Reap the Real Benefits of International Standards in Local Settings – A Chinese Perspective

 

Speech at the Cross-straits, Hong Kong S. A. R., Macau S.A.R. Accountancy Profession Seminar

4 September 2012

By Dr. Chen Yugui, Deputy President & Secretary General, CICPA

 

INTRODUCTION

 

Undisputedly, convergence of practicing standards for professional accountants, including accounting, auditing and ethics standards, is a significant initiative to promote global economic development, to increase comparability of financial statements across jurisdictions and to stabilize global financial governance and security. From the outset, China has been a proponent for convergence and quick to incorporate international standards, specifically, IFRSs, ISAs and the IESBA Code, into Chinese standards. Our continuous efforts on convergence have enabled us to advance our profession swiftly and have won accolades from the international business community. The whole convergence process is reviewed in the context of the development of a market economy system in China. From it, some insights and lessons are distilled.

 

Along with rapid development resulting from internationalization of accounting and auditing standards, convergence has also highlighted several challenges and emerging issues specific to local application of international standards. How to translate the “exotic” nature of international standards into the daily practice of millions of accountants in order to deliver high-quality accounting information is the major concern. Now, more so than before, we find that even after completing the formal steps of “adoption” and “convergence”, we still need to ensure that not only the wording of the standards are “adopted”, but that they also become the professional protocol embraced by all accountants and auditors. I have highlighted these issues as worthy of discussion and review, supplemented with a few recommendations derived from our own experience in China.

 

 

Section 1 Internationalization of Chinese Practicing Standards for Professional Accountants

 

The internationalization of Chinese practicing standards for professional accountants started in 1978 when China entered a period of radical changes featuring economic reform and opening up to the world. In 35 years, Chinese practicing standards for professional accountants went through three distinct stages: selective application, radical conversion and substantial convergence,from reform and exploration, to steady promotion, and eventuallyleaps in quality. 

 

1.1 Three milestone stages of the development of the Chinese standards

 

1.1.1 Selective Application (1980’s - 1992)

 

The interest of opening up to foreign investment and revitalizing domestic economy brought dramatic economic reforms and policy changes in China. It was a time of restructuring state-owned enterprises, developing joint-ventures, privatizing industries by introducing the shareholding system and establishing modern corporate system. The government saw the pressing need to re-establish a strong accountancy profession in China and thus re-established Chinese practicing standards for professional accountants, accounting systems (equivalent to standards) for joint-ventures, and made amendments to the accounting system for domestic enterprises by observing the prevailing international practice for some business transactions.

 

1.1.2 Radical Conversion (1992 – 2005)

 

Continuing the momentum of opening up to the world, this was a period of nation-wide engagement in establishing a marketeconomy in China. The reform in the corporate system and the development of capital market rapidly revealed the shortcomings of an accounting system steeped in the history of a centrally-planned economy. There was a pressing need for comprehensive changes to our accounting system along with other economic policies and frameworks. It was during this period that the Chinese accounting model was converted to fit a market economy.

 

In 1992, China established “Accounting Standards for Business Enterprises” (ASBE) and accounting systems for specific industries. The establishment of so-called “Dual-standards, Dual-systems” marked the integration of accounting standards in China with international standards. Subsequently, in 1997, the first specific accounting standard on related parties was issued, followed by several other specific accounting standards.

 

Enacted in 1993, “The Law of the People's Republic of China on Certified Public Accountants” empowered the Chinese Institute for Certified Public Accountants (CICPA) to establish professional standards for CPAs. In May 1994, CICPA commenced drafting the independent auditing standards. By 2004, CICPA had released six batches of successive independent auditing standards, by which a system of auditing and ethical standards for CPAs was completed.

 

1.1.3Substantial Convergence (since 2005)

 

As economic globalization continued to gain momentum in the 21^st century, for mainland Chinato adapt swiftly and integrate into the dynamic global economy, the country further affirmed its strategic positionin supportinginternational convergence of practicing standards for professional accountants. This response articulated China’s strategy of using international standards as benchmarks, to achieve convergence of Chinese standards with international standards.

 

In early 2006, “Chinese Accounting Standards” (CAS) and “Chinese Standards on Auditing” (CSA) were released by the Ministry of Finance. These standards marked the establishment of a system of practicing standards for professional accountants which caters for the deepening of the market economy and conforms to the trend of international convergence. Generally, the system has been well received and is being implemented smoothly.

 

In October 2009, CICPA issued the Code of Ethics for Chinese Certified Public Accountants (the “Chinese Code”). The Chinese Code was convergent with the prevailing international code issued by IESBA.

 

In November 2010, CSAs were updated to maintain continuous convergence with the clarified ISAs.

 

1.2 International reaction to convergence in China

 

In review of China’s work on convergence, there have been dramatic and sweeping changes in the accountancy profession over the past 35 years. The acknowledgement is not solely from within China, but also from the international community. 

