The impact of changing from Chinese GAAP to IFRS Name: Si Chen H00121138 Module: Coursework Assessment Abstract In the 21st century, economic globalization has become an investible trend. With the rapid growth of economic globalization and the growth of international capital markets, international accounting convergence has become an irreversibly realistic issue for countries worldwide. Thus, international accounting convergence has become the focus of the theoretical and practical issues. At the same time, the development has surged in China.
Due to the fact that China adopted IFRS as references in standard-setting, making an objective assessment of the accounting convergence effect if important to the development of accounting theory and practice. This essay analyses the process of Chinese accounting standard and the possible factors influencing the international convergence effect in China. Key words: GAAP China impact IFRS 1. Introduction In the late 1980s, the philosophy of the Chinese economy underwent a revolutionay shift as the system changed from a socialist-planned economy to a socialist-market economy(Graham & Li, 1997).
This economic reform was designed to modernize China and integrate it more fully with the international market(Hilmy, 1999; Winkle, Huss, & Zhu, 1994). After the government organized stock exchanges in Shanghai and Shenzhen in 1991, the firms issuing A-share are required to obey Chinese GAAP. Meanwhile, the international accounting standards (IFRS) in the world had rapidly promoted, and increasingly close to make it become one of the world’s primary standard which most countries are applying.
The essay analyses the ‘Chinese GAAP and IFRS: an analysis of the convergence process’ which is written by Songlan Peng and Joyce van der Laan Smith. It is crucial to investors because the impact that IFRS influenced the level of financial reporting comparability. 2. The development of Chinese GAAP Nowadays, a high-quality accounting information played a vital role as it can help both freign and domestic inestors to evaluate investments and increase the confidence about the future of the company. The Chinese government decided to organize these issues and developed a set of accounting standards.
China accounting standards committee (CASC) and IASB actively cooperated to achieve convergence of accounting standards. In February 2006, CASC has worked out a set of new accounting standards and related guidelines which based on IFRS. The main content is roughly the same with IFRS. Then, the new accounting standards began to apply to merge and separate financial statements in the listed company since 2007. This large-scale inform aimed to improve the Chinese capital market economy, and strive to the convergence of international accounting standards.
Meanwhile, they improve the accounting information transparency and comparability in order to attract more investment from other countries. In 1998, the government issued the new accounting regulation for listed companies, in order to eliminate some problems between Chinese GAAP and IFRS, such as the value assets. Chinese GAAP require the adhering historical cost strictly, and government has fixed the depreciation rates for capital assets and bad debt allowances for receivables (0. 3%-0. 5%) regardless the type of the business.
Since 1999, all Chinese companies are required to adopt the 1998 regulations. In 2001, there was the system which called accounting regulations for business enterprise, it suited to all Chinese listed companies, foreign investment firms and state owned enterprises. Furthermore, Chinese accounting system generally covered all types of business by now. For example, before 1998, the item as fixed assets, construction in progress and intangible assets used to be regarded as the historical cost and regarded as actual cost incurred since 2001 GAAP. Still, indirect loans are regarded as “principal amount”.
The assets has a new definition which is a resource owned or controlled by an enterprise as the result of a past transaction or an event from which future economic benefits are expected to flow to the enterprise” Before 1998 GAAP, some fixed assets such as obsolete fixed assets held for disposal may be recorded as a separate item for long-term assets. However, before 2001 GAAP, these items should be canceled. Although there is no precise article to explain these item in IFRS, Chinese standard become convergence with IFRS because it results from the newly revised definition of “assets” . The impact of accounting convergence 3. 1 Stock price The impact on the performance of assessment of companies, for instants, stock price, and the result of the market value of firms will fluctuate. This is a great problem recently concerned by many investors. Generally speaking, the fluctuation result in from the change of accounting standards can be divided into two aspects. First aspect is the manipulation may be conducted by companies before the implementation of new standards.
Most of them may use the new restrictions on accounting treatments, the aim is to make proper adjustments before it published or effective. They may, for example, revise back the provision for depreciation in advance, because in the new standards, it is will not allowed. Another way is the fluctuation on the liabilities and assets value and liabilities in order to achieve the accordance with the new standards, for example, a series of chain reaction is the result of the adoption of fair value computation instead of the method of historical cost.
However, the impact generated by the new accounting standards is greatly determined by the market efficiency level. For fully efficient markets, the accounting profits changes induced by the change in accounting standards would not show significantly effect upon stock price. The reason is that stock price is usually influenced by the future expectation of the inventors and their required return rate, most changes in accounting standards will often only influence the accounting profits figure, but not the investors’ short-term expectation and companies’ cash flows.
As a result, it will not impact so much on the stock price. 3. 2 Financial situation The difference between Chinese GAAP and IFRS may caused variety of influnce on operation results. Referring to the Asset impairment criteria, there have the example showed below. Assuming that there is a company A, who is used both of Chinese GAAP and IFRS to make the balance sheet, the condition is the same except the asset impairment. And then, analyses the effect of the difference between GAAP and IFRS considering the influence of tax.
Suppose that without the factor of impairment, company A can turn the asset impairment back to 500 000 yuan under IFRS. The exhibit 1 below showing the comparison of balance sheet according Chinese GAAP and IFRS separately, and the exhibit 2 shows the difference between them. As we can see from exhibit 2, Chinese GAAP prohibit the impairment to turn back, it lead to make the assets impairment higher 100% than IFRS, but the net value of fixed assets account for 14% lower, also the total assets, non-current assets, shareholder’s equity and undistributed profits become lower than IFRS.
