China Petroleum and Chemical Corporation

232 Chapter Six Comparative Acco unting Learning Objectives After reading this chapter, you should be able to • Describe some aspects of the environment in which accounting operates in\ fi ve countries: China, Germany, Japan, Mexico, and the United Kingdom.

• Explain the nature of the accounting profession in the selected countrie\ s.

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• Discuss the mechanisms in place for regulating accounting and fi nancial reporting in the selected countries.

• Examine some of the accounting principles and practices used by companie\ s in these countries.

• Identify the areas where national accounting practices in these countrie\ s differ from International Financial Reporting Standards (IFRS). INTRODUCTION This chapter describes the accounting environments in fi ve countries: China, Germany, Japan, Mexico, and the United Kingdom. We selected these countr\ ies because they are economically important and they represent a cross-secti\ on of the different accounting systems used around the world. Further, their accou\ nting systems refl ect their unique historical and cultural backgrounds. Exhibit  6.1 pro- vides comparative demographic and economic data for these countries. Germany, Japan, and the United Kingdom are among the wealthiest nations in the wo\ rld, whereas China and Mexico are developing economies. China, with a populat\ ion of over 1.4 billion, has been one of the fastest-growing economies in recen\ t years. As a result of recent economic reforms, Chinese accounting is experiencing \ a period of rapid evolution. Germany is one of the economic powerhouses in Europe\ , and its accounting system is undergoing change from the Continental European\ ap- proach to accounting. Japan became a major economic power within a short\ period after World War II, focusing on high-tech industries. Its unique system \ of business interrelationships has had a profound impact on accounting. Mexico is re\ presenta- tive of Latin American countries. As a member of the North American Free\ Trade Agreement (NAFTA), Mexico has been under external pressure to change i\ ts accounting system. The United Kingdom represents the Anglo-Saxon model o\ f ac- counting. Recently, accounting in the United Kingdom has been strongly a\ ffected by the country’s membership in the European Union. dou62206_ch06_232-299.indd 232dou62206_ch06_232-299.indd 232 23/12/13 4:11 PM23/12/13 4:11 PM 233 EXHIBIT 6.1 Country Profi les Source: http://news.bbc.co.uk/2/hi/country_pr ofi les/default.stm China GermanyJapanMexicoUnited Kingdom Area 9.6 million sq. km (3.7 million sq. miles) 357,027 sq. km (137,849 sq. miles)377,864 sq. km (145,894 sq. miles)1.96 million sq. km (758,449 sq. miles)242,514 sq. km (93,638 sq. miles) Population 1.34 billion (UN 2009) 82.2 million (UN 2009)127.2 million (UN 2009)109.6 million (UN 2009)61.6 million (UN 2009) Capital City Beijing BerlinTokyoMexico CityLondon Life Expectancy 71 years (men) 75 years (women) (UN) 77 years (men) 82 years (women)79 years (men) 86 years (women)74 years (men) 79 years (women)77 years (men) 82 years (women) Currency Renminbi (Yuan) (1 = 10 jiao = 100 fen) Euro (1 = 100 cents) Yen Peso (1 = 100 centavos)Pound Sterling (1 = 100 pence) GNI Per Capita US$2,940 (World Bank, 2008) US$42,440 (World Bank, 2008)US$38,210 (World Bank, 2008)US$9,980 (World Bank, 2008)US$45,390 (World Bank, 2008) dou62206_ch06_232-299.indd 233dou62206_ch06_232-299.indd 233 23/12/13 4:11 PM23/12/13 4:11 PM 234 Chapter Six The discussion related to each country’s accounting system is organized into four parts: (1) background, (2) accounting profession, (3) accounting regulation, and (4) accounting principles and practices. We discuss the countries in alphabeti- cal order. PEOPLE’S REPUBLIC OF CHINA (PRC) Background The ultimate legislative authority in China rests with the National Peop\ le’s Con- gress, the highest organ of state power. It is elected for a term of fi\ ve years and has the power to amend the constitution; make laws; select the president, vi\ ce presi- dent, and other leading offi cials of the state; approve the national economic plan, the state budget, and the fi nal state accounts; and decide on questions of war and peace. The State Council is the highest organ of the state administratio\ n. It is com- posed of the premier, the vice premiers, the state councillors, heads of\ ministries and commissions, the auditor general, and the secretary-general. With the formation of the People’s Republic of China (PRC) in 1949, \ the government adopted a policy of establishing a single public ownership ec\ onomy with centralized management of businesses and control of all economic resources.

By 1956, all private companies had been transformed into state or collec\ tive ownership. However, these state-owned enterprises (SOEs) eventually proved to be economic failures. For example, during 1995–1997, more than half of them were in the red, and the losses in 1995 alone were close to 100 billion renminbi (US$12 billion). 1 Restructuring the loss-making SOEs was a major part of the sub- sequent economic reforms, which aimed at transforming the centrally planned economy into a socialist market economy, that is, a market economy based on so- cialist principles. Under the reform agenda, private enterprises, cooperatives, and joint ventures coexist and compete with state-run entities. The radical economic changes implemented over the last decade have made China one of the fast\ est- growing and largest economies, with annual economic growth rates among the highest in the world. Currently, in terms of gross domestic product (GDP), China ranks second behind the United States. To carry out its reform program, China needed capital and advanced technol- ogy. This led to an open-door policy of attracting foreign direct investment (FDI), which emphasized the importance of developing a capital market. With nearly 500,000 FDI enterprises, China is now the world’s number one recipient of foreign direct investment. Today there are about half a million foreign investment entities in China, with parent entities in more than 170 countries. Foreign direct invest- ment started to move into China in 1979, when the Equity Joint Venture Law was issued. In 2004, China received $60.6 billion worth of FDI, accounting for more than one-third of total FDI infl ows in developing countries and about 15 percent of FDI infl ows worldwide. The FDI infl ows into China are mainly through large-scale transnational corporations, in high-tech areas and capital-intensive projects, such as petroleum, automobiles, and large-scale integrated circuits, and a tertiary sector including securities, banking, telecommunications, transportation, and t\ ourism. 2 1 C. J. Lee, “Financial Restructuring of State Owned Enterprises in Ch\ ina: The Case of Shanghai Sunve Pharmaceutical Corporation,” Accounting, Organizations and Society 26 (2001), p. 673. 2 T. Xiaowen, Managing International Business in China (Cambridge: Cambridge University Press, 2007), p. 7. dou62206_ch06_232-299.indd 234dou62206_ch06_232-299.indd 234 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 235 Chinese companies were encouraged to raise funds on international capital markets as well as on the domestic one by issuing shares and bonds. For China to maintain the momentum in its development as a player in the foreign invest- ment market, it needed to update its business practices, which had often\ been considered out of sync with the rest of the world. For example, China’s accounting practices were often criticized for falling somewhat short of those set out by the IASB. An accounting practice aimed at measuring how well production targets are met in a planned economy was largely at odds with what was required in a market economy. Chinese accounting statements provided no measure of profi t and loss; there was no recording of the debts of a company; and managers were unable to determine from where the fi rm was making a loss. This caused problems for foreign investors, for example, when looking to perform due diligence work \ on domestic Chinese fi rms. Further, foreign investors in the developing Chinese stock market had diffi culty interpreting the fi nancial statements of Chinese fi rms, and the restatement of the fi nancial statements into “Western terms” was a costly process. The rapid market development and the desire to attract domestic and overseas capital provided direct incentives and pressures for both the Chinese government and listed fi rms to improve the quality of fi nancial reporting.

During the early 1990s, the government introduced nongovernmental own- ership in state-owned enterprises and organized stock exchanges in Shanghai (SHSE) and Shenzhen (SZSE). The government took steps to develop its\ domes- tic capital market. Shanghai’s municipal government approved the fi rst securi- ties regulation in China in 1984. Share dealings did not become popular until the beginning of the next decade, when the Shanghai Stock Exchange (SHSE) \ was reactivated in December 1990 and a second stock exchange, the Shenzhen St\ ock Exchange (SZSE), was established in April 1991. 3 The capital market in China is controlled by the government. In July 1992, the Chinese Security Regulatory C\ om- mission (CSRC) was set up as China’s equivalent of the U.S. Securit\ ies and Ex- change Commission to monitor and regulate the stock market. This provided an encouragement for investors to engage in capital market activities. The \ number of companies listed on the two stock exchanges increased from 50 in 1992 to 1,831 at the end of April 2010. By the end of April 2010, according to the World Federation of Exchange, the Shanghai stock exchange had emerged as the sixth largest ex- change in the world, with a market capitalization of US$2,704,778 millio\ n (market capitalization of Shenzhen stock exchange is US$868,374 million; NYSE Eu\ ronext US$11,839,793 million; Tokyo stock exchange US$3,306,082 million; NASDAQ OMX US$3,239,492  million; London stock exchange US$2,796,444 million; and Hong Kong stock exchange US$2,305,143 million). The capital market in C\ hina has now become one of the largest such markets in Asia, second only to that in Tokyo.

It was originally designed to offer opportunities for state-owned enterprises to raise capital, and even today nearly 90 percent of the companies listed on the two stock exchanges are still state-owned. Chinese companies also trade on exchanges outside China (about 100 companies), including the New York Stock Exchange (NYSE) (about 20 companies). Recently, the government announced its plans to allow foreign companies to list in China, which refl ects the government’s desire to open up the country’s fi nancial sector and transform Shanghai into an international fi nancial center. Further, the Minister of Finance and the CSRC have jointly issued an announcement tha\ t CPA 3 I. Haw, D. Qi, and W. Wu, “The Nature of Information in Accruals and Cash Flows in an Emerging Capital Market: The Case of China,” International Journal of Accounting 36 (2001), pp. 391–406. dou62206_ch06_232-299.indd 235dou62206_ch06_232-299.indd 235 23/12/13 4:11 PM23/12/13 4:11 PM 236 Chapter Six fi rms in mainland China will be allowed to audit companies listed on the H\ ong Kong Stock Exchange. By the end of 2009, there were 54 accounting fi rms in China licensed to audit listed company fi nancial statements.