 

The International Accounting Standards Board (IASB), and the International Auditing and Assurance Standards Board (IAASB), signed joint statements with China Accounting Standards Committee (CASC) and Chinese Auditing Standards Board (CASB), to recognize China’s achievements in international convergence of accounting and auditing standards.

 

Sir David Tweedie, former Chairman of IASB, commended the actions taken by China on its accounting reform and recognized China’s contribution in pushing international convergence of accounting standards. The IAASB also commended China’s great efforts and the enormous progress in achieving international convergence of auditing standards and commented that China may serve as an example for other developing or transitional economies.

 

The World Bank, in its assessment report released in October 2009, gave high marks for the achievements in reform of Chinese accounting and auditing standards. In the “Report of The Observance of Standards and Codes-Accounting and Auditing”, it noted that there is an invaluable lesson from China related to the transition of accounting and auditing standards and improvement of practice quality, which can serve as a guiding example for other countries.

 

1.3 Lessons and insights from the internationalization of Chinese standards

 

The work related to convergence has brought a significant transformation to the accountancy profession in China. Perseverance in convergence over the past 35 years has taught us much and offered valuable insights.

 

1.3.1 Maintaining an interaction between accounting and economic reform

 

First and foremost, we now have a firm grasp on the process of national economic reform and development. We lost no time in promoting the accounting reform as we responded to the vast economic reforms in China, which started in 1978. We have also learned that it is both sound and imperative to match and integrate accounting reforms with economic reforms.

 

Economy and accounting go hand in hand. On the one hand, we see accounting reform should support economic reform. Whenever there is economic reform, revision in accounting standards should follow. It can be seen in China’s example, that our three stages of accountancy development are closely timed and tied to the country’s opening up policy and economic reforms.It’s not an overstatement to say much of the transformation of the accountancy profession correlated to China’s development as a market economy. China’s ambitious plans for reform and opening up, to attract foreign investment, and to increase outbound investment, all pointed to the crucial need for practicing standards for professional accountants that can support and sustain such initiatives.  

 

On the other hand, accounting reform also pushes economic reform forward. Released in 1992, the “Dual standards, Dual systems” not only popularized the common rules and practice of market economy, but also educated entrepreneurs and supervisory agencies to the core ideas underlying a market economy and modern corporate system.

 

1.3.2 Drive accounting development through global cooperation

 

Secondly, what we have learned is the need to closely follow the trend in the development of the global accountancy profession and, through international cooperation, jointly catalyze future advancements in the profession. In the process of convergence, multi-level and all-dimensional channels of communication were opened with international standard-setting bodies. Close cooperation with major economic communities were established. We maintain regular contact with the International Accounting Standards Board (IASB), the International Federation of Accountants (IFAC), regional accounting and auditing organizations and many other professional bodies around the world. We also advocated the establishment of the Asian-Oceania Standard-Setters Group (AOSSG). We were instrumental in urging the International Accounting Standards Board to establish the Working Group for emerging economies to enhance communication. We also sent representatives to serve in senior positions in international accounting bodies. We increased our influence, impact and input through close interaction with the international standard-setting bodies.

 

In 2012, we received recognition of equivalence in China-EU accounting standards. With the US, we have a regular communication process with FASB. In 2011, China agreed to a plan with Japanese and Korean accounting standards setting bodies on how to collaborate over the coming 10 years.

 

Involvement in the international community has helped China to gain recognition and praise. In particular, the contribution and open mind shown by China’s accountancy profession in the recent global financial crisis brought praises from the global accountancy profession, the G20 summit, and the Financial Stability Board (FSB).

 

It is worthy of note that cooperation among mainland China, Hong Kong S. A. R., Macau S. A.R. and Chinese Taipei is well established in the field of accounting and auditing. "Joint Declaration on the Convergence of China Auditing Standards (CAuSs) and Hong Kong Auditing Standards (HKAuSs)” was signed between CICPA and HKICPA in 2007. We established a CPA exam centre in Macao S.A.R. in 2010. Since 2010, we have established multiple channels to enhance cooperation in the field of practicing standards for professional accountants with Chinese Taipei such as creating a base for “Accounting Cooperation between Mainland China and Chinese Taipei” and “Cross-Straits Forum” as bridges to strengthen exchanges and cooperation.

 

1.3.3 Create a "Chinese convergence" model and establish a continued convergence mechanism

 

Thirdly, we believe that the establishment and internationalization of accounting and auditing standards is aninfrastructurein driving forward the development of a market-oriented economy and to enhance global cooperation.

 

In consideration of the legal background, linguistic habits, and the progress of market-oriented economy, we applied a "Chinese convergence" model and used international standards as the basis for setting domestic standards. The model was consistent with the trend towards globalization of practicing standards for professional accountants, while being fit for the economic circumstances in mainland China.