Obviously, these date explained that there is a large difference so that we can not ignore. EXHIBIT 1 Balance Sheet As 31 December 2007 | |IFRS |Chinese GAAP | | |Rmb’00 |Rmb’00 |Current assets | | | |Cash at bank and on hand |10 |10 | | Inventories | 90 | 90 | | | | | |Total current assets |100 |100 | | | | | |Fixed assets | | | | Cost |400 |400 | | Less: Accumulated depreciation |(50) |(100) | |Net value of fixed assets |350 |300 | |Construction in progress |40 |40 | | Project material | 60 | 60 | | | | | | Total fixed assets |450 |400 | |Total assets | 550 | 550 | | | | | |Current liability | | | |Prepayment, deposit and other payable |80 |80 | | Employee payable |10 |10 | | | | | | Total current liability | 90 | 90 | | | | |Non-current liability | | | | Long-term liabilities |100 |100 | | | | | |Total Non-current liability | 100 | 100 | |Total liability | 190 | 190 | | | | | |Equity | | | | Share capital |200 |200 | | Undistributed profits |160 |110 | | | | | |Total share holder’s equity | 360 | 310 | |Total liability ; shareholder’s equity | 550 | 550 | EXHIBIT 2 The difference of balance sheet table Item |Difference frontal |Difference in ratio | |Accumulated depreciation |50 |100% | |Net value of fixed assets |-50 |-14% | |Total fixed assets |-50 |-11% | |Total assets |-50 |-9% | |Undistributed profits |-50 |-31% | |Total share holder’s equity |-50 |-14% | |Total liability ; shareholder’s equity |-50 |-9% | 3. 3 Financial ratios
Due to the asset-liability ratio which equal to total liabilities divided by the total value of assets, the total assets will be lower than the IFRS and the liabilities will not affected under Chinese GAAP, so the asset-liability ratio is higher than IFRS. Also, the impairment of assets are not allowed to return will reduce the total assets and does not affect the liability, thus this situation may lead to the asset-liability ratio stay on the high side under Chinese GAAP. Again with company A as an example above, according to the Chinese GAAP, the asset-liability ratio accounts for 38%, besides, it calculated the asset-liability ratio is 34. 5% according to IFRS. Comparing with Chinese GAAP and IFRS, the asset-liability ratio absolute value is higher about 3. 45%, at the same time, the proportion is about 10%. Visible, two criteria differences will affect on asset liability ratio changes. Method of adopting IFRS According to the analyses which stated above, there are five method of adopting the IFRS. Firstly, evaluating the relevant information of the project is important, and then indentifies internal and external capabilities and resources. It is likely that the CFO will make an assessment depended on the situation which companies involved and then make a strategy of adopting IFRS.
After evaluating, the companies should analyses some detail of the accounting project, such as recognizing the difference between IFRS and GAAP, and making it convergence. The procedure of convergence is important as some of primary IFRS/GAAP difference will be displaced and make the convergence effective. So the leader of company will summarize and extend the analysis to deal with all the problem may happen. After all the information is gathered, companies understand the information about the costs, benefits and accounting targets. In order to solve this issue, there have the changing process including timeline and training and then applying into practice. At last, companies should monitor the process.
For example, Since IFRS adoption isn’t likely to be optional for public companies, the overall project provides for compliance with the new reporting regulations. Measuring benefits under these circumstances can be somewhat academic, especially when the benefits cited in the public policy debate concern efficiencies of global capital markets and don’t translate easily into measurable incremental revenues or cost savings at the company level. (Joseph M. , 2011) Conclusion The development of accounting circumstance became a gradual process, thus, the difference of Chinese economy, capital market, principal of law et cetera will exist in the future. Also, accounting in any countries are in certain accounting environment, it will change under the object factor.
Because of the different of external environment, the local accounting became difference and represented their national characteristics. Based on this, even though the Chinese accounting standards has substantial convergence into IFRS, but in a certain ranges and certain period of time, as the result of China’s accounting environment and the difference of the western countries is inevitable exist, therefore, the difference between Chinese accounting standards and IFRS are not totally equate in the short term. with the trend of economic globalization, the rise of international capital flow and economic exchanges is speeding up day by day. In the face of global accounting standards, China should actively help to bring about the convergence of account.
The period of IAS/IFRS transition during 2005 to 2007, through the cooperation of IASB and FASB and make them intergradation, most of the quality about IFRS is expected to substantially improve, China as a member of the IASB should take an active part in the concrete work of IASB. At present, most of the European Union member states and Australia are actively formulate plans and measures and expansion joint Rail work. Chinese government should recognize the situation, in order to make up his own practice measures as early as possible. Reference 1. Peng, S and Smith, J (2010) ‘Chinese GAAP and IFRS: An analysis of the convergence process’ [online], available: http://ezproxy1. hw. ac. uk:2171/science/article/pii/S10619518090 00287 [accessed 12 October 2012]. 2. Joseph M.
Langmead (2011) ‘How to adopt IFRS in five steps’ Strategic Finance [Online] available: https://vision. hw. ac. uk/webapps/portal/frameset. jsp? tab_tab_group_id=_9_1 [accessed 12 October 2012] 3. Li, R(2007) ‘The impact of difference between Chinese GAAP and IFRS’ accounting[Online available: http://www. cnki. net/KCMS/detail/detail. aspx? QueryID=2&CurRec=2&recid=&filena e=KJZO200711049&dbname=CJFD2007&DbCode=CJFQ&urlid=&yx= [accessed 12 October 2012] 4. Liu C. , Yao L, Hu N and Liu L ‘The impact of IFRS on accounting quality in a regulated market: an empirical study of china’ journal of accounting’ [online] available: https://vision. hw. a c. uk/webapps/portal/frameset. jsp? tab_tab_group_id=_9_1[accessed 12 October 2012]