Long-term investment in China’s highly speculative stock market is st\ ill an ex- ception to the rule. Stock holdings typically range from days to a few months.

Investors basically strive for short-term stock price gains, which are not necessar- ily based on fundamental company data. The validity and reliability of fi nancial disclosure are therefore of limited importance to investors. Companies in China issue four categories of shares:

1. “A” shares, which can be owned only by Chinese citizens and are traded on the two stock exchanges. 2. “B” shares (introduced in 1992), which can be owned by foreigners. 3. “C” shares, which are nontradable and held mainly by the government and other SOEs. 4. “H” shares, which can be owned only by foreigners and are traded in Hong Kong. The market capitalization of A shares on the two stock exchanges account\ s for more than 90 percent of the total market capitalization. B shares are fo\ r foreign individuals, institutional investors, and Chinese nationals able to trad\ e in for- eign currency. As of late 2001, only 112 out of China’s 1,160 listed \ fi rms issued B shares; approximately 50 were listed in Hong Kong, and another 20 were l\ isted in New York. 4 Companies listed on the local capital market have a distinctive capital\ structure in which a large portion is made up of C shares, which cannot \ be traded publicly. The categories of shares issued by Chinese companies are very different from those in the United States or Europe, and they have different infl uences on the fi rm. Further, the dynamics in the Chinese boardrooms are quite different from those of Western companies. For example, chairs are full-time executives, and they wield signifi cant power. Senior managers are most likely to be former government bureaucrats, and so they may have a different mind-set than top executives in U.S.

fi rms.

With the introduction of the Qualifi ed Foreign Institutional Investor (QFII) scheme in 2002, which was designed to allow “qualifi ed” foreign institutional in- vestors to purchase a limited amount of securities using Chinese currency, includ- ing the A shares of any Chinese companies listed on the share market, foreign companies can now purchase the shares of Chinese companies listed on the stock market. For example, in October 2003, Kodak succeeded in purchasing 20  per- cent of the shares of Lucky Films, a local company listed on the Shanghai Stock Exchange. By September 2006, 40 foreign fi nancial institutions had been granted QFII status, including Morgan Stanley, Goldman Sachs, HSBC, Deutsche Bank, JP Morgan, Chase Bank, and Merrill Lynch International. Accounting Profession Accounting has a long history and a close association with the developme\ nt of Chinese culture. Its roots can be found in the teachings of the philosop\ her and educator Confucius, which highlight the imperative to keep history and v\ iew ac- counting records as part of that history. The word accounting is noted as far back as 4 China Securities Regulatory Commission China Securities and Futures Statistical Yearbook, (Beijing:

CSRC, 2002). dou62206_ch06_232-299.indd 236dou62206_ch06_232-299.indd 236 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 237 the Hsiu Dynasty, around 2200 BC, when the stewardship function of accou\ nting was emphasized. Later, in the Xia Dynasty (2000–1500 BC), the conce\ pt of measur- ing wealth and accomplishment was mentioned. In China, through thousands\ of years under a feudal social structure, people respected court and schola\ rly offi cials and looked down upon merchants. Accounting for business was viewed as be\ ing a nonskilled profession. More recently, the master–apprentice system \ was used to train accountants up until the 1900s. The fi rst professional accounting legislation was enacted by the Northern Warloads government in 1918. Also, in the ea\ rly 1900s, university study in accounting became an accepted way to understa\ nd and advance the principles and practice of accounting. The fi rst local professional body, the Chinese Chartered Accountants’ Society of Shanghai, was est\ ablished in 1925. By 1947, there were 2,619 certifi ed accountants in China. Since 1949, Chinese scholars returning home after completing their accounting studies abroad, mainly in the Soviet Union, pioneered the development of a body of new knowledge in China, which resulted in existing practices. 5 After the revolution, accountants be- came totally subject to bureaucracy. However, until the 1980s, those who carried out accounting work were not held in high regard in Chinese society compared with their Western counterparts. This was partly due to the traditional Chinese culture of “respecting the peasants and despising the merchants.” 6 Consequently, accounting education has never been well developed in China and was particularly disrupted during the Cultural Revolution (beginning in the mid-1960s). Graham explains some aspects \ of the accounting environment in China as follows: Accounting became focused on reporting compliance with State economic plans, using a specifi ed structure of accounts and following a sources and uses of funds concept. But it is commonly agreed the period of the Cultural Revolution (1966– 1976) marks a dark period for the profession, as accounting was overly simplifi ed with the objective of making accounting accessible and understandable to\ the “masses.” University professors were ousted and occasionally brutalized, and ac- counting theory all but abandoned. . . . The consequence of \ this simplifi cation on top of an already crude Soviet-based system was the loss of a generation or so of true accounting thought, and the absence of any need to refl ect the nature of modern transactions or business concepts in the accounting system. 7 The economic reform and the open-door policy introduced in the 1980s brought about a large number of Sino–foreign joint ventures in China. This resulted in the reemergence of a private auditing profession, supported by the Accounting Law issued in 1985 and the CPA Regulations in 1986. The CPA Regulations, promul- gated by the State Council, prescribed the scope of practice for certifi ed public accountants (CPAs) and some working and ethical rules. These developments led to the formation of the Chinese Institute of Certifi ed Public Accountants (CICPA) in 1988, the fi rst professional accounting body in China since the establishment of the PRC in 1949. Unlike in the United States, accounting and auditing in China took different paths in their development processes. For many years, auditing fi rms mainly 5 L. E. Graham and C. Li, “Cultural and Economic Infl uences on Current Accounting Standards in the People’s Republic of China,” International Journal of Accounting 32, no. 3 (1997), pp. 247–78. 6 Y. Chen, P. Jubb, and A. Tran, “Problems of Accounting Reform in the People’s Republic of China,” International Journal of Accounting 32, no. 2 (1997), pp. 139–53. 7 L. E. Graham, “Setting a Research Agenda for Auditing Issues in the People’s Republic of China,” International Journal of Accounting 31, no. 1 (1996), p. 22. dou62206_ch06_232-299.indd 237dou62206_ch06_232-299.indd 237 23/12/13 4:11 PM23/12/13 4:11 PM 238 Chapter Six audited domestic companies, whereas accounting fi rms focused on companies using foreign investments. Accounting fi rms were sponsored by the Ministry of Finance (MoF), and auditing fi rms were under the State Administration of Audit (SAA), a department within the State Council responsible for government audits.

In 1991, the SAA, in competition with the CICPA, issued its “Tentative Rules on Certifi ed Public Auditors” to regulate auditors employed in audit fi rms. In 1992, the Chinese Association of Certifi ed Practicing Auditors (CACPA) was formed under the auspices of the SAA. 8 The competition between accountants and auditors with their own rules is- sued by different government departments was confusing, particularly to interna- tional accounting fi rms. Consequently, steps were taken to merge the CICPA and CACPA. In 1993, the CPA Regulations were upgraded to become the CPA Law. 9 As a result, the MoF was given the authority to regulate both the accounting and the auditing fi rms. The CICPA became a member of the IASC (and IFAC) in 1997. The merger between the CICPA and the CACPA was completed in 1998. By way of comparison, there are some clear differences between the evolution of the accounting profession in China and in other countries such as the United Kingdom. For example, in the United Kingdom, auditors enjoyed a good leg\ isla- tive and judicial environment during the early stages of development, whereas a market-oriented legal and judicial infrastructure is still emerging in China. Further, UK auditors were able to establish and maintain high quality because they had the support of their professional accounting bodies, which emphasized professional education, training, and examinations. By contrast, these support mechan\ isms are still lacking in China. 10 Finally, unlike in the United Kingdom, accounting and au- diting fi rms in China have been treated separately. This is evident from the coexis- tence of the CICPA and the CACPA, with their admission requirements governed by the respective sponsoring agencies (i.e., the MoF and the SAA). By the end \ of 1997, there were 62,460 practicing CPAs and 6,900 accounting and auditing fi rms in China. 11 The economic reform program, with its open-door policy, has stimulated the growth of accounting and related activities in China in many ways. Prior to re- forms, the accounting system was no more than a way to provide information to the government. The economic reforms rapidly changed, among other things, the ownership structure of organizations. 12 The joint stock company was recognized by the state as the desired organizational structure to reform the SOEs. This cre- ated new demands for fi nancial information from investors and other interested parties. The establishment of the two stock exchanges aiming to develop \ capital market activities led to major changes in China’s accounting system. \ For example, companies that issue B shares are now required to restate their earnings accord- ing to International Financial Reporting Standards, and to provide two annual 8 J. Z. Xiao, Y. Zhang, and Z. Xie, “The Making of Independent Auditing Standards in China,” Accounting Horizons 14, no. 1 (2000), pp. 69–89. 9 In China, laws have a higher legal status than regulations, as laws are stipulated by the National Peoples’ Congress, whereas regulations are promulgated by the State Council (ibid.). 10 Xiao, Zhang, and Xie, “The Making. . . .” 11 Y. Tang, “Bumpy Road Leading to Internationalization: A Review of Accounting Development in China,” Accounting Horizons 14, no. 1 (2000), pp. 93–102. 12 Z. Xiao and A. Pan, “Developing Accounting Standards on the Basis of a Conceptual Framework by the Chinese Government,” International Journal of Accounting 32, no. 3 (1997), pp. 279–99. dou62206_ch06_232-299.indd 238dou62206_ch06_232-299.indd 238 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 239 reports—one prepared by an international auditing fi rm, and one certifi ed by a local accounting fi rm.

Many aspects of the reform program rely on accounting and auditing services to assist the market to work in an orderly manner. Various government regulations on the implementation of economic reform measures require the involvement of independent auditors. The post-Enron era has witnessed a growing concern with the issues of auditor independence and audit quality. Legislators, regulators, and professional bodies have suggested mandatory auditor rotation at both the part- ner and the fi rm level after a fi xed period of tenure, as a method to enhance audi- tor independence. Unlike in the United States, auditors in China (norma\ lly two CPAs) are required to sign their names on audit reports. In October 2003, the CSRC and the MoF jointly issued a policy requiring auditors who sign the audit report of a listed company to be rotated off after fi ve years. Given the close relationship between audit partners and their listed clients, this policy was aimed a\ t ensuring auditor independence and audit quality. The laws on Sino–foreign joint ventures require the audit of annual statements and income tax returns and the verifi cation of capital contributions by registered Chinese CPAs. These additional demands for accounting services created new opportunities for international accounting fi rms to enter the Chinese market. In the past, because only certifi ed public accountants (CPAs) licensed by the Chinese authorities would be allowed to establish p\ artner- ships or limited liability accounting fi rms in China, to be able to operate in China, foreign accounting fi rms needed to affi liate with local fi rms.

