The Global Commercial Market and the Firms Accounting System in China - Research Paper Example

China’s increased role in the world economy has stimulated reforms of China’s accounting standards to make them increasingly 1. Introduction The development of commercial activities worldwide has led governments to establish appropriate schemes ensuring that the various aspects of these activities will be appropriately monitored; accounting is an important part of business operations; because of the complexity and the needs of the particular sector, an international authority, the International Accounting Standards Board has been established aiming to support organizations in the private and public sector to improve the credibility of their financial reports. Moreover, the International Financial Reporting Standards are set as the basis for the development of accounting standards worldwide. Current paper focuses on China’s accounting standards; emphasis is given on the reasons for which the introduction of these standards has been considered as necessary; at the next level, the impact of the international accounting standards on the Chinese accounting standards is examined and evaluated; it is proved that the existing framework in regard to the monitoring of a firm’s financial report is inadequate; therefore, the alignment of the Chinese accounting standards with the international accounting standards is required – it is assumed that such a decision could lead to the increase of effectiveness of Chinese accounting standards. Another important issue, revealed through this study, is the fact that International Financial Reporting Standards are effective but their performance is depended on a series of factors – as explained below; in this context, their use in the development of the Chinese accounting standards might not lead to the expected results – at least not in a short period of time. 2. China’s accounting reforms since the 1980s – Overview The Chinese Ministry of Finance has the power to establish and monitor the accounting standards across the specific country; because the accounting needs of the organizations operating in the country’s public and private sector were many, the establishment of an organization that would deal with the application and the enforcement of accounting standards was considered as necessary. In the past – referring especially to the pre-1980s period - all relevant issues were handled by the appropriately authorized governmental departments but with the increase of commercial activities across China, appropriate measures should be taken for the establishment and monitoring of appropriate accounting practices in firms of all sectors – in this way, the attractiveness of the Chinese market towards the foreign investors would be expected to be increased. The Chinese Institute of Certified Public Accountants is an organization that was developed in order to support the development of the country’s existing accounting standards – also to introduce the principles of international accounting standards so that a balance to exist – in terms of similar theoretical basis and practical aspects – between the existing accounting standards and the ones that have been already applied in countries of the West; the above Institute was fist established in 1988 and is considered as one of the most important efforts of the Chinese government to improve the existing accounting standards by using the principles of international accounting standards (OECD, 2003, p.162). In accordance with Godfrey et al. (2007) the development of China’s accounting standards started in 1979; in the above study it is made clear that China’s accounting standards (CAS) have been based ‘on the standards set by the International Accounting Standards Board and the International Accounting Standards Committee’ (Godfrey et al., 2007, p.193); therefore, the efforts of Chinese government on the specific sector can be characterized as significant; however, the fact that international accounting standards have been used as the basis, or else the pattern, for the CAS cannot lead to the assumption that the relevant effort has been successful; in other words, the CAS have not been proved to be effective – at least at the level expected if taking into consideration the principles on which these standards have been based. From another point of view, the failure of the Chinese accounting standards to meet the demands of the Chinese market indicates the weakness of the country’s authorities to monitor effectively the activities of firms operating in various industries across the country. Moreover, no specific mechanism for supporting the alignment of the CAS with the international accounting standards – currently known as International Financial Reporting Standards (IFRS) - seems to exist – a failure not only of the Chinese authorities but also of the International Accounting Standards Board (Godfrey et al., 2007, p.193). Because of the difficulties related to the development of commercial activities in China, the application and enforcement of accounting standards in the country have been delegated to an organization operating in the context of the country’s Ministry of Finance, the China Securities Regulatory Commission which has ‘the responsibility to enforce the accounting standards since 1992’ (Godfrey et al., 2007, p.194). Another authority, the Chinese Accounting Standards Committee that was established in 1998, ensures the promotion of accounting standards in firms across China (OECD, 2003, p.162); the introduction of Chinese Accounting Standards for Enterprises in 1992 (Smyth, 2005, p.88) has been an important initiative towards the alignment of the country’s accounting standards with the international accounting standards. 