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The past, present, and future of auditing in China.

China opened its doors to foreign investment in the 1980s, during the leadership of Deng Xiaoping. During this time, key events influenced the evolution of auditing in China and shaped many aspects of today's profession. An understanding of this recent history can help CPAs lay a foundation for a deeper and more thorough understanding of China's present-day auditing profession.

Today, that profession is well on its way toward achieving convergence with international standards. The Chinese leadership has begun to speak about China gaining more influence in the global auditing arena The devil is in the details, however, as the profession comes to grips with applying the requirements of international standards in China's dynamic and diverse environment China's audit oversight bodies remain independent and structurally free from any connections to the profession--a sign of good audit regulatory practice, recognized by international audit regulatory communities. Yet, much work still remains to address the complexities of such a structure in order to deliver the efficient and effective auditor oversight that Chinese authorities have set out to achieve.

A Look Back in Time

When China opened its doors to foreign investment in the 1980s, companies from Hong Kong and Taiwan reacted quickly in order to seize potential commercial opportunities. They made their way into China and soon became major players, largely by forming joint ventures with local affiliates, setting up factories, and entering into commercial arrangements to export Chinese-made goods overseas. Rapid market growth and an increase of commercial activities generated a local demand for accounting and auditing services; in turn, this resulted in a renewed focus on building a national auditing profession. Prior to this, there had been little development of China's auditing profession.

Chinese authorities needed a quick solution to meet the demand in the capital market for audit know-how--particularly demand generated by foreign companies that had started new ventures in China. The Chinese government's intermediate response was to look to the global accounting network firms to fill the skills gap; thus, it permitted the Big Four to operate in China, cooperatively with firms affiliated with China's Ministry of Finance (MOF). In most cases, the Chinese affiliates of the global accounting networks were established by the firms' Hong Kong affiliates. These arrangements were referred to as Sino-foreign cooperative accounting firms. The Chinese authorities set an operational period of 20 years for these arrangements; it was thought that, after 20 years, such joint-venture firms would be ready to become local Chinese accounting firms.

As a result of these events, the relationships between the Chinese authorities and the Hong Kong affiliates of the global firms went beyond that of business partners. Not only did Hong Kong auditors help fill the skills shortage in China; they also provided auditing knowledge and technical expertise that China needed to develop within its own auditing profession. Access to such expertise spurred the local growth of Chinese auditing profession. Among other things, it introduced Chinese standards setters and regulators to international standards. By responding to the auditing skills shortage in China at that time, the Hong Kong auditing profession contributed significantly to shaping today's auditing landscape.

Chinese audit professionals from foreign jurisdictions also responded to the demand for their skills in China. Being ethnic Chinese, these individuals' language skills gave them the competitive advantage of communicating effectively with their mainland counterparts and being in sync with the local cultures. Thus, to a large extent, foreign ethnic Chinese audit professionals also contributed to the growth of the auditing profession.

Signs of Progress

In October 1993, the Law of the People's Republic of China for CPAs was passed--a groundbreaking piece of legislation enshrining the accounting profession's role in fostering the growth of companies and ensuring the stability of China's capital. Numerous other laws also stipulated the roles of Chinese CPAs, such as the China's Company Law, Securities Law, Law on State-Owned Enterprises, and Commercial Bank Law.

China's auditing profession has made notable progress as Chinese regulators continue to focus on building the profession's capabilities and competencies. In 2012, as planned, the Sino-foreign cooperative arrangements expired. Under the directive of the MOF, these joint-venture firms converted into special general partnerships (SGP), a new legal form created by the MOF specifically for the Big Four Sino-foreign cooperative accounting firms, in recognition of their unique historical development and circumstances (Caikuai, No. 8, "Notice on Issuing the Scheme on the Localized Restructuring of SinoForeign Cooperative Accounting Firms," 2012).

To take on the SGP structure, the firms must meet specific requirements relating to the proportion of partners who are Chinese-qualified public accountants and partners who are foreign-qualified public accountants. Contrary to what has been portrayed in the media, such a requirement is targeted at regulating the qualifications and licensing--not the nationality--of public accountants. Similar requirements are also common in many other jurisdictions. Commenced in August 2012, the conversion process for the firms is now complete.

Despite this, the effects of the evolution of China's accountancy profession are still felt today. Beginning in 2006, the Chinese Institute of Certified Public Accountants (CICPA) has held the annual Cross-straits, Hong Kong S.A.R. and Macau S.A.R. Accounting Profession Conference. The conference is supported by the Federation of CPA Associations of Chinese Taiwan, the Hong Kong Institute of Certified Public Accountants (HKICPA), and the Union of Associations of Professional Accountants of Macau. This key event provides a platform for dialogue among accounting professionals in mainland China, Hong Kong, Macau, and Chinese Taipei. Well attended by leaders of the various bodies of the accountancy profession, the conference aims to do the following:

* Enhance the economic cooperation of the four cross-strait jurisdictions by deepening exchanges and cooperation of the local accounting professions; the jurisdictions cooperate and actively work toward achieving convergence with international professional standards

* Promote the convergence and mutual recognition of the professional standards of the four cross-strait jurisdictions, with the larger objective of enhancing collective economic competitiveness

* Strengthen dialogue and coordination between the four cross-strait jurisdictions, with the greater objective of building the foundation for participating and influencing the formulation of international standards at the global level.