Recently, Beijing has offi cially announced its plan to allow foreign companies to list in China. This refl ects the government’s ambitions to open up the country’s fi nancial sector and transform Shanghai into an international fi nancial center. Fur- ther, in the process of globalization, it is necessary for investors and accountants over the world to both celebrate common ground achieved and understand the deeply rooted differences. By providing services to foreign investors, the international accounting fi rms have assisted in the implementation of the open-door policy. They also have as- sisted in the development of the Chinese capital market by, for example, undertak- ing fi nancial audits of Chinese companies that offer shares to overseas investors and that wish to obtain a foreign stock exchange listing. In addition, the interna- tional fi rms have been involved in training Chinese auditors and setting audit- ing standards. More than 200 of the world’s top 500 companies have invested in China. All of the leading international accounting fi rms, following their clients, have moved into China by opening representative offi ces.

The Practice of “Hooking Up” The practice of “hooking up” refers to an affi liate relationship between an ac- counting/auditing fi rm and its sponsoring organization, normally a government body. 13 The hooking-up relationship is rooted in the circumstances in which the\ se professional accounting fi rms were originally established. At the beginning of the reform process, the Chinese government required all newly established pr\ ofes- sional accounting fi rms to affi liate themselves with a government agency or a government-run institute. Before 1996, all Chinese audit fi rms were affi liated with government agencies, government-sponsored bodies, or universities and re\ search 13 X. Dai, A. H. Lav, and J. Yang, “Hooking-up: A Unique Feature of China’s Public Accounting Firms,” Managerial Finance 26, no. 5 (2000), pp. 21–30. dou62206_ch06_232-299.indd 239dou62206_ch06_232-299.indd 239 23/12/13 4:11 PM23/12/13 4:11 PM 240 Chapter Six institutions. Aiming at ensuring fi nancial and operational independence for audi- tors, the CICPA and the MoF launched the disaffi liation program in 1996. This program required all auditors to sever their links with their sponsoring\ bodies.

The CICPA and the MoF had also been engaged in establishing a new set of\ Inde- pendent Auditing Standards since 1995 which were in line with the Intern\ ational Standards on Auditing promulgated by the IFAC. However, it was diffi cult for them to be independent because of the historical connections. As a result, most domestic professional accounting fi rms continued to have some government con- nection, and truly independent private accounting fi rms are rarely seen in China.

Further, some of the clients of these organizations are themselves directly or in- directly related to the “hooked” organization because of complex ownership and control arrangements.

Guanxi Guanxi refers to connections or tight, close-knit networks. It can be consider\ ed an important feature of Chinese business culture. With guanxi, it is possible to ac- complish almost anything, but without it, life is likely to be a series \ of long lines and tightly closed doors, and a maze of administrative and bureaucratic \ hassles. 14 Although it is common practice in China, it is likely to create an ethic\ al dilemma for foreign investors because if they do not practice guanxi , they are unlikely to succeed in China, but if they do practice guanxi , they may be doing something ethically wrong or against the law of their own country, for example, th\ e Foreign Corrupt Practices Act of 1977 in the United States. The prevalence of guanxi may be contributing to the large-scale corruption in China. Under its infl uence, guanxi -related considerations often prevail over ethics- related considerations in accounting and auditing practice. Accountants and fi nancial managers often have to use guanxi to do business with business partners or government offi cials in a way that is in violation of their professional ethics. 15 This shows the importance of understanding the environment in which ac- counting is practiced in a country. In China, civil litigation is very rare, and thus the CSRC is the prime discipliner of fi rms and their managements. Further, the relatively young Chinese auditing profession provides insuffi cient support for accounting standards, because auditors lack both professional training and in- dependence. 16 Until recently, accounting education in China has been based on “Uniform Accounting Systems” (UAS) and lacked a conceptual underpinning and an international outlook. Furthermore, as a result of the absence of sophis- ticated users and providers of accounting information, Chinese auditors have enjoyed an almost litigation-free environment. China is said to have a set of collectivism-oriented societal values and\ a rela- tively low degree of professionalism. 17 Independence, belief in individual deci- sions, and respect for individual endeavor are not emphasized. People do not take responsibility for something that has not been approved by systems and rules. 14 S. D. Seligman, “ Guanxi: Grease for the Wheels of China,” China Business Review 26, no. 5 (1999), pp. 34–38. 15 M. Islamand and M. Gowing, “Some Empirical Evidence of Chinese Accou\ nting System and Business Management Practices from an Ethical Perspective,” Journal of Business Ethics 42, no. 4 (2003), p. 358. 16 B. Xiang, “Institutional Factors Infl uencing China’s Accounting Reforms and Standards,” Accounting Horizons 12, no. 2 (1998). 17 L. M. Chow, G. K. Chua, and S. J. Gray, “Accounting Reforms in China: Cultural Constraints on Implementation and Development,” Accounting and Business Research 26, no. 1 (1995). dou62206_ch06_232-299.indd 240dou62206_ch06_232-299.indd 240 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 241 Collectivism thus supports devising uniform accounting systems and makin\ g ac- counting policy at the national level. This mentality is widely refl ected in account- ing and auditing practices in China.

Accounting professionalization in China over the past 60 years, particularly in recent years, has been dramatic. The public practice of accountants was s\ uspended immediately after the communist government came into power in 1949. The \ ac- counting system in the country was reformed following the Soviet Union model.

As stated earlier, accountants became totally subject to bureaucracy. China revived the public practice of accountants in 1980. Since then, there has been rapid growth in the professionalization of accounting. For example, the CICPA was established in 1988. In 1991, the fi rst national CPA qualifi cation examination was held. The Law on Certifi ed Public Accountants was enacted in 1993, raising the legal status of certifi ed public accountants. However, there are many issues associated with the process of professionalization, and a lack of autonomy might be regarded as the most critical hurdle in that respect. The CICPA is under the direct control of the Ministry of Finance, which has the authority to appoint the leader ship. In re- sponse to numerous accounting scandals, the CICPA has set up the accounting ethics code with “independence, integrity, and objectivity” at the core. However, the spirit of “professional autonomy” is not necessarily encouraged by the existing institutional structure. In October 2007, the ICAEW in the UK and CICPA set up a joint project to facili- tate and promote cooperation between the accounting professions in both coun- tries. As a result, preparers and users of fi nancial statements in China benefi ted from the ICAEW certifi cate in IFRS. Developed by experts and focused on an un- derstanding of all International Standards, the Chinese edition of learning materi- als aims to help China strengthen its commitment to applying rigorous accounting and auditing standards. This speeded up the process of international convergence of accounting standards. China’s Ministry of Finance has issued Draft Interpretation 3 for Chinese new accounting standards, which are consistent with IFRS, to ensure their appropriate application. According to the Chinese Certifi ed Public Accountant, the offi cial journal of the CICPA, China had more than 7,200 accounting fi rms by the end of 2008. This number is 36 times more than in 1988, the year the CICPA came into being. By De- cember 2008, China had registered more than 83,000 CPAs (population 1.34 billion).

The Minister of Finance (MoF) and the China Securities Regulatory Comm\ ission (CSRC) have jointly issued an announcement that CPA fi rms in mainland China will be allowed to audit H-share companies (i.e., those listed on the Hong Kong Stock Exchange) after January 2010. The MoF also provided guidance at the end of 2009 on further improving accounting practice and fi nancial reporting quality for 2010, including additional guidance on fi rst-time adoption, appropriate use of professional judgment, elimination of the difference in A-share and H-share listed fi rms, and adoption of the concept of “other comprehensive income” in IFRS. Accounting Regulation The government continues to act as the accounting regulator in order to \ retain political control. Through the MoF it issues IFRS-based accounting stand\ ards mainly to meet external pressures but retains a UAS-based approach in pa\ rallel as a means of detailed regulatory control. The UAS has the benefi t of familiarity, both for the regulator and for those subject to regulation. Direct government\ involve- ment in accounting regulation in China is a political tradition that ori\ ginated in the era of central planning. dou62206_ch06_232-299.indd 241dou62206_ch06_232-299.indd 241 23/12/13 4:11 PM23/12/13 4:11 PM 242 Chapter Six In Anglo-American countries, for example, setting authoritative accounting \ standards is the responsibility of accounting societies or independent bodies cre- ated for that purpose, whereas in China, it is the responsibility of the Ministry of Finance, rather than the Accounting Society of China (ASC) or the CICPA or any independent body. In recent years, accounting regulation in China has been infl uenced mainly by China’s desire to harmonize domestic accounting practices (the various uniform accounting systems used in different industries produced inconsistent practices across industries), harmonize Chinese accounting with IFRS, and meet the r\ e- quirements of economic reforms. As new forms of business (such as Sino– foreign joint ventures and joint stock companies) emerged, they created a need for in- ternational accounting harmonization. This prompted the Ministry of Finance to issue pronouncements to achieve it. These pronouncements include the following:

1. The Accounting Systems for Sino–Foreign Joint Ventures (1985). 2. Accounting Systems for Companies Experimenting with a Shareholding System and the Accounting Standard for Business Enterprises (ASBE) (1992) (the ASBE is simi- lar to a conceptual framework). 3. The Accounting Regulations for Selected Joint Stock Limited Companies, issued in 1991 and revised in 1998. 4. Accounting Law (1999). 5. The Regulations on Financial Reporting of Enterprises (2000). 6. The Accounting Systems for Business Enterprises (2001).

