China cautious over West's fair value stance

Though its top trading partners continue to stick with the fair value or
mark-to-market accounting principle dictated by international financial
reporting standards (IFRS), China remains unwilling to embrace the technique.

Beijing, keen to nurture its companies into global corporate champions, has
been bringing its accounting standards for business enterprises closer to IFRS,
but it won’t require listed companies to use the fair value approach, at least
‘not for the foreseeable future,’ Dickson Leung, partner at the Beijing offices
of Lehman Brown, told Accountancy Age.

Fair value, which requires companies to value their assets at current market
value, has become an increasingly controversial issue during the credit crisis.
Critics argue that the principle is responsible for the multi-billion pound
write-downs taking place on financial assets.

The International Accounting Standards Board has made its application of fair
value more flexible, while the US financial watchdog, the Securities and
Exchange Commission, undertook a study to see whether fair value accounting was
in need of reform. Both organisations have broadly stood by the principle.

Cold shoulder

So, it will come as a surprise to many to see that elsewhere in the world the
authorities do not, as yet, see fair value as a burning issue.

Currently, China offers listed companies the option of using fair value to
assess the cost of certain investment assets, but prohibits fair value for
operational assets such as property, plant and equipment. China’s policymakers,
he says, are keen to protect the value of China’s nascent, largely state-owned
multinationals: ‘They see fair value as encouraging dangerous boom and bust
cycles.’

If China does finally adopt fair value, however, this could certainly make
life easier for accountancy firms servicing international clients in the
country. The clash between Chinese and international accounting standards on the
use of fair value, however, rarely becomes an issue for accountancy practices
such as Lehman Brown, explains Leung, because most foreign firms in China are
(due to restrictions on many business sectors) manufacturing or trading
companies rather than publicly quoted companies requiring detailed accounts.

That said, a lack of knowledge among China’s accountants of fair value
accounting can still be a headache for international accounting firms. Local
accountants, explains Leung, can manage short-term investments designated as
‘financial assets at fair value through profit or loss’ by using quoted prices
in an active market as the best evidence of fair value.

‘But they particularly struggle if the financial instrument does not have an
active market… they’re very inexperienced in using alternative valuation
techniques to establish fair value,’ he added.

And it is not a simple case of bringing in western talent to do the job. To
practice in mainland China, western and Hong Kong accountants must pass the
Chinese Institute of Certified Public Accountants examination and prove three
years’ auditing experience.

Crucially, the exams are in Mandarin only, says Hong Kong-based Christine
Fung, an accountant overseeing the mainland practice for Fiducia Management
Consultants.

Aside from taking exams for the bookkeeping and the main accounting licence,
Chinese accountants are required to take annual courses in specific skills
areas, typically two or three courses which are certified by the CICPA. Fung’s
own qualifications from the US are recognised in Hong Kong, but she has had to
take separate exams in local law and taxation. She says that mainland China,
unlike Hong Kong, requires non-CPAs (Chinese chartered professional accountants)
to have a separate licence to practice basic bookkeeping.

Non-Chinese accountants find challenges other than language. The biggest
difference between doing accounts in Hong Kong and the mainland is tax related.
Tax filings must be made monthly on the mainland and annually in Hong Kong, says
Juan Silvestre, former CFO of the mainland China operations of Spanish food firm
Cola Cao.

Data-day obstruction

Meanwhile, the opaque nature of China’s regulatory system will complicate any
shift to fair value. The availability and reliability of data in mainland China
makes it difficult to use accepted valuation techniques in fair value
calculations, says Leung.

‘When applying the discounted cash flow analysis, it may be difficult to
obtain the cash flow forecast and projections of the investee. It’s also
difficult to judge how reliable these figures may be,’ he says.

Similarly, the lack of reliable information in the marketplace ‘makes it hard
to derive the fair value through making reference to the current fair value of
another instrument that is substantially the same.’

Leung predicts that better training for Chinese CPAs will make life easier
if, and when, China goes to fair value. Indeed, the CICPA, according to its
secretary general Dr Chen Yugui, has a strategic plan to improve the quality of
local CPAs, by drawing on international training standards.

A series of CICPA agreements with countries including the UK and Singapore
allow Chinese CPAs to take qualifications in these territories. In China, CPA
programmes in about 20 higher education institutions have produced nearly 20,000
graduates since 1994. Chen claims to have observed ‘remarkable improvement’ in
the managerial skills and competence of local CPA trainees.

Meanwhile, the still-dominant role of the state in China’s economy may be an
Achilles heel for Chinese accountants with international aspirations.
Accountants at state-owned companies have never had to project cash flow since
state-owned companies have relied on loans from state-owned banks, instructed to
lend by their political masters, says Juan Silvestre.

State-owned firms will be hard pressed to use fair value principles, since
much of the information required has not been habitually collected by
state-owned firms, said Silvestre.