IFRS Adoption:The China Experience

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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.

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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.

“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

Taylor

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.

“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

Conway

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.”