7. Accounting Standards for Business Enterprises (2006) (it replaced the 1992 ASBE, and CASs previously issued). As these laws and regulations draw heavily on regulations and practices in Western countries, the current accounting concepts and practices in China mirror, to an extent, those in the mature market economies. Following are examples: the Accounting Law (1999) stressed the importance of “true and complete” accounting information; the Regulations on Financial Reporting of Enterprises (2000) redefi ned the elements of fi nancial statements in line with the conceptual framework of the IASC and stipulated responsibilities and liabilities for parties involved in account- ing, auditing, and reporting. However, the Chinese government has retained a uniform accounting system in the Enterprise Accounting System, issued in 2000 to accommodate the special circumstances of a transforming government, strong state ownership, a weak ac- counting profession, a weak equity market, and the inertial effect of accounting tradition and cultural factors. The movement toward private ownership has required a revision of China’s accounting and disclosure standards. Several major Chinese fi nancial scandals in the early 1990s highlighted the problems associated with the accounting system, which was modeled on the system that existed in the former Soviet Union.\ One of the most notorious was the Great Wall fund-raising scandal, which implicated the Zhongchen accounting fi rm.

In this case, the Great Wall Electrical Engineering Science and Technology Co.

illegally raised one billion Yuan in a few months between 1992 and 1993 by issuing very high coupon securities to over 100,000 private investors in 17 large cities in China. The money raised was partly embezzled and partly used to establis\ h over 20 subsidiaries and more than 100 branches all over the country. A branch of the dou62206_ch06_232-299.indd 242dou62206_ch06_232-299.indd 242 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 243 Zhongchen accounting fi rm played a key role in the fraud: its three CPAs provided an unfounded certifi cate confi rming 0.3 billion Yuan capital after just one day’s work with only 25 pages of working papers. . . . Five CPAs from the accounting fi rm were disqualifi ed and the whole fi rm was dismantled. The president of the client company received the death penalty, a deputy minister was jailed for bribery, and the president of the People’s Bank of China was terminated. 18 The MoF establishes accounting standards and regulations, while the CSRC issues disclosure requirements for listed companies. The MoF began setting ac- counting standards in 1988 (the same year in which the CICPA was established).

The MoF adopted a policy of following international accounting practice \ in set- ting Chinese standards. To this end, it developed ASBE in 1992. In 1993, it ap- pointed an international accounting fi rm (with technical assistance funds from the World Bank) as consultants to the MoF’s standard-setting program and es- tablished two advisory committees, one consisting of international accou\ nting experts and the other consisting of Chinese accounting experts. 19 The promulga- tion of a conceptual framework by the MoF in 1992 was a landmark event i\ n the recent accounting reforms in China. It was a clear signal that Anglo-American accounting principles were to replace the rigid Soviet accounting model practiced in China since 1949. However, extensive false reporting and earnings management by companies have discredited accounting information and hampered the development of the capital market. As a result, the Accounting Law amendment in 1999 stressed the importance of “true and complete” accounting information. In 2000, the State Council issued an Enterprise Financial Reporting Regulation, redefi ning the ele- ments of fi nancial statements in line with the conceptual framework of the IASC and stipulating responsibilities and liabilities for parties involved in accounting, auditing and reporting. 20 The CPA Law requires auditors to audit Chinese enterprises’ fi nancial state- ments; verify the enterprises’ capital contribution; engage in the au\ dit work of the enterprises’ merger, demerger, and liquidation; and provide professional services specifi ed by the law and regulations. 21 The accounting regulations applicable to a Chinese listed fi rm depend on the type of security issued, A or B shares or both.

The IFRS-based annual report must be audited by an internationally recognized auditor, but not necessarily a Big Four fi rm, while the Chinese GAAP-based an- nual report may be audited by local accounting fi rms. Both sets of annual reports must be released to the public simultaneously, and any difference in net incomes between Chinese GAAP and IFRS must be reconciled and presented in the fi nan- cial statement footnotes. Accountants who intentionally provide false certifi cates may be sentenced to up to fi ve years of fi xed-term imprisonment or criminal de- tention and a fi ne. The law requires a CPA to refuse to issue any relevant report where (1) the client suggests, overtly or covertly, that a false or misleading re- port or statement be issued; (2) the client intentionally fails to provide relevant 18 Xiao, Zhang, and Xie, “The Making. . . .” 19 Y. Tang, “Bumpy Road. . . .” 20 B. Xiang, “Institutional Factors Infl uencing China’s Accounting Reforms and Standards,” Accounting Horizons 12, no. 2 (1998). 21 K. Z. Lin and K. H. Chan, “Auditing Standards in China: A Comparative Analysis with Relevant International Standards and Guidelines,” International Journal of Accounting 35, no. 4 (2000), pp. 559–77. dou62206_ch06_232-299.indd 243dou62206_ch06_232-299.indd 243 23/12/13 4:11 PM23/12/13 4:11 PM 244 Chapter Six accounting material and documents; and (3) the report to be issued by a certifi ed public accountant cannot correctly represent all material information due to the client’s unreasonable behavior. The China Accounting Standards Committee (CASC)—comprising government experts, academics, and members of accounting fi rms—was established within the MoF in 1998. China has not adopted IFRS, but it has stated that it will \ develop its own standards based on IFRS. However, different types of companies are required to comply with different sets of standards; for example, companies with B shares must follow IFRS, companies with A shares must follow Chinese GAAP, and com- panies with H shares must follow either Hong Kong GAAP or IFRS. In June 2002, the CICPA issued new guidelines on professional ethics as a sup- plement to the General Standard on Professional Ethics. The guidelines stress the importance of a CPA’s independence and also contain extensive discussion on change in a professional appointment, service fees charged to clients, practice promotion, and confi dentiality. 22 The CSRC requires companies listed on the two stock exchanges to post their annual reports on the exchanges’ respective Web sites. 23 The CSRC and the two stock exchanges have also adopted new corporate governance rules that require listed companies to disclose detailed related-party transaction information re- lating to intangible assets. 24 However, both internal and external corporate gov- ernance mechanisms are weak in China. For example, externally the market for corporate control and the managerial labor market are seriously underdevel- oped, while internally it was not until 2002 that independent directors and audit committees appeared in listed companies. 25 The CSRC has recently moved to require more outside directors on the boards of companies, as companies with a high proportion of nonexecutive directors on the board are less likely to engage in fraud. In November 2003 (effective January 2004), the CSRC and the MoF issued a joint document requiring companies to rotate their auditors every fi ve years and to take a two-year break before auditing the same client again. China is follow- ing the international trend toward tighter regulation of auditing practices, which has gained momentum following the collapse of Arthur Andersen in the after- math of the Enron scandal. The CSRC seems to follow the recommendations of the Sarbanes-Oxley Act in the United States. Convergence of Chinese GAAP with international standards can be summarized as follows: 1992 Chinese GAAP (1992–1997) The 1992 Chinese GAAP marked a radical change in China’s accounting r\ ules and regulations, representing a shift in focus from providing information fo\ r a central government-planned economy to a socialist-market economy. The 1992 Chine\ se GAAP was comprised of the Accounting Systems for Companies Experimenting with a Shareholding System and the Accounting Standard for Business Enterprises (ASBE).

The ASBE (1992) is similar to a conceptual framework.

22 For more details, see IAS PLUS, July 2002, at www.iasplus.com. 23 The Shanghai Stock Exchange Web site ( www.sse.com.cn ) and the Shenzhen Stock Exchange Web site ( www.cninfo.com.cn ). 24 See IAS PLUS, January 2001, at www.iasplus.com . 25 G. Chen, M. Firth, D. N Gao, and O. M. Rui, “Ownership Structure, Corporate Governance and Fraud:

Evidence from China,” Journal of Corporate Finance 12 (2006), pp. 424–48. dou62206_ch06_232-299.indd 244dou62206_ch06_232-299.indd 244 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 245 1998 Chinese GAAP (1998–2000) The second stage of regulatory development is characterized by the adoption of the Accounting System for Joint Stock Limited Enterprises by the MoF in 1998. This regulation replaced the 1992 Chinese GAAP and aimed at eliminating discrepan- cies between Chinese GAAP and IAS, which existed in the 1992 regulation. In ad- dition, 10 specifi c Chinese Accounting Standards (CAS) were issued by the MoF.

2001 Chinese GAAP (2001–2006) The third stage of development was characterized by the issuance of the Account- ing System for Business Enterprises by the MoF in 2001, which replaced the 1998 Chi- nese GAAP. Inventory valuation at lower of cost or market (LCM) was optional in\ 1998 GAAP but required in 2001 GAAP. Further, recognition of impairment losses was required only for investments in 1998 GAAP, but it was also required for prop- erty, plant, and equipment (PP&E); intangible assets; construction in process; and investment property in 2001 GAAP.

2006 Chinese GAAP This stage is characterized by the issuance in February 2006 of the Accounting Standards for Business Enterprises (ASBE). It replaced the 1992 ASBE and CASs previously issued. The ASBE became mandatory for all PRC listed companies in January 2007.

