Big four accounting firms: winning again in China - Paul Gillis

Paul Gillis

The Chinese government has tried to promote local CPA's on the expense of the Big Four, but - says  Beida accounting professor Paul Gillis - the 2018 top-10 CPA ranking shows the Big Four are back winning market shares, with PwC, Deloitte and E&Y in the top three, he writes at his Chinaaccountingblog.

Paul Gillis:

China had a policy to promote the development of local CPA firms, but it no longer seems to be on that path. The first indication was mandatory audit rotation on companies with state ownership. The first large scale rotation was in 2012 and somewhat surprisingly nearly all of these companies simply moved from one Big Four firm to another, albeit with significant fee reductions. The government strongly encouraged companies to select a non-Big Four auditor, but they were largely ignored. The next round of audit rotation takes place in 2020, and if local firms do not win some of the large state-owned enterprises I think the Big Four will be cemented into these slots. 2020 is shaping up to be one of the most significant years in the development of the CPA profession in China.  If the Big Four can retain the large state controlled enterprises in the 2020 audit rotations they are likely to retain a strong market position for the foreseable future. 

The Big Four have over 27,000 employees in China, led by PwC at 9,460 out of 250,000 PwC employeees worldwide. Overall, there are 120,604 people working for accounting firms in China. 

Big Four firms do not release information on profitability.  But since payroll is the largest expense for accounting firms, a good measure is revenue per employee. As expected, the Big Four have significantly higher revenue per employee than local firms, with a notable exception of PwC. PwC has revenue per employee of RMB 540,635 compared to an average of RMB 652,390 for the other Big Four.  This suggests PwC is likely less profitable than the other firms and is potentially overstaffed.

More (including the 2018 ranking) in the Chinaaccountingblog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers' request form.

Are you looking for more financial experts on the China Speakers Bureau? Do check out this list.  

Record fine for failed audit - Paul Gillis

Paul Gillis

Shinewing, leading Chinese CPA, got a record fine from China's regulators for a failed audit of a listed company, writes professor Paul Gillis of Practice at Peking University's Guanghua School of Management at his weblog Chinaaccountingblog. He applauds the tough action.

Paul Gillis:

Chinese regulators have fined leading Chinese CPA firm Shinewing a stunning 4.4 million yuan (US$667,000) for a failed audit of a Chinese listed company.  I believe this is the largest fine ever assessed on a CPA firm in China, although many firms have received the death penalty in previous regulatory crackdowns.  Earlier this year China's two of China's largest local firms (RSM affiliate Ruihua and BDO affiliate Lixin) faced short term practice bans. 

Shinewing was the 9th largest Chinese CPA firm in 2015, the latest year for which CICPA data has been released. Shinewing developed from the former joint venture between Coopers & Lybrand and CITIC. It did not join PWC when PW merged with C&L. Shinewing has long held a reputation of being one of the high quality local CPA firms, although it has not gained the market share that its larger competitors obtained by aligning with second-tier networks like RSM and BDO. 

It is a good thing that Chinese regulators are getting tough on CPA firms, since these firms play a vital role in the development of China's capital markets. 

The Shinewing fine exceeds the fine (US$500k) paid by each of the Chinese member firms of the Big Four to the U.S. SEC for failing to turn over audit workpapers to the SEC. 

It is significant that Chinese regulators have not assessed any major penalties against the Big Four in China. The Big Four firms would likely argue that their quality control is higher, but I think that the main reason is the client base. There are about 5,000 companies listed on the major Chinese exchanges, and the Big Four audit only 374. A sizable portion of the Big Four audits are dual listed companies (H-shares in Hong Kong and NYSE listings) The Big Four has about 90% of the dual listed market which includes major state-owned enterprises like the Bank of China and Sinopec. I think it is highly unlikely regulators will find any problems with the accounts of large SOEs, so the Big Four are less likely to be cited by regulators than a large local firm auditing a thousand smaller publicly listed companies. I expect there will be political pressure on regulators to bring a case against a Big Four firm just to even the playing field.