3. Main distinguishing features of IFRS International Financial Reporting Standards were first introduced in 2003 (Elliott et al., 2007, p.208); in order to align their accounting standards with the IFRS countries internationally had to proceed to a series of initiatives including: ‘a) identify the accounting strategies that are more related to the IFRS, b) developing an opening balance sheet that would be used when the transmission to the IFRS was to begin, c) use of the IFRS in order to estimate the firm’s performance both in regard to its opening balance sheet and the rest financial years’ (Elliott et al., 2007, p.208). The International Financial Reporting Standards were introduced in order to help to the increase of credibility of financial accounts but also to the protection of investors from potential losses. The key features of IFRS could be described as follows: a) IFRS are likely to be applied retrospectively; this means that when IFRS are introduced in the end of a financial year – aiming to be applied on the next financial year – they are likely to produce their results from the beginning of the year in which they are introduced, b) under IFRS the estimation of the historic cost of specific assets is not always necessary, c) a firm is not obligated to use IFRS in regard to ‘business combinations recognized under previous GAAP’ (Elliott et al., 2007, p.209), d) ‘cumulative exchange differences on foreign entities should be presented under IFRS rules as a separate reserve’ (Elliott et al., 2007, p.209), e) the application of IFRS rules on ‘share-based payment transactions’ (Elliott et al., 2007, p.209) is not obligated, f) IFRS rules can be quite complicated – especially when they have not been used in the past – referring to business entities that use IFRS rules for first time. 4. How and at what level China’s adoption of International Accounting Standards shifted the quality of Chinese companies’ accounts towards international levels In order to understand the level at which the adoption of International Accounting Standards by China has affected the quality of Chinese companies’ accounts it would be necessary to refer primarily to the structure and the characteristics of the Chinese accounting standards; then the relationship between these standards and the International Accounting Standards could be identified; at the next level, the level at which this interaction has led to the development of quality of Chinese companies’ accounts in the context of international accounting standards would be located and evaluated. In accordance with Chen et al. (2006) the Chinese accounting standards are developed through a series of phases which could be summarized as follows: a) the Chinese Ministry of Finance sets the accounting standards applied on organizations in all industrial sectors; the above power of the Ministry of Finance is clearly set in the Chinese Accounting Law, b) a specific type of accounting was initially promoted for a particular time period: the joint venture accounting; this type of accounting was gradually developed covering all business activities and c) the international accounting standards are reviewed and their principles are used – as possible – in the Chinese accounting standards; the accounting standards of individual countries are likely to be avoided (Chen et al., 2006, p.213). The criteria of credibility of firm’s accounts in China are included in the Accounting Law; another legislative text, ‘the corporate law of the PRC, 1993’ (Chen et al., 2006, p.211) refers to the accounting requirements of firms operating in the Chinese market. Through the above texts, the harmonization of the accounting standards of businesses in China with the accounting standards of firms operating in other markets internationally is attempted; it is not clear whether the above harmonization is closely monitored by the state; the examination of the relevant literature leads to the assumption that the interaction between the Chinese accounting standards and the international accounting standards is not obligated – it is rather depended on the discretion of entrepreneurs. On the other hand, Chapman et al. (2007) note that in China ‘policymaking in the accounting arena had focused on financial accounting, auditing and reporting’ (Chapman et al., 2007, p.932). Under these terms, it is expected that the influence of the Chinese firms from the international accounting standards will be limited; however, even under current delays and obstacles, the international accounting standards are likely to be used as the basis for the development of Chinese accounting standards; therefore, the influence of the international accounting standards on the Chinese firms’ accounts is rather indirect. The above influence is expressed through specific events in regard to accounts of firms in China: a) financial accounts of firms operating in the Chinese market have been made more precise; figures are placed in order to indicate clearly the performance of particular business sectors, b) provisions exist in regard to the responsibility of these firms’ accountants. In accordance with Nobes et al. (2008) the dependency of a country’s accounting standards on the international accounting standards or other similar frameworks could lead to the delay in completing various business projects; more specifically, Nobes et al. (2008) note that ‘influence can slow down the rate at which an accounting system will change response to a growing equity market’ ((Nobes et al., 2008, p.38); it is not made clear however whether an alternative scheme could be applied in case that the accounting standards of a particular state are proved to be ineffective. In other words, even if the influence of the international accounting standards on the firms operating in various sectors of the Chinese market is significant, the quality of these firms’ accounts is not particularly affected by the above fact; rather, quality in firms’ accounts seem to be related to the governmental policies on business operations (for instance taxation, process of establishment/ resolution/ merger and so on) instead of the rules set in the context of the international market – referring also to the international accounting standards. 