Down the Path of International Convergence

Given China's growing importance on the world's stage, Chinese standards setters and regulators decided upon the merits of adopting international standards. Chinese authorities effectively achieved convergence with IFRS in 2006 ( -and-Speeches/Pages/China-affirms-commitment-to-converge-with-IFRSs.aspx). Efforts to achieve convergence with International Standards on Auditing (ISA) began in 2005 and reached fruition in 2010 ( 2010-11 /chinese-auditing-standards-boardand-intemational-auditing-and-assurance-standa). Furthermore, convergence with the International Code of Ethics for Professional Accountants was completed in 2009 ( 201208ChinaCICPA.pdf).

In the late 1990s, prior to its convergence efforts, China had become a member of the International Federation of Accountants (IFAC) and Confederation of Asian and Pacific Accountants (CAPA) (http://www 38000.html). It currently has representation on key international regulatory and standards-setting bodies, including the International Organization of Securities Commissions (IOSCO), the IASB, the International Auditing and Assurance Standards Board (IAASB), the International Organization of Supreme Audit Institutions (INTOSAI), IF AC and committees, the International Integrated Reporting Council (1IRC), the International Valuation Standards Committee (IVSC), and the World Bank.

Having taken these steps, the challenge that lies ahead is for China to establish a structure for ongoing monitoring and improvement of the standards as it gains a better understanding of how they are used in practice. In general, auditors grapple with understanding and complying with accounting and auditing requirements; the need to concurrently juggle China's business environment and local cultures makes this even more challenging. Consequently, the profession demands more detailed interpretations and guidance. China has historically been a rules-based society; as such, professionals, businesses, and society at large are highly dependent upon direct guidance and interpretations from governmental authorities, and this extends to China's regulatory framework as well.

Alongside the adoption of international standards, Chinese authorities have also encouraged local accounting firms to focus on the development of their practices. In its 2011-2015 strategic plan, the CICPA indicated that facilitating the internationalization of local accounting firms is one of its strategic objectives. In working to achieve this goal, the CICPA is encouraging local accounting firms to join global accounting networks.

Audit Licensing

Audit firms in mainland China are required to be licensed by the MOF and the relevant provincial governmental finance departments. Firms that undertake audits of fisted entities must also obtain a license from the Chinese Securities Regulatory Commission (CSRC). Registration requirements for firms include criteria relating to registered capital investment, the number of CPAs, and scope of business operations (see Exhibit 1). Provincial CPA institutes issue licenses for individual auditors. CPA licensing requirements include a qualifying examination, held nationally and administered by the CICPA, and work experience requirements.

For non-mainland China accounting firms, a temporary license from MOF is required to perform audit work in China. China-based accounting firms are prohibited from cooperating or sharing working papers and other information with non-mainland China accounting firms that do not have a valid license. The licenses normally have a validity period of six months, with the exception of Hong Kong (five years), Macau (five years), and Taiwan (one year). In terms of scope, the licenses only cover the firm's existing audit engagements and do not extend to new audit engagements. Any changes in circumstances need to be reported to the MOF, which has imposed reporting obligations for license holders and possesses inspection powers. Licensees are required to comply with China's laws and regulations, including state-secrets laws, such as the following:

* Accounting records of Chinese companies are prohibited from being taken outside of China.

* Information obtained may not be shared with third parties outside of the provisions of the temporary license.

* Where the MOF has signed regulatory cooperative agreements with foreign audit regulators, matters regarding regulatory procedures and audit working papers access will be dealt with in accordance with the agreements in place.

The MOF may impose penalties on licensees for noncompliance, including a prohibition from applying for a temporary license for five years.

Audit Oversight Frameworks

Mainland China has a tripartite audit oversight framework that consists of the MOF, the CSRC, and the CICPA. All of these bodies have oversight responsibilities for the auditing profession and the power to inspect accounting firms. The MOF has the power to inspect companies and require auditors to provide audit documentation for the companies under inspection, as deemed necessary for purpose of the inspection. The CSRC has the ability to inspect companies listed on mainland China's stock exchanges and the accounting firms that perform audits of those listed companies. Unlike in many other jurisdictions, the CICPA, although a professional accounting body, is a government entity that operates under the auspices of the MOF; it has inspection powers over mainland accounting firms. In Chinese Taipei, the independent Financial Supervisory Commission (FSC) has responsibility for audit oversight, and in Macau, the Financial Services Bureau's Committee for the Registry of Auditors and Accountants plays this role. Only Chinese Taipei is currently a member of the International Forum of Independent Audit Regulators (IFIAR), composed of independent audit regulators from around the world. IFIAR members are committed to sharing knowledge on the audit market and independent audit regulatory activity, as well as promoting collaboration and consistency in regulatory activity.