Other PRC enterprises were encouraged to apply the ASBE. Instead of phasing them in gradually over time, China chose to adopt the\ main standards essentially in one go in the convergence process. With the introduction of the ASBE, China adopted a signifi cant number of the accounting standards laid out by the IASB. The ASBE cover almost all of the major topics included in IFRS, albeit with some notable exceptions. Convergence occurred through both the direct import of standards from IFRS and progressive changes to Chinese GAAP. Direct import was observed for items either refl ective of traditional Chinese accounting practice or that addressed situ- ations not considered or not relevant under the previous accounting model. Pro- gressive changes to Chinese GAAP were observed on items substantially different from traditional practice. Currently, the CAS is comprised of Basic Standard, 38 specifi c standards, and application guidance. CAS are unique because they originated in a socialist period in which the stat\ e was the sole owner of industry. Therefore, unlike Western accounting standards, they were less a tool of profi t and loss than an inventory of assets available to a company. In contrast to a Western balance sheet, CAS did not include an ac- counting of a company’s debts, and were less suitable for management control than for accounting for tax purposes. The differences that do exist represent China’s unique position in the global economy. This includes a prohibition on re- versing an asset impairment decision; fi nancial statements incorporating certain government grants; and related-party disclosures between certain state-owned enterprises. Prior to the reforms, Chinese companies which offered shares for sale in the United States used to be required to prepare three sets of statements, one using Chinese GAAP, one using IFRS, and one using U.S. GAAP. However, since 2008, the SEC has allowed foreign private issuers to use fi nancial statements prepared in accordance with IFRS. The pressure is on for China to harmonize its accounting standards and prac- tices with international standards. As a result, international harmonization has been recognized as a priority for the development of the profession. China’s desire dou62206_ch06_232-299.indd 245dou62206_ch06_232-299.indd 245 23/12/13 4:11 PM23/12/13 4:11 PM 246 Chapter Six to join the World Trade Organization (WTO) was a major incentive for the push toward international harmonization. WTO membership, granted in 2002, was con- ditional upon, among other things, the adoption of internationally accep\ table ac- counting and fi nancial reporting practices, and the opening up of the accounting and auditing markets. The problem of corruption and the involvement of accountants in corruption became so alarming that in 2004, the Chinese government launched a natio\ nwide “auditing storm” campaign to check on accounting misconduct in gov\ ernment agencies, institutions, and enterprises. According to the report that was submitted to the National Congress, serious fraud and embezzlement of public funds were found in many government agencies and government-funded projects and often implicated accounting malpractice. Accounting Principles and Practices In the prereform period, the aim of the accounting system in China was t\ o help the government plan its economic activities and manage the various gover\ nment funds, and it was therefore called the “fund accounting system.” A\ ll accounting bodies and personnel were closely linked with the government at the cent\ ral or the local level, and there were no independent accountants and independent a\ ccount- ing institutions. Furthermore, China’s accounting system was complete\ ly closed to the outside world. The reliance on UASs was reinforced because many C\ hinese accountants and auditors lacked professional education and training. 26 Further, it was also supported by the Chinese culture. With the economic reform, which aimed at opening up the economy, Chinese enterprises began to operate independently, foreign companies moved in, and a stock market emerged. All these developments required fundamental changes in the accounting system. The reform of the system gained momentum in the 1990s, following the establishment of the two stock exchanges. However, although the capital market has played an important role in accounting standard-setting in China, its continued structural weaknesses and signifi cant imperfections have se- riously restricted the supply of, and demand for, decision-useful accounting infor- mation and IAS-type accounting standards. State ownership is present in more than 90 percent of listed companies, 27 and the government remains an important infl uence on corporate governance by way of personnel control and resource allocation. Consequently the government is re- garded as the main user of accounting information. China is an economy in transition, and its market-based systems are still at an early stage of development. Traditionally in China, there has been a close link between taxation and accounting, and the calculation of taxable income h\ as been a major purpose of accounting. Further, under China’s communist ideological in- fl uences, accounting conservatism has long been criticized as a tool used \ to ma- nipulate accounting numbers and maximize the profi ts of capitalists in exploiting workers. Accounting conservatism is the principle that stipulates that, in a situ\ – ation where there are acceptable accounting alternatives, the one that produces lower current amounts for net income and net assets ought to be chosen. This accounting convention has virtually been prohibited in China since 1949. 28 A lack 26 Xiang, “International Factors. . . .” 27 Q. Sun, W. Tong, and J. Tong, “How Does Government Ownership Affect Firm Performance? Evidence from China’s Privatization Experience,” Journal of Business Finance and Accounting 29, no.1/2 (2002). 28 Lin and Chan, “Auditing Standards in China.” dou62206_ch06_232-299.indd 246dou62206_ch06_232-299.indd 246 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 247 of conservatism in Chinese accounting standards and practices continues to be a major difference between Chinese GAAP and IFRS.

The fi nancial statements published by Chinese companies typically include a balance sheet, an income statement, a cash fl ow statement, notes to fi nancial state- ments, and other supporting schedules. One of the major problems associated with accounting practices adopted by enterprises in China is the lack of\ coherent interpretation of the relevant requirements. Regulations are subject to different interpretations and applications on the part of government agencies in different locations. As a result, the formal harmonization of accounting and auditing stan- dards that has occurred within China has not brought about a harmonization of accounting practices. China, being a transitional economy, is only beginning to de- velop the infrastructure required to support credible fi nancial reporting. As China intensifi es its integration into the global economy and fulfi lls its obligations agreed on in the WTO accession treaty, for example, to open up its market to foreign audi- tors, 29 market forces in the accounting and auditing sector undoubtedly will be- come more active, which should strengthen the effectiveness of private safeguard mechanisms. The conceptual framework, fi rst issued in 1992, has since been superseded by 16 Chinese Accounting Standards (see Exhibit 6.2 ) and other regulations, such as the Accounting System for Business Enterprises (ASBE) issued in 2001. The ASBE aims, among other things, to enhance comparability of fi nancial information, separate accounting and taxation treatments, and ensure harmonization with internation- ally accepted accounting practices. The ASBE defi nes fundamental principles (going concern, accounting period, substance over form, consistency, timeliness, understandability, accrual basis, matching, impairment recognition, prudence, materiality, and measurement cur- rency vs. presentation currency) and fi nancial statement elements (assets, liabili- ties, owners’ equity, revenues, expenses, and profi ts), which are similar to those found in IFRS . It also specifi es the contents of fi nancial reports (which fi nancial statements are to be presented annually, semiannually, quarterly, and monthly), minimum notes to the fi nancial statements, and how soon after the end of the accounting period reports should be published. The ASBE also includes 1. Classifi cations within the asset, liability, and equity elements, as well as recog- nition and measurement principles for a wide variety of assets and liabilities. 2. Revenue recognition principles for goods, services, royalties, and interest. 3. Expense recognition principles for bad debts, cost of goods sold, depreciation, major overheads, and impairment of assets. 4. Accounting principles for nonmonetary transactions, assets contributed b\ y in- vestors, accounting for income taxes, foreign currency transactions, changes in accounting policies, changes in estimates, corrections of errors, post–balance sheet events, contingencies, and related-party transactions. 5. Principles for consolidated fi nancial statements and accounting for investments in joint ventures. 29 Foreign fi rms that have obtained CPA licenses are permitted to affi liate with Chinese fi rms and enter into contractual agreements to provide accounting, auditing and bookkeeping services. (World Trade Organization, Report of the Working Party on the Accession to China, Addendum, Schedule of Specifi c Commitment on Services, October 1, 2001, available at www.wto.org/english/thewto_e/completeacc_e.htm .) dou62206_ch06_232-299.indd 247dou62206_ch06_232-299.indd 247 23/12/13 4:11 PM23/12/13 4:11 PM 248 Chapter Six Accounting Standard Effective Date Applicability 1 Disclosure of Related Party January 1, 1997 Listed enterprises Relationships and Transactions 2 Cash Flow Statements (minor revision in 2001) January 1, 2001 All enterprises 3 Events Occurring After the Balance Sheet Date January 1, 1998 Listed enterprises 4 Debt Restructuring (revised signifi cantly in 2001) January 1, 2002 All enterprises 5 Revenue January 1, 1999 Listed enterprises 6 Investments (minor revision in 2001) January 1, 2001 Joint stock limited enterprises (prior to January 1, 2001, listed enterprises only) 7 Construction Contracts January 1, 1999 Listed enterprises 8 Changes in Accounting Policies and Estimates and Corrections of Accounting Errors (minor revision in 2001) January 1, 2001 All enterprises (prior to January 1, 2001, listed enterprises only) 9 Non-monetary Transactions (revised signifi cantly in 2001) January 1, 2001 All enterprises 10 Contingencies July 1, 2000 All enterprises 11 Intangible Assets January 1, 2001 Joint stock limited enterprises 12 Borrowing Costs January 1, 2001 All enterprises 13 Leases January 1, 2001 All enterprises 14 Interim Financial Reporting January 1, 2002 Listed enterprises 15 Inventories January 1, 2002 Joint stock limited enterprises 16 Fixed Assets January 1, 2002 Joint stock limited enterprises EXHIBIT 6.2 Chinese Accounting Standards as at January 1, 2002 In addition, it requires that expenses be classifi ed as operating, administrative, or fi nancing expenses and that profi t be classifi ed between operating profi t, invest- ment income, subsidy income, and several other nonoperating income categ\ ories.

Finally, its requirement to include management discussion of fi nancial condition is similar to requirements in the United States. Further, with economic reforms, a new auditing system has emerged under which the purpose of auditing has changed from ascertaining a company’s tax liabilities to ascertaining the truthful- ness and fairness of a company’s fi nancial statements. Currently most companies in China are subject to the annual audit carried out by certifi ed public accounting fi rms registered in China. Nearly half a million enterprises in China, including all listed compani\ es, now follow one unifi ed ASBE. The MoF required all 170,000 SOEs to adopt the ASBE in 2005. The ASBE and Chinese Accounting Standards together form the structure of dou62206_ch06_232-299.indd 248dou62206_ch06_232-299.indd 248 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 249 fi nancial reporting in modern China. Since 1978 China has introduced measures to reform its accounting system, which is now converging with standard accounting practices in mature market economies. Initially, fi rms undergoing the transition to the new system found it diffi cult to present a true picture of the impact of the change, and hence tended to provide misleading information to shareholders in the form of incorrect fi nancial reporting, damaging share values. This was mainly because they did not seem to fully contemplate the amount of fi nancial informa- tion that was needed, since most of it had not been collected in the pas\ t. As a result, signifi cant differences remain with respect to those practices and the accounting institutional environment between China and mature market economies, for ex- ample, and fair value is not recognized for accounting purposes. Chinese accounting practices differ in some respects from those required under IFRS. In some areas covered by IFRS, there are no specifi c rules in China. In other areas, transactions are treated differently under the two sets of rules. For example, there are no specifi c rules in the areas of business combinations, including provi- sions in the context of acquisitions (IAS 22); impairment of assets, p\ articularly as (except for investments) diminutions in value are not allowed (IAS 36); the defi nitions of operating and fi nance leases (IAS 17); employee benefi ts obliga- tions (IAS 19); and accounting for an issuer ’s fi nancial instruments (IAS 32). Fur- ther, there are no specifi c rules requiring disclosures of discontinuing operations (IAS 35), segment liabilities (IAS 14), or diluted earnings per shar\ e (IAS 33). The methods of treating certain transactions are different from those required under IFRS. In China, proposed dividends are accrued before being approved (IAS 10); preoperating expenses are deferred and amortized (IAS 38); a wider defi nition of extraordinary items is used (IAS 8); and in segment reporting, the line of business basis is always treated as primary (IAS 14). Each of these practices is inconsistent with IFRS. Exhibit 6.3 presents some of the differences between IFRS and Chinese GAAP. Several Chinese companies provide fi nancial statements prepared in accor- dance with both Chinese (PRC) GAAP and IFRS. Exhibit 6.4 provides an excerpt from Sinopec Shanghai Petrochemical Company Ltd.’s Form 20-F for the year ended December 31, 2012. The unique features in the Chinese environment include the following:

