What makes Chinese accounting different from Western standards? - Paul Gillis

Paul Gillis

Accountants have to figure out what is happening in a company, and the difference between Western and Chinese practices makes that often hard, says Paul Gillis, accounting professor at Peking University, and author of the leading website ChinaAccountingBlog to Young China Watchers.

Young China Watchers:

YCW: You have a wealth of experience as a certified public accountant (CPA) across many countries. At a high level, is there anything specific that analysts and observers should take into account when trying to understand financial statements and general business practices in China? 

PG: One of the biggest challenges has been adapting Western accounting and auditing practices to Chinese business practices, where personal relationships can overshadow contracts and laws. In the West, internal controls often rely on the separation of duties on the premise that it is hard to get two employees to agree to commit a fraud. What we found in China is that the existence of 关系(guanxi) relationships between actors often overrode controls. There was a big problem with bank confirmations. A standard audit practice is for the auditor to ask the bank to confirm the bank account balances of clients. In China, it proved not very difficult for many companies to lean on the bank branch manager to confirm a false balance. Auditors needed to find other ways to audit to overcome these problems, but there were many frauds in the meantime.    

YCW: A lot has been said about Beijing’s intention to open up China’s financial sector. How do you see this impacting the audit industry? Have you observed any broad trends recently as a result of the latest round of market reforms? 

PG: Accounting is not directly affected by the opening up of the financial sector. Foreign accounting firms in China are structured like the firms elsewhere in the world: Local partners own the local firm. There has always been a lot of talk about allowing foreigners to own interests in local accounting firms—they already can, but the biggest obstacle is passing China’s CPA exam, which is the toughest in the world! It actually makes sense for local partners to own and operate the firms in China. They have local expertise and since most of them are now local Chinese, they better understand the cultural aspects of doing business.    

YCW: A lack of transparency has always concerned investors and lenders in China, perhaps unjustifiably so. While the perception is changing, can you identify any obvious steps to be taken at the state and firm levels to speed up this process, or has all the low-hanging fruit been picked? 

PG: Disclosures of public companies in China, particularly those listed abroad are pretty extensive. The greatest difficulty often lies in opaque ownership structures where it is hard to figure out who is ultimately in control. One thing I have observed is that Chinese companies often do not do things in the most straightforward manner. For example, it is not uncommon to put the ownership of companies in the names of friends or relatives. I guess that gives people plausible deniability if problems come up, but it often scares investors and business partners who think they are trying to hide something. I think a lot of this is a legacy of earlier times when being a “capitalist roader” (走资派, zou zi pai) was a bad thing.

More at the Young China Watchers.

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.

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In China, small print can kill you - Paul Gillis

Paul Gillis

Registering offshore, through so-called VIE' or variable interest entities, is more popular than ever for Chinese companies, even though the Chinese government tries to stop this circumventing trick. Tencent Music Entertainment was the last one to use it for its IPO and get away with it because investors seldom read the disclosure, says Paul Gillis, accounting professor at the Peking University, at the Nikkei Asian Review. And for good reasons.

The Nikkei Asian Review:

As with the Tencent Music prospectus, VIE risks are regularly disclosed in the IPO process -- for those paying enough attention. 

Referring to Tencent Music's discussion of its use of VIEs, Paul Gillis, an accounting professor at Peking University in Beijing, said: "It is extensively disclosed, but the filling is 300 pages long. Many investors do not read it." 

Meanwhile, it remains unclear when Beijing will move forward with the draft foreign investment law, as Tencent Music's prospectus notes. 

Said Gillis, "If investors cannot stand ambiguity, they should stay out of China."

More at the Nikkei Asian Review.

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.

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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.  

Will bike-sharing firms merge? Not yet - Jeffrey Towson

Jeffrey Towson

Will Mobike and Ofo, China's largest bike-sharing companies merge, like car-sharing firm did in the past? Not yet, says Peking University professor Jeffrey Towson. International expansions goes well, capital is freely available, and a crippling price war has not yet emerged, he argues.

Jeffrey Towson 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.

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Trying something new is hot in China - Jeffrey Towson

Jeffrey Towson

The rest of the world looks with amazement at the crazy, booming sharing economy in China, and wonder whether the rest of the world might follow. One of the reasons, people here like to jump in when something is new, says Peking University professor Jeffrey Towson at CBS.

Jeffrey Towson 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.

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What works in China, might not work elsewhere - Jeffrey Towson

Jeffrey Towson

Whether bike-sharing is heading for a success or just a financial sinkhole is still unclear, despite a giant surge in VC funding. But Beida business professor Jeffrey Towson, a bear in this industry, is sure that it will not work outside China, because of the rather special situation in China, he tells the South China Morning Post.
The South China Morning Post:

Jeffrey Towson, an investment professor at China’s elite Peking University, views the booming industry slightly differently, calling it a new wave of “digital disruptors” in access and convenience: a living example, he adds, of “making it easy and making it now” for consumers. 