 

Since this is a dynamic process, we have established a continuous convergence mechanism.

 

In April 2010, the "China Accounting Standards and International Financial Reporting Standards continued convergence roadmap" further confirmed the convergence model. Chinese standards on auditing were subsequently revised in November 2010 to adopt fruits of the “clarity project” to maintain the trend of continuedconvergence towards international standards.

 

1.3.4 Standards should be developed in conjunction with the supporting enforcement mechanism

 

Fourthly, standards setting and enforcement mechanism should evolve simultaneously. Under the process of standard setting, we learned effective implementation was of equal importance to the globalization of Chinese practicing standards for professional accountants.

 

Aiming to expand and strengthen the achievements of the globalization of Chinese standards, we have provided a range of supporting measures related to the implementation of standards, including: setting and releasing interpretations and application guidance, organizing promotion and training, improving the supervision mechanism, especially a quality assurance system focused on the prevention of systematic risk.

 

 

Section 2 The Challenges of ApplyingInternational Standards Locally

 

It should be noted that, the fundamental ideology of international standards was derived from developed countries’ economic and accounting background. The concepts and assumptions underlying international standards are, therefore, rooted in this environment. For emerging economies, countries with economies in transition, as well as non-English-speaking countries or regions, international standards are likely to be seen as more “exotic”, rather than the crystallization of local professional practice.

 

The major obstacle that we identified in achieving the internationalization of accounting and auditing standards is how to translate the “exotic” nature of international standards into the daily practice of millions of accountants in order to deliver high-quality accounting information. This is the ultimate end and essentially the “challenge of local implementation".

 

2.1 Difficulties arise from linguistic diversity

 

International standards are written in English. For economies where English is not the lingua franca, it is highly likely that there will be a divergent understanding of the standards. Even in different English-speaking economies, it is likely that some different interpretations of language will arise. Thus the limitation of language is likely to become a major obstacle to achieving uniformity in understanding international standards and in maintaining implementation consistency.

 

Historically, scholars identified widely divergent interpretations of the term "probable", commonly used in IFRSs, from one country to another. The IASB subsequently addressed this problem by developing the Glossary.

 

Another example drawn from auditing standards relates to the use of some modal verbs such as "would", which resulted in ambiguity as to whether the stated procedures were always required or only when required by professional judgement. This issue has been addressed by IAASB in its clarity project. However, differences still remain in wording for mandatory requirements between US standards that use "must" and "should" while ISAs use "shall".

 

The difficulties encountered are even greater where standards need to be translated into a language other than English. For many technical English words, it is often difficult to find a corresponding native expression. One of the important aspects for local implementation of international standards is to be able to translate the standards with a scientific and prudent attitude, using paraphrasing where necessary.

 

2.2 Distinction of “substance” versus “form”

 

From the perspective of accounting, a given type of economic transaction should lead to an identical result, regardless of location or the entity involved. This is the fundamental objective defined by IASB for international convergence of accounting standards. A core principle of accountancy profession globally is, therefore, that “substance” takes precedence over “legal form”. We note that, due to differences in legal systems, history, tradition, and many other factors, in different places there will be diverse types of transaction, forms of transactions or combination of transactions. IFRSs were developed based on transactions experienced in a developed economy – particularly those encountered in Western Europe and U. S.. However, even between developed economies, differences can be found in the kinds of transactions. The differences will be even greater for developing and emerging economies. It’s very likely that transactions of the same form may have different economic substance. If we apply IFRSs on a clause-by-clause basis, it may be possible that the results will be diametrically opposed to those intended. It is therefore essential to implement IFRSs with a firm grasp of the objectives and underlying principles to be able to identify the appropriate substance of a transaction.

 

2.3The impact of traditional culture

 

In the context of Chinese culture, relationships such as family, friendship and others play an important role in influencing social relationships. Similar cultural features inevitably impact on the application of international standards.

 

For instance, immediate family is an extremely important concept in the IESBA Code. This concept is utilized extensively in defining audit independence. The Code defines the immediate family as spouses or dependents. This definition reflects the cultural background of western society which focuses on self-independence. According to these independence requirements, the definition seems to be too narrow in the Chinese cultural environment and would not be sufficient to fulfil its original goal of protecting audit independence.

 

We consider that there are likely to be some cases where audit independence may be compromised by the use of such a narrow definition. Compared with the Code, Chinese Code has therefore expanded on the definition of immediate family by defining it as “parents, spouse and children” without an emphasis on “economically-relied relationship”. Also, similar room for analysis exists for the definition of “close member of the family” in international accounting standards.

 

As another example, ISA240 has the basic requirements in terms of identification, assessment and response of fraud risk. Those requirements unquestionably would also be applied to Mainland China. In the Chinese cultural environment, however, it is also necessary to consider social relationships, such as family, friendship and others who might have a significant impact on the identification of, the assessment of and response to fraud risk.