• Civil litigation is very rare, and thus the CSRC is the prime discipliner of fi rms and their managements. • In the ownership structure of listed fi rms, blockholders are usually the state and quasi-state institutions such as SOEs. (These are very different from the companies in Anglo-American countries, and they have different infl uences on the fi rm.) • The dynamics in Chinese boardrooms are likely to be different from those of their counterparts in Anglo-American countries. For example, chairs are full- time executives and they wield signifi cant power; and senior management typi- cally started their careers as government bureaucrats. • The auditing profession in China is relatively new, and it has faced a steep learning curve. • State ownership still has an important infl uence on the organization and devel- opment of accounting standards. • Wholly foreign-owned large multinational corporations competing against weaker and smaller domestic fi rms are becoming a major concern. dou62206_ch06_232-299.indd 249dou62206_ch06_232-299.indd 249 23/12/13 4:11 PM23/12/13 4:11 PM 250 Chapter Six • Due to contextual differences, Chinese regulators view harmonization between Chinese GAAP and IFRS as a two-way process that should permit differences and local innovation. • The capital market in China is controlled by government. It is characterized by weak equity outsiders, strong market speculation, weak form effi ciency, ex- tensive earnings management and deceptive reporting, and large-scale market manipuIation. In recent years, Chinese regulators have taken signifi cant steps to reform Chinese accounting standards in line with IFRS. EXHIBIT 6.3 Differences between Chinese GAAP and IFRS Issue IFRS Chinese GAAP Profi t or loss on disposal of fi xed assets IAS 16: Included in operating profi t or loss. Presented as a nonoperating gain or loss.

Requirement to provide segment information IAS 14: Listed companies only.

Listed companies and other enterprises applying the system.

Measurement of property, plant, and equipment IAS 16: May use either fair value or historical cost. Generally required to use historical cost.

Borrowing costs related to self-use assets that take a substantial time to complete IAS 23: May either capitalize as part of the asset’s cost or charge to expenses.

Must capitalize as part of the asset’s cost.

Impairment of assets that do not generate cash fl ows individually IAS 36: An asset is impaired when its book value exceeds its recoverable amount, which is the greater of net realizable value and the net present value of future net cash fl ows expected to arise from continued use of the asset. Specifi c guidance is not provided.

Research and development costs IAS 38: Expense all research costs.

Capitalize development costs if certain criteria are met. Expense all research and development costs (except patent registration and legal costs, which are capitalized).

Preoperating expenses IAS 38: Charged to expenses when incurred. Deferred until the entity begins operations, then charged to expenses.

Land use rights IAS 38: Accounted for as an operating lease. Cost of land use rights is treated as prepaid lease payments. Accounted for as a purchased intangible asset until the construction or development commences, then accounted for as fi xed assets under construction or property development costs until the construction or development is complete; on completion, total costs are transferred to property held for use.

Amortization of intangible assets IAS 38: Amortize over the estimated useful life, which is presumed to be 20 years or less. Amortized over the shorter of the estimated useful life and the contractual or legal life; if no contractual or legal life, amortize over the estimated useful life, but not more than 10 years.

Revaluation of intangible assets IAS 38: Permitted only if the intangible asset trades in an active market. Prohibited. dou62206_ch06_232-299.indd 250dou62206_ch06_232-299.indd 250 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 251 EXHIBIT 6.4 SINOPEC SHANGHAI PETROCHEMICAL COMPANY LTD. Excerpts from Form 20-F 2012 1. ORGANIZATION, PRINCIPAL ACTIVITIES AND BASIS OF PREPARATION Sinopec Shanghai Petrochemical Company Limited (“the Company”), formerly Shanghai Pet\ rochemical Company Limited, was established in the People’s Republic of China (“the PRC” or “the State”) on June 29,\ 1993 as a joint stock limited company to hold the assets and liabilities of the production divisions and certain other units of the Shanghai Petrochemical Complex (“SPC”). SPC was established in 1972 and owned and managed the production divisions as well as the related housing, stores, schools, hotels, transportation, hospitals and other municipal services in the community \ of Jinshanwei. The Company’s former controlling shareholder, China Petrochemical Corporation (“CPC”) completed its reorganization on February 25, 2000 in which its interests in the Company were transferred to its subsidiary, China Petroleum & Chemical Corporation (“Sinopec Corp”). In connection with the reorganization, CPC transferred the ownership of its 4,000,000,000 of the Company’s state owned legal shares, which represented 55.56 percent of the issued share capital of the Company, to Sinopec Corp. On October 12, 2000, the Company changed its name to Sinopec Shanghai Petrochemical Company Limited. The principal activity of the Company and its subsidiaries (the “Group”) is the processing of crude oil into petrochemical products for sale. The Group is one of the largest petrochemical enterprises in the PRC, with a highly integrated petrochemical complex which processes crude oil into a broad range of synthetic fi bers, resins and plastics, intermediate petrochemicals and petroleum products.

Substantially all of its products are sold in the PRC domestic market. These fi nancial statements have been approved by the Board of Directors on March 27, 2013. At December 31, 2012, the following list contains the particulars of sub\ sidiaries, all of which are limited companies established and operating in the PRC, which principally affected the results and assets of the Group. Company Registered Capital Percentage of equity held by the Company % Percentage of equity held by sub- sidiaries % Principal activities Shanghai Petrochemical Investment Development Company Limited . . . . . . RMB 1,000,000 100 — Investment management China Jinshan Associated Trading Corporation . . . . . . . . . . . . . . . . . . . . . RMB 25,000 67.33 — Import and export of petrochemical products and equipment Shanghai Jinchang Engineering Plastics Company Limited . . . . . . . . . . . US$ 9,154 — 74.25Production of polypropylene compound products Shanghai Golden Phillips Petrochemical Company Limited . . . . . . US$ 50,000 — 60Production of polyethylene products Zhejiang Jin Yong Acrylic Fibre Company Limited . . . . . . . . . . . . . . . . . RMB 250,000 75 — Production of acrylic fi ber products Shanghai Golden Conti Petrochemical Company Limited . . . . . . . . . . . . . . . . . RMB 545,776 — 100 Production of petrochemical products None of the subsidiaries have issued any debt securities.

The consolidated fi nancial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The consolidated fi nancial statements are prepared on the historical cost basis except for available-for-sale fi nancial assets (see note 2(b)) which are stated at fair value. The preparation of fi nancial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of policies and reported amounts of assets and liabilities, income and expenses. The esti\ mates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis of making the judgments about the carryin\ g values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Continued dou62206_ch06_232-299.indd 251dou62206_ch06_232-299.indd 251 23/12/13 4:11 PM23/12/13 4:11 PM 252 Chapter SixThe estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. Judgments made by management in the application of IFRS that have signifi\ cant effect on the fi nancial statements and major sources of estimation uncertainty are disclosed in note 27.

2. PRINCIPAL ACCOUNTING POLICIES (a) Basis of consolidation (i) Subsidiaries and non-controlling interests The consolidated fi nancial statements of the Group include the fi nancial statements of the Company and all of its principal subsidiaries. Subsidiaries are entities controlled by the Group. Control exists when the Group has the power to govern the fi nancial and operating policies of an entity so as to obtain benefi ts from its activities. In assessing control, potential voting rights that presently are exercisable are taken into account.An investment in a subsidiary is consolidated into the consolidated fi\ nancial statements from the date that control commences until the date that control ceases. Intra-group balances and transactions and any unrealized profi ts arising from intra-group transactions are eliminated in full in preparing the consolidated fi nancial statements. Unrealized losses resulting from intra-group transactions are eliminated in the same way as unrealized gains but only to the extent that there is no evidence of impairment. Non-controlling interests represent the equity in a subsidiary not attributable directly or indirectly to the Company, and in respect of which the Group has not agreed any additional terms with the holders of those interests which would result in the Group as a whole having a contractual obligation in respect of those interests that meets the defi nition of a fi nancial liability.

For each business combination, the Group can elect to measure any non-controlling interests either at fair value or at their proportionate share of the subsidiary’s net identifi able assets. Non-controlling interests are presented in the consolidated balance sheet within equity, separately from equity attributable to the equity shareholders of the Company. Non-controlling interests in the results of the Group are presented on the face of the consolidated statements of operations and the consoli\ dated statements of comprehensive income as an allocation of the total profi t or loss and total comprehensive income for the year between non-controlling interests and the equity shareholders of the Company. Loans from holders of non-controlling interests and other contractual obligations towards these holders are presented as fi nancial liabilities in accordance with notes 2(i) or 2(j) depending on the nature of the liability. Changes in the Group’s interests in a subsidiary that do not result in a loss of control are accounted for as equity transactions, whereby adjustments are made to the amounts of controlling and non-controlling interests within consolidated equity to refl ect the change in relative interests, but no adjustments are made to goodwill and no gain or loss is recognized. When the Group loses control of a subsidiary, it is accounted for as a disposal of the entire interest in that subsidiary, with a resulting gain or loss being recognized in profi t or loss. Any interest retained in that former subsidiary at the date when control is lost is recognized at fair value and this amount is regarded as the fair value on initial recognition of a fi nancial asset (see note 2(b)) or, when appropriate, the cost on initial recognition of an investment in an associate or jointly controlled entity (see note 2(a)(ii)).

