UNDERSTANDING CHINA
IFRS comes to China
By Yang Jian

There may still be a number of barriers that get in the way of mutual understanding between Chinese businesses and foreign investors, but at least accounting standards will no longer be one of them.

Starting January 2007, companies listed on the Shanghai and Shenzhen stock exchanges will be required to present their accounts based on International Financial Reporting Standards (IFRS), set by the International Accounting Standards Board, which are now in use in some 70 countries. The move signals a commitment by the Chinese government to create rules and regulations friendlier to foreign investors.

China has been increasing the percentage of foreign ownership in certain sectors by joint venture or mergers and acquisitions. Last December, it introduced rules giving foreign investors easier and greater access to the renminbi-denominated A-share market. The convergence of China Accounting Standards with IFRS should make foreigners invest in Chinese companies with a little less skepticism.

One of those expecting to benefit is Xue Jianmin, CFO of Shanghai Tire & Rubber, a manufacturing company. “With so much foreign capital flowing into and out of China, it is wise of the government to adopt IFRS,” he says. “If Chinese companies speak the same ‘language’ as foreign enterprises do, it will definitely help local companies attract foreign investment.” The new standards will be more rigorous than current ones, admits Xue. Until this year, he says, Chinese companies do not have to consolidate the figures of majority-controlled subsidiaries whose assets, sales or profits account for less than 10% of the parent’s total figures. That will change starting in 2007.

It may also impact their earnings, some more favorably than others. “The subsidiaries that we haven’t consolidated into our statements represent only 5% of our total figures, in terms of assets, sales, or profits,” says Xue, “so I don’t foresee the new standards significantly changing our figures.” According to China Securities News, listed companies may report 20 bn renminbi in surplus profit for 2006 due to some changes in recording gains from non-cash equity shares and exempted debt, as well as in asset provisions and expenses. Says Chen Ying, CFO of Baosteel: “Implementing new standards will certainly generate some impact on our earnings, especially the concept of fair value reintroduced into investment properties, exchange of non-monetary assets, debt restructuring, and recognition and measurement of financial instruments.”

To be sure, China does not swallow IFRS hook, line, and sinker. Three major exemptions – on disclosures of related-party transactions, prohibition of the reversal of asset impairment, and accounting of government grants – accommodate practices unique to the communist state, where many enterprises are entangled in a complex web of control by communes, local governments, and state agencies. The exemptions are a relief to CFOs. “If state-owned enterprises were all considered related parties, there would be a huge number of related-party transactions and workload of information disclosure would be overwhelming,” says Ying. Patricia McBride, director for standard setting at the Hong Kong Institute of Certified Public Accountants, says while IFRS provisions on related-party disclosure is not in place, China may require companies to identify and distinguish arms-length transactions.

Nonetheless, China’s CFOs expect a number of changes in their finance departments. “I’m not going to hire more people or another accounting firm, but we need more training to familiarize us with the new standards,” says Xue, who employs one local and one foreign accounting firm. “We expect the accounting firms we use now to provide the training.” Ying adds that Baosteel, despite having taken the initiative to comply with IFRS on certain practices that the local standards have failed to address, will still need to “make proper changes” to its financial information system to cope with demands of additional disclosure. That’s a small sacrifice for potentially big gains.