5. Reasons for which China failed to reach International Accounting Standards The Chinese government has made significant efforts for the development of the country’s accounting standards and especially for their alignment with the international accounting standards; at a first level, the above targets seemed as having been achieved; however, the careful review of the literature published on the particular field leads to the assumption that the effectiveness of the measures taken towards the alignment of the Chinese accounting standards with the International ones has been limited; different views have been stated in the literature in regard to the reasons of this failure; in accordance with Smyth (2005, p.88) the reasons of the above failure can be identified to the fact that Chinese accounting standards are more related to theory; their practical aspects are not analytically explained; in this context, their application in practice is problematic compared to the accounting standards in other countries, like in UK and Australia (Smyth, 2005, p.88); another important reason of the failure of the Chinese Accounting Standards to reach the International Accounting Standards is the structure of the Chinese business sector: more specifically, in China most firms are owned by the state, either directly or indirectly (Smyth, 2005, p.97); this means that the application of any business policy – including of the accounting standards – needs to be reviewed and approved by the relevant governmental authorities; however, this procedure can be time-consuming and can be easily led to a failure – especially if the organization involved is well developed within its market, a fact that indicates the organization’s increased needs for effective accounting standards. Towards the same direction, it can be noted that the business regulation in China is differentiated from the one of the Western markets; the development of business activities is strongly supported by local authorities; however, strict terms and conditions are set in regard to the development of business activities in China. An important factor influencing the performance of international accounting standards in the Chinese firms is the organizational structure; in most Chinese firms employee satisfaction is at low levels; rewarding also is not generally used as a method for supporting employees; therefore, the participation of employees in new schemes is expected to be low; the successful development of international accounting standards in firms operating in the Chinese market is expected to face the resistance of employees; the lack of participation of the employees to these schemes would have a similar effect. Regarding this issue, it is noted by Chapman et al. (2007) that in the firms operating in the Chinese markets employees are not expected ‘to share information in regard to business performance’ (Chapman et al., 2007, p.264); this means that the development of international accounting standards in firms operating in China would face significant delays. Finally, the political framework of China is differentiated from those of the Western countries; the accounting standards used across China need to reflect not only the business culture and aims but also the local social and political ethics; in this way, the complete alignment of the Chinese accounting standards with the international accounting standards has not been feasible. In accordance with Godfrey et al. (2007) China has emphasized on the importance of convergence as a priority when setting its accounting standards; the level at which convergence is promoted across the country can be understood by the following fact: the setters of the Chinese accounting standards has assured that these standards will be similar with the international accounting standards at such a point that the financial accounts of Chinese firms (using the Chinese accounting standards) will be similar with those produced by the firms using the international accounting standards (Godfrey et al., 2007, p.211); however, the above target has not been achieved yet. 6. Do “all other countries” have identical standards to which China could move? As explained above, the international accounting standards – known as international financial reporting standards – are used as the basis for the development of accounting standards worldwide; this means that the accounting standards of most firms worldwide present similarities – this is the case specifically in countries which are members of communities – or unions – with common interests, like in European Union; however, countries with different social, cultural and political background could not easily align their strategies; an exception seems to exist in regard to the accounting standards. More specifically, financial transactions worldwide have similar forms; for this reason, the accounting principles and frameworks worldwide can be based on common principles – under the terms explained above, referring to the local ethics and political structure. From this point of view, China could move towards the standards of other states; however, in accordance with Chen et al. (2006, p.213) the development of Chinese accounting standards is based – among other criteria – on the independency of these standards from the standards of individual countries – only the international accounting standards are likely to be taken into consideration by the setters of the Chinese accounting standards. In this context, China could not be based on the accounting standards of other states; rather it would further develop its existing accounting standards in order to meet the criteria of the international accounting standards. 7. Conclusion China is among the most powerful countries in terms of its presence in the global commercial market; the firm’s accounting system is based on a series of texts and practices, especially the Accounting Law, the specific accounting standards and the enterprise accounting system’ (Meng et al., 2005, p.301); through the years, the country has managed to develop its accounting system by adopting the international accounting standards – aiming to respond to the needs of firms that operate internationally and increase its competitiveness towards other countries that have also a powerful commercial sector, like Germany. On the other hand, the examination of the aspects of IFRS rules led to the assumption that these rules can be quite complex; their successful application is depended on a series of factors; in dynamic markets, like the Chinese, the level at which IFRS are applied is not of particular importance since the credibility of the firms’ financial accounts is appropriately checked by relevant mechanisms. References Alexandroff, A., Ostry, S., 2003. China and the long march to global trade: the accession of China to the World Trade Organization. Routledge Alexandroff, A., Ostry, S., 2003. China and the long march to global trade: the accession of China to the World Trade Organization. Routledge Chapman, C., Hopwood, A., Shields, M., 2007. Handbook of management accounting research, Volume 2. Elsevier Chen, J., Yao, S., 2006. Globalization, competition and growth in China. Routledge Elliott, B., Elliott, J., 2007. Financial accounting and reporting. 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