This structure is similar to many other jurisdictions, including the United States, the United Kingdom, Australia, and Japan, where the responsibility for audit oversight lies with a body that is independent of the profession. Although mainland China, Macau, and Chinese Taipei all have audit regulators that are structurally independent from the profession, Hong Kong stands in stark contrast to this. There, the auditing profession's self-regulatory framework has remained unchanged for a period of time, with the HKICPA holding oversight and discipline powers over the audit profession. An independent government agency, the Hong Kong Financial Reporting Council (HKFRC), was established in 2006 and tasked with investigating possible auditing and reporting irregularities in relation to listed entities; however, registration, inspection, and disciplinary powers over the profession continue to mostly reside with the HKICPA.

On the securities market front, the Securities and Futures Commission (SFC) has regulatory powers over fisted companies in Hong Kong. The SFC can command auditors to furnish working papers to assist in its investigations of companies. The Hong Kong government is currently considering changes to its audit regulatory framework in order to better align with international norms. An Information Paper was issued in October 2013 with proposals for changes in an attempt to stimulate public debate. (See communications/regulatory-framework for more information.)

The Profession in China Today

As of December 2013, there were approximately 99,000 practicing CPAs and 8,100 accounting firms in China ( 30207_40210.html). The profession served a nation of over 1.3 billion people, accounting for trade volume of more than $3.8 trillion ( This equals one CPA for about every 13,000 people, and one accounting firm for every 160,000 people. As of December 2013, there were 40 accounting firms licensed to audit fisted companies in mainland China (http://www. Big Four accounting firms made up only about 5.4% of total audits of companies listed on Chinese stock exchanges as of 2012, according to the authors' sources. The number of accounting firms in China licensed to provide audit services for H-shares--that is, Chinese companies listed in Hong Kong--was far lower as of January 2011, at only 12 (http://www.csrc.

In the eyes of Chinese regulators, only these handful of firms are sufficiently competent to perform multijurisdictional audits. In contrast, in the United States, there are more than 600,000 practicing CPAs (http ://www. aganycap. org/newsletters/ newsletter_sept_oct_2006.pdf) and more than 40,000 accounting firms (http://www., serving a nation of more than 300 million people and accounting for trade volume comparable to China in 2012. This equals one CPA for every 500 people and one accounting firm for every 7,500 people. These differences are staggering. Investors should be well aware of them and consider their implications on the quality of financial reporting and audits performed for the Chinese companies they are looking to invest in.

The Importance of Good Corporate Governance

High-quality audits in China cannot be achieved just by focusing on developing China's auditing profession; rather, this goes hand-in-hand with building a foundation of good corporate governance and high-quality financial reporting in Chinese companies. This principle needs to be firmly imprinted in China's blueprint for nurturing and promoting its accounting and auditing professions. Importantly, companies need to build up the resources necessary to implement and monitor effective corporate governance. Such a structure should be supported by a tone at the top that emphasizes high-quality financial reporting. At the same time, initiatives are needed to educate the capital markets and investors on how important it is for companies in which they invest to focus on good corporate governance. In order for good corporate governance to become a permanent feature of Chinese companies, the demand for such best practices needs to be driven by the market.

In the authors' opinion, the immediate next step for China's regulatory community is to focus in developing a skilled and competent accounting profession. This is fundamental to ensuring high-quality financial reporting in Chinese companies. It is urgent for regulators to make progress on this task, rather than devoting even more resources to auditing reforms.

Len Jui, CPA, CGMA, is a partner with KPMG China and head of public policy and regulatory affairs. Jui is currently a member of the China Auditing Standards Board, and he is also technical adviser to China's member on the IF AC Board and to China's member on the IAASB. He was formerly an associate chief accountant at the SEC. Jessie Wong, PhD, CPA, is a director, also with KPMG China, public policy and regulatory affairs. Wong is currently a member of the Chinese Institute of Certified Public Accountants' international standards task force. She was formerly a senior technical manager at the IAASB and a policy adviser at CPA Australia.

Criteria for Chinese Audit Firms

Criteria to Qualify to Perform      Criteria to Qualify to Perform
Audits of Listed Entities in        Audits of H-Share Entities

* Net assets: greater than RMB      * Possess license to audit listed
[yen] 5 million, up from RMB        companies
[yen] 3 million
                                    * Total revenue: greater than RMB
* Annual revenue: greater than      [yen] 300 million
RMB [yen] 80 million, up from RMB
[yen] 16 million                    * Total audit revenue: greater
                                    than RMB [yen] 200 million
* Number of CPAs: 200, up from 80
                                    * Total revenue for securities
                                    engagements: greater than RMB
                                    [yen] 50 million or greater than
                                    30 listed audit clients

                                    * Number of CPAs: greater than

RMB = Chinese Yuan Renminbi
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Title Annotation:News & Views: international auditing
Author:Jui, Len; Wong, Jessie
Publication:The CPA Journal
Geographic Code:9CHIN
Date:Feb 1, 2015
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