More at the Chinaaccountingblog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers' request form.

Are you looking for previous stories by Paul Gillis? Do check out this list.  

Regulators start to punish auditors - Paul Gillis

Paul Gillis

China's auditing regulators have issued temporary bans for the Chinese affiliate of BDO and Ruihua, the Chinese affiliate of both Crowe Horwath and RSM, over the past few months. Harsh measures to get auditing firms in line, even for international standards. Beida auditing professor Paul Gillis has his doubts, he writes at his weblog.

Paul Gillis:

The January ban came during the audit season, causing the firms to lose many clients. 

I have a mixed view on these actions. First, I think they are a good thing, reflecting that China is taking audit quality seriously. Audit quality is essential to the orderly development of China’s capital markets. On the other hand, I think the penalty is too severe and may hurt the development of the profession. I fear the short-term result may slow the development of the capital markets. 

The CPA profession in China is young, and is currently entering its third phase of development. The first stage, infancy, began with the reemergence of the profession in 1980 and continued through the separation of CPA firms from the state about 1999. The second stage, adolescence, saw the firms grow into sizable, but clumsy teenagers. The largest firms now have over 10,000 accountants and have contributed significantly to the development of China. We are now beginning the third stage where the firms enter adulthood.  As adults, regulators are now holding the firms to task for their responsibilities as independent auditors essential to the integrity of capital markets. 

I understand that many of the problems are coming from the lightly regulated National Equities and Exchange Quotation, commonly known as China’s Third Board. There are thousands of small companies listed on this board, which was created to allow small private companies access to capital. I believe this board has rampant accounting fraud, yet it has been tolerated by regulators who dealt with the risk by limiting access to the market to wealthy investors. I expected that someday regulators would clean up this market, probably by getting tough on auditors, and it appears that day has arrived. 

The CPA firms need to respond to these actions by focusing on quality instead of growth. Client acceptance processes need to be tightened, and internal quality review processes strengthened. The culture of the firms needs to change, shifting the focus from winning new clients and growing quickly to doing a better job auditing and managing risk. The firms are going to have to learn to say no more often. That will be a painful shift, and some accounting firm partners are unlikely to be able to make the change. Those partners will need to find a new profession, because this one needs umbrella holders, not rainmakers. 

Regulators should also reconsider their approach. I think the bans against the large firms are too harsh and hurt too many innocent people. In the short term, they will hurt the integrity of the capital markets by disrupting audits. The trip-wire approach of suspending firms with two disciplinary actions unfairly targets large firms that audit many companies. Instead, regulators should punish individual partners and punish firms only if they have ineffective quality control processes.

More at Paul Gillis' weblog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers' request form.

Are you looking for more financial experts at the China Speakers Bureau? Do check out this list.  

Big Four: hit by financial crisis and domestic competition - Paul Gillis

Paul Gillis

Accounting professor Paul Gillis dives further into the demise of the Big Four accounting firms in China, at his weblog. After a successful entry into the China market, both the financial crisis and domestic competition wiped away whatever advantage they had.

Paul Gillis:

This chart tells the story. It shows growth rates of the Big Four compared to local Chinese CPA firms over the past dozen years. The Big Four were growing at a spectacular rate in the early 2000s, with growth peaking at an astonishing 57.4% in 2004, driven by high levels of overseas IPOs by Chinese companies and huge foreign investment in China by multinational corporations. Local CPA firms were growing well, but at a pace behind the Big Four. 

That all changed with the global financial crisis. The Big Four suffered negative growth of 12.1% in 2008, while local firms kept growing at 26.5%. The Big Four returned to growth in 2009, but have lagged local firms ever since. The main reason, from what I can tell, is that Chinese companies shifted from looking overseas for capital to domestic markets that provided higher valuations. The problem for the Big Four is that they have failed to present a compelling case for why they should audit companies listed on Chinese stock exchanges, and nearly all of that work is done by local firms. 