(ii) Associates and jointly controlled entities An associate is an entity in which the Group has signifi cant infl uence, but not control or joint control, over its management, including participation in the fi nancial and operating policy decisions.

A jointly controlled entity is an entity which operates under a contractual arrangement\ between the Group and other parties, where the contractual arrangement establishes that the Group and one or more of the other parties share joint control over the economic activity of the entity. An investment in an associate or a jointly controlled entity is accounted for in the consolidated fi nancial statements under the equity method. Under the equity method, the investment is init\ ially recorded at cost, adjusted for any excess of the Group’s share of the acquisition-date fair values of the investee’s identifi able net assets over the cost of the investment (if any). Thereafter, the investment is adjusted for the post acquisition change in the Group’s share of the investee’s net assets and any impairment loss relating to the investment (see note 2(s)). Any acquisition-date exce\ ss over cost, the Group’s share of the post-acquisition, post-tax results of the investees and any impairment losses for the year are recognized in the consolidated statements of operations, whereas the Group’s share of the post-acquisition post-tax items of the investees’ other comprehensive income is recognized in the consolidated statements of comprehensive income. For the periods presented, no adjustments have been made (or are necessary) to conform the associate’s or jointly controlled entity’s accounting policies to those of the Group as there are no material differences between the accounting policies adopted by the associate and the jointly controlled entity and the Group.

EXHIBIT 6.4 (Continued) dou62206_ch06_232-299.indd 252dou62206_ch06_232-299.indd 252 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 253 When the Group’s share of losses exceeds its interest in the associate or the jointly controlled entity, the Group’s interest is reduced to nil and recognition of further losses is discontinued except to the extent that t\ he Group has incurred legal or constructive obligations or made payments on behalf of the investee. For\ this purpose, the Group’s interest is the carrying amount of the investment under the equity method together with the Group’s long term interests that in substance form part of the Group’s net investment in the associate or the jointly controlled entity. Unrealized profi ts and losses resulting from transactions between the Group and its associates and jointly controlled entities are eliminated to the extent of the Group’s interest in the investee, except where unrealized losses provide evidence of an impairment of the asset transferred, in which case they are recognized immediately in profi t or loss. When the Group ceases to have signifi cant infl uence over an associate or joint control over a jointly controlled entity, it is accounted for as a disposal of the entire interest in that investee, with a resulting gain or loss being recognized in profi t or loss. Any interest retained in that former investee at the date when signifi cant infl uence or joint control is lost is recognized at fair value and this amount is regarded as the fair value on initial recognition of a fi nancial asset (see note 2(b)) or, when appropriate, the cost on initial recognition of an investment (see note 2(b)).

(b) Other investments The Group’s policies for other investments, other than investments in associates a\ nd jointly controlled entities, are as follows: Investments in available-for-sale fi nancial assets are carried at fair value with any change in fair value recognized in other comprehensive income and accumulated separately in equity in the fair value r\ eserve. When these investments are derecognized or impaired, the cumulative gain or loss is reclassifi ed from equity to profi t or loss. Investments in equity securities that do not have a quoted market price in an active market and whose fair value cann\ ot be reliably measured are recognized in the balance sheet at cost less impairment losses (see note 2(s)).

(c) Property, plant and equipment Property, plant and equipment are stated at cost less accumulated depreciation and impairment losses (see note 2(s)). The cost of self-constructed assets includes the cost of materials, direct labor, the initial estimate, where relevant, of the costs of dismantling and removing the items and restoring the site on which they are located, and an appropriate proportion of production overheads and borrowing costs. Gains or losses arising from the retirement or disposal of items of property, plant and equipment are determined as the difference between the net disposal proceeds and the carrying amount of the items and are recognized in profi t or loss on the date of retirement or disposal. Depreciation is calculated to write off the costs of property, plant and equipment over their estimated useful lives on a straight-line basis, after taking into account their estimated residual values, as follows:

Buildings 12 to 40 years Plant and machinery 5 to 20 years Vehicles and other equipment 4 to 20 years Where parts of an item of property, plant and equipment have different useful lives, the cost of the item is allocated on a reasonable basis between the parts and each part is depreciated separately. The depreciation method, useful life and the residual value of an asset are reviewed annually.

(d) Investment property Investment properties are properties which are owned or held under a leasehold interest either to earn rental income and /or for capital appreciation.

Investment properties are stated in the balance sheet at cost less accumulated depreciation and impairment losses (see note 2(s)). Depreciation is provided over their estimated useful lives on a straight-line basis, after\ taking into account their estimated residual values. Estimated useful life of the investment property is 40 years.

(e) Lease prepayments and other assets Lease prepayments and other assets mainly represent prepayments for land use rights and catalysts used in production. The assets are carried at cost less accumulated amortization and impairment losses (\ see note 2(s)). Lease prepayments and other assets are written off on a straight-line basis over the respective periods of the rights and the estimated useful lives of the catalysts.

(f) Construction in progress Construction in progress represents buildings, various plant and equipment under construction and pen\ ding installation, and is stated at cost less government grants that compensate the Group for the cost of construction, and impairment losses (see note 2(s)). Cost comprises direct costs of construction as well as interest charges, and foreign exchange differences on related borrowed funds to the extent that they are regarded as an adjustment to interest charges, during the period of construction.

Construction in progress is transferred to property, plant and equipment when the asset is substantially ready for its intended use. No depreciation is provided in respect of construction in progress. Continued dou62206_ch06_232-299.indd 253dou62206_ch06_232-299.indd 253 23/12/13 4:11 PM23/12/13 4:11 PM 254 Chapter Six (g) Inventories Inventories, other than spare parts and consumables, are carried at the lower of cost and net realizable value. Cost is calculated using the weighted average cost formula and comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of conversion of inventories include\ cost directly related to the units of production as well as allocation of production overheads. The allocation of fi xed production overhead to the costs of conversion is based on normal operating capacity of the production facilities, whereas variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the\ estimated costs necessary to make the sale.

When inventories are sold, the carrying amount of the inventories is recognized as an expense in the period in which the related revenue is recognized. The amount of any write-down of inventories to net realizable value and all losses of inventories are recognized as an expense in the period the write-down or loss occurs. The\ amount of any reversal of any write-down of inventories is recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs. Spare parts and consumables are stated at cost less any provision for obsolescence.

(h) Trade receivables, bills and other receivables Trade receivables, bills and other receivables are initially recognized at fair value and thereafter stated at amortized cost using the effective interest method less allowance for impairment of doubtful debts (see note 2(\ s)), except where the receivables are interest-free loans made to related parties without any fi xed repayment terms or the effect of discounting would be immaterial.

In such cases, the receivables are stated at cost less allowance for impairment of doubtful debts.

Trade receivables, bills and other receivables are derecognized if the Group’s contractual rights to the cash fl ows from these fi nancial assets expire or if the Group transfers these fi nancial assets to another party without retaining control or substantially all risks and rewards of the assets.

(i) Interest-bearing borrowings Interest-bearing borrowings are recognized initially at fair value less attributable transaction costs. S\ ubsequent to initial recognition, interest-bearing borrowings are stated at amortized cost with any difference between the amount initially recognized and redemption value being recognized in profi t or loss over the period of the borrowings, together with any interest and fees payable, using the effective interest method.

(j) Trade and other payables Trade and other payables are initially recognized at fair value and thereafter stated at amortized cost unless the effect of discounting would be immaterial, in which case they are stated at cost.

(k) Cash and cash equivalents Cash and cash equivalents comprise cash at bank and on hand and time dep\ osits with banks and other fi nancial institutions with an initial term of less than three months at acquisition. Cash equivalents are stated at cost, which approximates fair value.

(l) Translation of foreign currencies Foreign currency transactions during the year are translated into Renminbi at the applicable exchange rates ruling at th\ e transaction dates.

Monetary assets and liabilities denominated in foreign currencies are translated into Renminbi at rates quoted by the People’s Bank of China at the balance sheet date. Non-monetary assets and liabili\ ties denominated in foreign currencies, which are stated at historical cost, are translated into Renminbi at the closing foreign exchange rate ruling at the date of the transaction. Foreign currency translation differences relating to funds borrowed to fi nance the construction of property, plant and equipment to the extent that they are regarded as an adjustment to interest costs are capitalized during the construction period.

All other exchange gains and losses are dealt with in profi t or loss.

(m) Revenue recognition Revenues associated with the sale of petroleum and chemical products are recognized in profi t or loss when the signifi cant risks and rewards of ownership have been transferred to the buyer. Revenue excludes value added tax and is after deduction of any trade discounts and returns. No revenue is recognized if there are signifi cant uncertainties regarding recovery of the consideration due to the possible return of goods, or when the amount of revenue and the costs incurred or to be incurred in respect of the transaction cannot be measured reliably.

The Group provides pipeline transportation services to customers. Revenues associate\ d with transportation services are recognized by reference to the stage of completion (that is, when the services are rendered) of the transaction at the end of the reporting period and when the outcome of the transaction can be estimated\ reliably. The outcome of the transaction can be estimated reliably when the amount of revenue, the costs incurred and the stage of completion can be measured reliably and it is probable that the economic benefi ts associated with the transaction will fl ow to the Group.

EXHIBIT 6.4 (Continued) dou62206_ch06_232-299.indd 254dou62206_ch06_232-299.indd 254 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 255 Dividend income is recognized in profi t or loss on the date the shareholder’s right to receive payment is established.

Gains or losses arising from the disposal of unlisted investments are determined as the difference between the net disposal proceeds and the carrying amount of the investment and are recognized in profi t or loss on the date of disposal. Rental income from investment property is recognized in profi t or loss on a straight-line basis over the term of the lease.

(n) Government grants Government grants are recognized in the balance sheet initially when there is reasonable assurance that they will be received and that the Group will comply with the conditions attaching to them. Grants that compe\ nsate the Group for expenses incurred are recognized as revenue in profi t or loss on a systematic basis in the same periods in which the expens\ es are incurred. Grants that compensate the Group for the cost of an asset are deducted from the carrying amount of the asset and consequently are effectively recognized in profi t or loss over the useful life of the asset by way of reduced depreciation expense.