“This is only possible in China,” he added, “because of the arrival of smartphones, mobile payments, and a very dynamic mobile app ecosystem. 

Wilson Chow, the technology, media, telecommunications leader of PwC in China and Hong Kong, agrees completely with Towson, but adds the nation’s tech-led stampede for sharing, isn’t really about saving money, it’s more to do with convenience.

More in the South China Morning Post.

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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.

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Next: home-grown designers - Jeffrey Towson

Jeffrey Towson

China has moved away from its copycat culture in much of manufacturing and R&D, but is still lacking experienced talent when it comes to developing design. That is just a matter of time, tells Peking University business professor Jeffrey Towson to Bloomberg. Branding and quality of design are getting higher on the agenda.

Bloomberg:

There may be a brighter future for home-grown designers..., said Mr Jeffrey Towson, a professor of investment at Guanghua School of Management at Peking University. 

China has invested heavily in art and design schools and that is bearing fruit, with more than a million art and design students graduating every year since 2009, he noted. 

"They don't have the experience yet, but they have the talent. "Fifteen years ago, nobody hired Chinese engineers. Now, every Fortune 500 company builds R&D centres in China. 

"It's going to be the same with designers."

More at Bloomberg.

Jeffrey Towson 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.

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Drug scandals will dwarf China's food scandals - Jeffrey Towson

Jeffrey Towson

Beida business professor Jeffrey Towson gives on his weblog reasons why China's drug scandals will be larger than any of its past food scandals. Morbidity is larger. Drug scandals are harder to detect and the profitability of the fake drug industry is higher. More troublesome: the industry is going global.

Jeffrey Towson:

#4 Unlike most food scandals, drug scandals are a global problem. 

If you are taking a pill in the US, part of it probably came from China. Over 80% of the world’s active pharmaceutical ingredients are now made in China and India (but mostly in China). So these drug problems have global reach. 

The most famous example of this was the 2008 Heparin scandal. Tainted Heparin from China ended up killing over 240 Americans. As a result, 34 China facilities (via Baxter International) were banned from exporting. 

And it gets more complicated. A lot of these quality problems are actually in the chemistry, as opposed to just in the final drug or in the active pharmaceutical ingredient. In 2012, police in China detained +60 people who were making chromium-tainted gel capsules with industrial waste. The police seized over 77 million gel capsules and shut down 80 production lines. Think about those numbers for a moment. 77M capsules and 80 production lines. 

But the biggest “global” aspect of this problem is likely in other developing economies. Fake drugs are everywhere in SE Asia and Africa. And many are coming from China. The morbidity and mortality resulting from this is hard to overstate. For example, the Wellcome Trust estimated that one-third of the malaria drugs in Uganda may be fake or substandard. 

Final Point: Pharmaceuticals in China are going to grow. But absent improvements, drug scandals could also become much bigger as well. 

Healthcare spending today in China is about 6% of GDP, up from 4-5% a few years ago. It is likely on its way to 12-13%. And China’s pharmaceutical market, already big at $108B (2015), is growing along with this. All of this is good news. It follows naturally from growing domestic demand (aging + increasing wealth + more chronic disease) and a continued movement of pharmaceutical production to China. 

So this is a big market that is growing fast and developing in sophistication. But it logically follows that any future quality problems will also be larger in scale. That is worrisome.

More at Jeffrey Towson's weblog.

Jeffrey Towson 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.

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Bike hailing does not make business sense - Paul Gillis

Paul Gillis

Bike hailing services got another round of funding this week in hundreds of million US dollars, but Beijing-based observers like Beida accounting professor Paul Gillis just do not see how those companies, involved in a giant competitive war, will ever pay back those loans, he tells QZ.

QZ:

But widespread customer negligence and razor-thin margins could make it hard for these businesses to stay afloat. The very factors that make China’s bike-share services so convenient—low prices and ease-of-use, namely—are the same factors that could spell their death. 

“What they’ve got is a very interesting technology, but a basic business model that makes no sense,” says Paul Gillis, who teaches accounting at Peking University in Beijing... 

All of these factors merely compound the stress placed on an already shaky business model. Mobike and its rivals won’t reveal how much their bikes cost to produce, but an old estimate (which Mobike says has since decreased) places the cost of a standard Mobike at 3,000 yuan (about $437). Professor Gillis says that fares alone will hardly recoup these costs in a timely manner—let alone cover labor and R&D expenses. 

“They rent for one yuan every half hour, and they expect that they might be rented four times a day for a half hour, which amounts to four yuan per day,” he tells Quartz. “If you take four yuan per day and you take that into the 3,000 yuan, you’ve got a long time before you’ve recovered the cost of a bike.”

More in QZ.

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 experts in managing your China risk at the China Speakers Bureau? Do check out this list.  

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