Two local firms that belong to international networks were the 2nd and 3rd largest firms in China in 2015. I expect that earlier this year Ruihua, a Chinese CPA firm affiliated with both Crowe Horwath and RSM, overtook PwC to take the No. 1 slot in China. Ruihua and the Chinese affiliate of BDO had already overtaken the other three members of the Big Four.

More at the ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´request form.

Are you looking for more financial experts at the China Speakers Bureau? Do check out this list.

Expected: crackdown on smaller CPA firms - Paul Gillis

Paul Gillis

 New rules apply to foreign CPA firms in China since July 1, and will rely on the cooperation of China´s regulators. The big four might not have much trouble, writes accounting professor Paul Gillis at his website. But the smaller foreign CPA firms might be heading for a hard time.

Paul Gillis:

I believe the real crackdown to come is over the US listed Chinese companies that are audited by small US based accounting firms. Most of these companies came to market through reverse mergers and trade thinly, if at all, on over-the-counter boards. These companies have had a high incidence of fraud and have embarrassed Chinese regulators who have no authority over them. After the NYSE and NASDAQ cracked down on reverse mergers by requiring a seasoning period before listing, the reverse merger market for Chinese companies in the U.S. died, replaced by China’s National Equities Exchange and Quotations(NEEQ – China’s third board). NEEQ has listed over 2,000 small Chinese companies with an average market cap of under $75 million.

Those US CPA firms with a significant client base in China are going to have more serious problems complying with these rules. Some of these firms have set up consulting practices in the form of wholly foreign owned enterprises (WFOEs) that do the audit work on the mainland. Such WOFEs are clearly violating Chinese law by doing auditing, and since most have not registered with the PCAOB, they are also violating US laws. Regulators have looked the other way, until now, perhaps. 

The audit committee of any firm audited by an overseas CPA firms should seek written assurance from its auditor that it will be able to comply with the new rules. The SEC should demand that companies disclose the material risk that the auditor may be unable to complete the audit if the auditor is not in compliance with the new rules. The Big Four all have significant mainland affiliates and should not face any difficulties in complying with the new rules.

More at the ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

Are you looking for more financial experts at the China Speakers Bureau? Do check out this list.  

Why some US CPA firms might lose their China market - Paul Gillis

Paul Gillis

On July 1, 2015 news rules on CPA practices by the Ministry of Finance will get in place. While the Big Four won´t have a lot of problems, Beida accounting professor Paul Gillis expects that the smaller CPA firms from the US might lose their work on the China market, he writes on his weblog.

Paul Gillis:

The new rules take effect on July 1, 2015. They will require foreign CPA firms that audit overseas listed Chinese companies to cooperate with a Chinese CPA firm that has at least 25 CPAs. An exception exists for companies with Hong Kong, Macau or Taiwan auditors that have more than 50% of the shares held be persons in those provinces that will be allowed to continue present arrangements. I think few public companies will qualify for the exception. 

I believe these rules were directed at the small US CPA firms that audit Chinese firms that mostly came to market through reverse mergers. Most of these firms clients trade thinly, if at all, on the OTCBB or Pink Sheets. Chinese regulators have expressed frustration that Chinese auditors have been tarred with the poor performance by some of these firms in detecting fraud. Many of the companies that use small US CPA firms are likely to have difficulty getting audits done under the new regulations. The auditor will have to align with a Chinese CPA firm yet still do enough work to be considered the principal auditor. The PCAOB has punished firms that outsourced the entire audit to a local firm. In any event, the economics of the business have changed, since the CPA firms are now going to have to share fees with a local firm. This may be the final straw that leads some of these firms to abandon the market.

More at the ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

Are you looking for more financial experts to manage your China risk at the China Speakers Bureau? Do check out our list here.  

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