(o) Net fi nancing (costs)/income Net fi nancing (costs)/income comprise interest payable on borrowings calculated using the effective interest rate method, interest income on bank deposits, foreign exchange gains and losses and bank charges.

Interest income from bank deposits is recognized in profi t or loss as it accrues using the effective interest method.

All interest and other costs incurred in connection with borrowings are expensed as incurred and included as part of net fi nancing costs, except to the extent that they are capitalized as being directly attributable to the acquisition or construction of an asset which necessarily takes a substantial period of time to get ready for its intended use or sale.

(p) Repairs and maintenance expenses Repairs and maintenance expenses are charged to profi t or loss as and when they are incurred.

(q) Research and development costs Research and development costs comprise all costs that are directly attributable to research and development activities or that can be allocated on a reasonable basis to such activities. Because of the nature of the Group’s research and development activities, no development costs satisfy the criteria for the recognition of such costs as an asset. Both research and development costs are therefore recognized as expenses in the period in which they are incurred.

(r) Employee benefi ts The contributions payable under the Group’s retirement plans are charged to the profi t or loss on an accrual basis according to the contribution determined by the plans. Further information is set out\ in note 24.

Termination benefi ts are recorded as employee reduction expenses in the profi t or loss, and are recognized when, and only when, the Group demonstrably commits itself to terminate employment or to provide benefi ts as a result of voluntary redundancy by having a detailed formal plan which is without realistic possibility of withdrawal.

(s) Impairment loss (i) Trade accounts receivable, bills and other receivables and investments in equity securities other than investments i\ n associates and jointly controlled entities, that do not have a quoted market price in an active mark\ et are reviewed at each balance sheet date to determine whether there is objective evidence of impairment. If any such evidence exists, an impairment loss is determined and recognized.

The impairment loss is measured as the difference between the asset’s carrying amount and the estimated future cash fl ows, discounted at the current market rate of return for a similar fi nancial asset where the effect of discounting is material, and is recognized as an expense in the profi t or loss. Impairment losses for trade accounts receivable, bills and other receivables are reversed through the profi t or loss if in a subsequent period the amount of the impairment loss d\ ecreases.

Impairment losses for investments in equity securities carried at cost a\ re not reversed. For investments in associates and jointly controlled entities recognized using the equity method (note 2(a)(ii)), the impairment loss is measured by comparing the recoverable amount of the investment as a whole with its carrying amount \ in accordance with note 2(s)(ii). The impairment loss is reversed if there has been a favourable change in the estimates used to determine the recoverable amount in accordance with note 2(s)(ii).

(ii) Impairment of other long-lived assets is accounted for as follows:

The carrying amounts of other long-lived assets, including property, plant and equipment, construction in progress, lease prepayments, other assets and investments in associates and jointly controlled entities, are reviewed at each balance sheet date to identify indications that the asset may be impaired. These assets are tested for impairment whenever events or changes in circumstances indicate that their recorded carrying amounts may not be recoverable. When such a decline has occurred, the carrying amount is reduced to the recoverable amount.

The recoverable amount is the greater of the fair value less costs to sell and the value in use. In dete\ rmining the value in use, expected future cash fl ows generated by the asset are discounted to their present value using a pre-tax discount rate that refl ects current market assessments of the time value of money and the risks specifi\ c to the asset. Where an asset does not generate cash infl ows largely independent of those from other assets, the recoverable amount is determined for the smallest group of assets that generates cash infl ows independently (i.e. a cash-generating unit). Continued dou62206_ch06_232-299.indd 255dou62206_ch06_232-299.indd 255 23/12/13 4:11 PM23/12/13 4:11 PM 256 Chapter SixThe amount of the reduction is recognized as an expense in the profi t or loss. Impairment losses recognized in respect of cash-generating units are allocated fi rst to reduce the carrying amount of any goodwill allocated to the cash-generati\ ng unit and then, to reduce the carrying amount of the other assets in the unit on a pro rata basis, except that the carrying value of an asset will not be reduced below its individual fair value less costs to sell, or value in u\ se, if determinable. Management assesses at each balance sheet date whether there is any indication that an impairment loss recognized for an asset, except in the case of goodwill, in prior years may no longer e\ xist. An impairment loss is reversed if there has been a favorable change in the estimates used to determine the recoverable amount. A subsequent increase in the recoverable amount of an asset, when the circumstances and events that led to the write-down or write-off cease to exist, is recognized in profi t or loss. The reversal is reduced by the amount that would have been recognized as depreciation had the write-down or write-off not occurred. An impairment loss in respect of goodwill is not reversed.

(t) Dividends payable Dividends are recognized as a liability in the period in which they are declared.

(u) Income tax Income tax expense comprises current and deferred tax. Income tax expense is recognized in profi t or loss except to the extent that it relates to items recognized in other comprehensive income or directly in equity, in which case the relevant amounts of tax are recognized in other comprehensive income or directly in equity, respectively.

Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantially enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for fi nancial reporting purposes and the amounts used for taxation purposes, except differences relating to goodwill not deductible for tax purposes and the initial recognition of assets or liabilities which affect neither accounting nor taxable income. The amount of deferred tax provided is based on the expected manner of realization or settlement of the carrying amount of assets and liabilities, using tax r\ ates enacted or substantially enacted at the balance sheet date. The effect on deferred tax of any changes in tax rates is charged or credited to the profi t or loss, except for the effect of a change in tax rate on the carrying amount of deferred tax assets and liabilities which were previously charged or credited directly to equity upon initial recognition, in such case the effect of a change in tax rate is also charged or credited to equity. A deferred tax asset is recognized only to the extent that it is probable that future taxable income will be available against the assets which can be realized or utilized. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefi t will be realized.

(v) Provisions and contingent liabilities Provisions are recognized for liabilities of uncertain timing or amount when the Group has a legal or constructive obligation arising as a result of a past event, it is probable that an outfl ow of economic benefi ts will be required to settle the obligation and a reliable estimate can be made. Where the time value of money is material, provisions are stated at the present value of the expenditure expected to settle the obligation.

Where it is not probable that an outfl ow of economic benefi ts will be required, or the amount cannot be estimated reliably, the obligation is disclosed as a contingent liability, unless the probability of outfl ow of economic benefi ts is remote. Possible obligations, whose existence will only be confi rmed by the occurrence or non-occurrence of one or more future events are also disclosed as contingent liabilities unless the probability of outfl ow of economic benefi ts is remote.

(w) Related parties (i) A person, or a close member of that person’s family, is related to the Group if that person:

(1) has control or joint control over the Group; (2) has signifi cant infl uence over the Group; or (3) is a member of the key management personnel of the Group or the Group’s parent.

(ii) An entity is related to the Group if any of the following conditions applies:

(1) The entity and the Group are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).

(2) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).

(3) Both entities are joint ventures of the same third party.

(4) One entity is a joint venture of a third entity and the other entity is an associate of the third entity.

(5) The entity is a post-employment benefi t plan for the benefi t of employees of either the Group or an entity related to the Group.

(6) The entity is controlled or jointly controlled by a person identifi ed in (i).

(7) A person identifi ed in (i)(1) has signifi cant infl uence over the entity or is a member of the key management personnel of\ the entity (or of a parent of the entity).

EXHIBIT 6.4 (Continued) dou62206_ch06_232-299.indd 256dou62206_ch06_232-299.indd 256 23/12/13 4:11 PM23/12/13 4:11 PM Comparative Accounting 257 Close members of the family of a person are those family members who may be expected to infl uence, or be infl uenced by, that person in their dealings with the entity.

(x) Segment reporting Operating segments, and the amounts of each segment item reported in the fi nancial statements, are identifi ed from the fi nancial information provided regularly to the Group’s chief operating decision maker for the purposes of allocating resources to, and assessing the performance of the Group’s various lines of business.

3. CHANGES IN ACCOUNTING POLICIES The IASB has issued a few amendments to IFRS that are fi rst effective for the current accounting period of the Group. None of the developments are relevant to the accounting policies applied in the fi nancial statements for the years presented. The Group has not applied any new standard or interpretation that is not yet effective for the current accounting period. The Chinese government has been active in developing accounting standards in harmony with international accounting standards due to self-motivation and external pressure. However, it has retained a uniform accounting system in the Enterprise Accounting System, issued in 2000 to accommodate the special circum- stances of a transforming government, strong state ownership, a weak accounting profession, a weak equity market, and the inertial effect of accounting tradition and cultural factors. 30 At the end of 2009, the Ministry of Finance provided guidance on how to fur- ther improve fi nancial reporting quality, which included fi rst-time adoption of IFRS, appropriate use of professional judgment, elimination of the difference be- tween A-share and H-share listed fi rms, and adoption of “other comprehensive income.” GERMANY Background After the Second World War, Germany was divided into American, French, British, and Soviet zones of occupation. In 1949, the Federal Republic o\ f Germany was created out of the western zones, and the communist-led German Democ\ ratic Republic was established in the Soviet zone. After reunifi cation in October 1990, Germany became a federal republic composed of 16 Länder (states): 10 from the former West, 5 from the former East, and Berlin, the capital city. The c\ onstitution provides for a president, elected by a federal convention for a fi ve-year term; the Bundestag (Lower House) of 667 members elected by direct universal suffrage for\ a four-year term of offi ce; and the Bundesrat (Upper House), composed of 69 mem- bers appointed by the governments of the Länder in proportion to their popula- tions, without a fi xed term of offi ce.

There are eight stock exchanges in Germany: Berliner Börse, Börse Hamburg, Börse Hannover, Börse München, Börse Stuttgard, Börse Düsseldorf, Eurex (Frankfurt-based), and Frankfurt Stock Exchange (FSE). The origins o\ f the FSE go back to the ninth century. By the sixteenth century, Frankfurt had developed into 30 J. Z. Xiao, P. Weetman, and M. Sun, “Political Infl uence and Coexistence of a Uniform Accounting System and Accounting Standards: Recent Developments in China,” Abacus 40, no. 2 (2004), pp. 193–218. dou62206_ch06_232-299.indd 257dou62206_ch06_232-299.indd 257 23/12/13 4:11 PM23/12/13 4:11 PM

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