between nations, IFRS will lose its value.

China’s IFRS Challenges

China also faces some practical problems related to IFRS adoption. The nation set a lightning-fast adoption schedule, formally announcing in early 2006 that all listed Chinese companies had to comply with IFRS by the start of 2007. By contrast, the United States is just now hoping to adopt IFRS by 2016; most countries give themselves three or four years to ease into the IFRS world. According to some Chinese accountants, China got ahead of itself.

“After the publication of IFRS in China, it was implemented soon,” says John Liu, a partner at Shanghai J&J Certified Public Accountants Firm. “There was no time for the CPAs to master it. For the Big 4, it’s no problem at all. But for the other CPA firms in China, I still think it is a big problem.”

Liu says that good texts covering and analyzing China’s IFRS are rare, and even the regulations themselves can be unclear; sometimes he has to consult the original English version of the standard to figure out what the Chinese version is trying to say. Liu notes, however, that nobody really knows whether the first batch of companies reporting under IFRS succeeded. Chinese regulators are currently going through the books of these firms, and probably won’t finish their inspections for several months

“China had less than one year to complete the harmonization procedures, which is quite different from most Western countries,” says Zhang Ying, a PhD candidate doing research on China and IFRS at the University of Wollongong in Australia. “I think the accountants or the companies must do what the government requires, but the reality is that they have no idea what is in IFRS. When I read articles in the Chinese media and see how people interpret the rules, I find some errors very obvious to me.”

The transition was certainly not as difficult as it could have been. China has been trying to bring its accounting standards into line with international norms for a decade, and some Chinese companies have long had “H” or “B” shares that are listed in Hong Kong and priced in dollars. Another helpful break: Most Chinese companies are exempt from filing in IFRS because they are small or private companies (although official policy is to encourage them to use IFRS anyway).

The government insists that everything is proceeding well. It acknowledges that small companies and small accounting firms may find IFRS challenging, and believes that fair value could be an issue in China due to the lack of good data on some investments and the lack of trading in others. Overall, however, Beijing is pleased.

“We have been implementing the standard for about one year, and the results are quite satisfactory,” says Wang Jianxin, vice director of the Accounting Research Office at the Ministry of Finance. “The transition to IFRS has been very smooth.”

“Of course, in implementing such a standard in a very huge and broad country, and with so many different levels of enterprises, there will be some problems,” he says. “But I have to say that we have to believe in our government and in the hard work and diligent spirit of out accountants. They will master the standard.”



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