 

2.4The impact of professional judgment

 

International standards are principle-based and respect professional judgment by professional accountants. Principle-based standards and professional judgment are dependent on each other, constituting the distinctive feature of international standards. The application of international standards is dependent on professional judgment being applied by the accountancy professionals. Examples from accounting standards include: choice of accounting policies, determination of accounting estimates, "control", "significant influence", and impairment of assets. Examples from auditing standards include: determination of materiality and the identification of, assessment of, and response to risks of material misstatement.

 

While principle-based international standards leave more room for professional judgment, many regions, including much of Asia, are more familiar with a "clause type" legal tradition, similar to the "Civil Law". Inherently, such a legal tradition restrains the professionals from fully establishing their confidence, authority and self-discipline, which in turn leads to professionals, including accountants, relying more on legal guidance than on professional judgement.

 

Implementation of international standards relies heavily on one’s ability to use professional judgement. Without it, the professional accountants may be at a loss on what to do especially when the issue is not covered or not explained fully by international standards. As this relates to a way of thinking, it is inherently more difficult than merely translating the international standards.

 

 

Section 3Recommendations on How International Standards can Function Well in Local Settings

 

3.1To international standard-setting bodies

 

In drafting international standards, the standard-setting bodies need to avoid making exclusive reference tothe context of English-speaking and/or developed economies, including market circumstances, customs and practice, and regulatory requirements. It is also necessary to consider other economic communities, such as: emerging economic communities and countries and regions with economy in transition, concerning their difficulties, thoughts, and demandsin understanding and implementing international standards.

 

While relying on the theory, technical methods, and practical experience of developed countries, international standard-setters also need to pay attention to other economic communities in terms of the level of involvement, relevance of clauses and degree of difficulty on implementation of new standards as they are developed.

 

Recently the IASB has established an emerging economies working group, which helped to increase participation from those economies in standard setting. The clarity project of IAASB has been completed, which made significant improvements tothe structure and contents of the auditing standards. Both of these actions deserve full affirmation and can be extended to other areas.

 

3.2To national and regional standard-setting bodies

 

For any given country, region or economy, much importance should be attached to local application of international standards. The fundamental objectives of a strategy to converge with international standards must be to improve the quality of auditing and accounting information, allow international standards to take root in the local setting, instead of merely adopting the literal words.

 

On the one hand, we emphasize the need to define the strategy and the specific mode for adopting international standards. On the other hand, we emphasize the need to define the tactics for local application of international standards.

 

Even for jurisdictions where international standards are being adopted directly, it is essential to consider the level of understanding and acceptance by indigenous accountants and regulators of the language, objectives and principles in international standards. Particular responses thereto will be required.

 

Furthermore, as international standards are written in English in the context of a well-developed market economy and a sophisticated accountancy profession, it is essential to devote effort to translation, identification of differences in backgrounds, development of application guidance and training. This is to ensure proper interpretation, and understanding in applying the new standards.

 

3.3To regulatory bodies

 

The differences between professional standards in various jurisdictionsare reducing and may eventually disappear along with the popularization of international standards. Nonetheless, the enormity in undertaking the implementation of international standards will exist for a long time. Supervision upon implementation will have a long way to go. We believe the following:

 

Firstly, there should be a principle-based supervision, which focuses on the analysis of the substance of the specific business transactions and avoids a clause-based approach to compliance.

 

Secondly, it is important to respect and value professional judgment in the supervision of the work of both accountants and auditors, by avoiding dictating the outcome.

 

Thirdly, the legal and regulatory framework applicable to the accountancy profession will need to be enhanced on a continuous basis. Supervision should respect the rules of the market economy. The more congruous the legal and regulatory framework is with the rules of the market economy, the more effective the implementation of international standards can be. Otherwise, it would be to cut the feet to fit the shoes.

 

3.4To the accountancy profession

 

A qualified accountant is largely dependent on his/her capability to apply professional judgment. Accounting is a profession because of this capability. It is also the precondition for internalization of both accounting and auditing standards.

 

Accountants should, therefore, firstly have the consciousness to make professional judgment and recognize that they are deemed to be experts with the duty to make professional judgments.

 

Secondly, it is essential for professional accountants to develop the confidence to make sound professional judgment. An accountant should be considered ashaving authority in the application of accounting principles and professional judgment.

 

Thirdly, maintain continuous self-development, especially with the improvement of the skill of professional judgment. One of the most important factors to have is a profound understanding of modern accounting and auditing theories and international standards, understand the substance of a specific business transaction (substance over form).

 

Finally, it is necessary to maintain self-discipline. Professional judgment is not only an authority but also a responsibility. An accountant should maintain integrity and keep his/her commitment. Someone who garners respect can then be called a true professional.